Over the last couple of months I have seen some farm operations that based upon the fair market value financial statements provided appear to have net worth, however, when you factor in the amount of deferred taxes that would be owed if all of the inventories, equipment and receivables were liquidated, the farming operation would go from positive net worth to negative net worth. Some of the extreme examples are a farming business with $25 million of assets, $6 million of net worth, however almost of the farming assets have zero or little income tax basis. If these assets were liquidated and taxes paid at 40% (or higher, almost all of this income is ordinary income), the farm operation would owe about $10 million in taxes and the positive net worth would become negative net worth of $4 million.
Now I know that many farmers say the payment of the deferred taxes will occur several years in the future. However, this assumes the farming operation is showing a profit and as you can see in my example, this operation has a large amount of leverage ($19 million of total debt versus $6 million of net worth). As many farmers have expanded rapidly in the last few years, we are starting to see more situations like our example.
The key is to know your deferred tax liability and have a manageable plan that deals with the liability each year. Although there is that genetic chip implanted in farmers at birth to never pay taxes, in many situations paying some each year is much better than getting with a large liability at once.
If you don't know how to calculate this liability, a qualified CPA should be able to help you with this analysis and it should not take too long. Get started now!