The Self-Employment (SE) tax rules for 2011 tax returns are different than the rules for 2010 tax returns, which were different than the rules for 2009 tax returns.

The Job Creation Act of 2010 reduced the Social Security tax component of the SE tax from 12.4% to 10.4%, for 2011 only.  Therefore, the SE tax rate on the first $106,800 of 2011 net SE income is “only” 13.3% (10.4% for FICA and 2.9% for Medicare) versus the normal 15.3%.  Since the temporary SE tax reduction only affects the first $106,800 of 2011 net SE income, the maximum amount that a farmer can save is $2,136 ($106,800 times 2%).

What you may not know is that the 2011 above-the-line federal income tax deduction (most states allow the deduction also) remains unchanged.  Before 2011, the deduction was a straightforward 50% of the SE tax bill.  For 2011, the deduction equals 57.51% of the SE tax amount, as long as the amount does not exceed $14,204 (the SE tax on $106,800 of net SE income).  If the SE tax exceeds this amount, you multiply it by 50% and add $1,067.

The effect is to allow a SE tax deduction equal to 50% of what the SE tax bill would have been if the Social Security tax component was the normal 12.4% (instead of the temporary 10.4%).

There has been an extension of this until February 29, 2012 and it may get extended, but we are dealing with Congress on this subject and who knows what will happen.

Also, one additional comment is that the self-employed health insurance premiums allowed as a deduction against SE income for 2010 in arriving at net SE tax owed has been eliminated for 2011.  This means that your SE tax bill will be higher this year than 2010 assuming the same amount of health insurance premiums.

Many of our clients operate their farm operation as either an S or C corporation and in many cases the only employee of the corporation is the farmer and perhaps their spouse and children.  Many of these farmers do not report any wages to them until the fourth quarter of the year.  In these cases, the wages reported in this quarter can easily exceed $20,000.

What many farmers do not realize is if the wages reported for any quarter exceed $20,000, the corporation is now subject to paying Federal Unemployment taxes (FUTA) and in most cases state Unemployment taxes (SUTA).  Although FUTA can be fairly minor (perhaps $42 per person), it can increase to around $400 per person if SUTA is no handled or paid correctly.

In many states, once you are subject to SUTA it can take a minimum of two years to get out of paying it since it requires you to be under the $20,000 quarterly threshold for the current year and the previous year.  Also, these states usually require you to be in the highest rated pool and your tax rate can exceed 3.5% and you would owe SUTA on up to $35,000 in wages or more.

Let’s look at an example, assume the farmer pays himself $50,000 per year in wages all in the fourth quarter.  Let’s assume his SUTA rate is 3.5% on the first $35,000 of wages.  His SUTA liability would be $1,225.  His normal FUTA liability would be 6% of $7,000 or $420, however, since he paid into the State, he is allowed a credit to reduce this liability down to $42 (some states do not get the maximum credit.  We recapped that in a post about two weeks ago).  Therefore, his total SUTA and FUTA liability for 2012 is $1,267.

Now, if the farmer has spread out his wages evenly over the four quarters, he would not owe any FUTA or SUTA.  Also, the payment of commodity wages is exempt from FUTA and SUTA (although you need to check your state rules).

Every state seems to have different rules on the application of SUTA to shareholders of a corporation, but at a minimum if you keep your total wages under $20,000 per quarter, you can save some payroll taxes.

Creighton University produces a Rural Main Street Index based upon a survey of rural bankers in six states, Colorado, Iowa, Minnesota, Nebraska, South Dakota and Wyoming.  The index ranges from 0 to 100.  Anything over 50 is considered in an expansion mode. 

For January, the index rose to 59.8 from 59.7 in December which is the highest it has been since June 2007.

Here are some other trends from the survey:

• Bankers expect average farm input costs to rise by 7.2% in 2012
• 9 of 10 bankers do not expect the end of the blender’s tax credit to have a significant negative impact
• More than one in four bankers indicated that a decline in agriculture commodity prices is the biggest economic challenge in 2012
• Almost as many indicated a shortage of jobs and workers was the main economic challenge

After rising to a record level of 84.1 in December, the farmland price index fell almost 12% to 74.3 in January, 2012.  A recap by state is as follows:

• Colorado – Dropped from 88.5 to 78.9
• Iowa – Dropped from 77.1 to 68.2
• Minnesota – Dropped from 76.2 to 57.8
• Nebraska – Dropped from 84.6 to 73.5
• South Dakota – Dropped from 69.4 to 60.1
• Wyoming – Dropped from 84.3 to 73.9

These are healthy drops in the index, however, this drop is based on only one month of data and December can very very skewed with certain sales happening for tax purposes.  It will be interesting to see what the index numbers for February are.

It is now apparent when I wrote my post last week on electing out of deferred sales contracts, that my terminology was not the best.  Sometimes when writing these posts, I know what I mean but when transmitting the brain waves to the keyboard, it does not always get put down correctly.

The correction on the post is that a deferred sales contract calls for the delivery and sale of the grain in 2011, however, the payment of the grains sales delivered in 2011 will be deferred til 2012.  If your grain sales contract meets this criteria, then you would normally report the grain sales in 2012 since that is when you collected the funds (assuming a cash basis farmer).

However, you may elect out of this installment sale on a contract by contract basis and report the income in 2011 if you so choose.

I am sorry for the confusion.

We had a reader ask the following question:

“You previously wrote about electing out of deferred farm sales where the farmer could elect to include the income for a March delivery contract into the previous year to increase his taxable income in the previous year. I deferred my payment on my 2011 grain until 1/3/12. Can I elect to show part of this income on my 2011 taxes. ”

When a farmer sells their grain on a deferred sales contract into the next year, they can elect out of the installment method on the grain that is covered by that particular sales contract.  The key point is that they have to elect out of all of the grain covered by the contract or none of it.

In the question, the bushels of grain covered by the contract for delivery on January 3, 2012, all of that grain would have to be reported as income in 2011 if he elects out of reporting it in 2012.  He cannot elect to report part in 2011 and part in 2012.

That is why we suggest having multiple smaller deferred sales contracts so you can pick the best one to defer if you need to.

For example, let’s assume the farmer above had sold 25,000 bushels of corn for $150,000 delivered on January 3, 2012.  He can elect to report all of this income in either 2011 or 2012, but it has to be all in one year or the other.  Now, let’s assume he entered into 5 separate 5,000 contracts at $30,000 apiece.  Under this example, he can elect out of 1, 2, 3, 4, or 5 of these contracts to bring in $30, 60, 90, 120 or $150,000 of income into 2011 if he so elects.  By spreading the contracts this way, he has five times the flexibility than having one contract.

For those farmers who have corporations for their farm operations, there are several changes to the form 1120 for this year.  These changes are as follows:

• Merchant card and third-party payments.  For the 2011 tax year, the IRS has deferred the requirement to separately report on the corporation’s tax return the amount of merchant card and third-party payments from form 1099-K.  These were going to be required to be reported on line 1a of the return.  The instructions now indicate these should be lumped in with all gross sales on line 1b.
• New form 1125-A, Cost of Goods Sold.  For tax years beginning in 2011, filers of form 1120, 1120-C, 1120-F, 1120-S, 1065, or 1065-B are required to use new form 1125-A to report any cost of goods sold.  For most farm operations, this would not be applicable if you report your farm income and expenses on Schedule F, but it may apply to you.
• New Form 1125-E, Compensation of Officers.  If you farm corporation has gross receipts greater than $500,000 and you pay officer compensation, then you are now required to fill out new form 1125-E.
• Change of Address.  Form 8822-B, Change of Address – Business, has been created by the IRS specifically for business use.  In the past, changing the address on form 1120 normally was sufficient, however, now the IRS wants this form filled out for a business change of address.

Although these changes are specifically associated with form 1120, most of the same changes apply to form 1065 for partnerships.  The only one that would not apply is form 1125-E, Compensation of Officers.

Several farm states including Illinois and Minnesota will not be able to claim the full 5.4% credit when filing their form 940 Federal Unemployment tax return this year.  This is due to these states not yet repaying the federal government the funds they borrowed to make state unemployment payments over the last few years.

IRS Headliner Volume 317 has the details on the states and the amount of reduction in the credit.  The painful part is that you also will have to fill out Schedule A as part of the return instead of taking the simple 5.4% credit on the front page of form 940.

I think the Kansas City Federal Reserve is one of my favorite sites to get good farm information.  In a recent issue of the Main Street Economist Agricultural and Rural Analysis, they had an article entitled “Is This Farm Boom Different?”  The article recapped the two primary farm booms of the 20th century.

In the 1910s, World War I ushered in the first farm boom.  In the second half of that decade, U.S. farm exports rose dramatically to meet war-time demand for food and most agricultural prices doubled.  Simultaneously, very low real interest rates allowed farmers to invest rapidly into capital improvements.  Between 1900 and 1919, farm real estate prices rose more than 70%.

The century’s second boom occured in the 1970s when farmland prices soared again.  With President Nixon’s trips to Russia and China, world demand for our farm products increased dramatically.  Even the recession in mid-decade only slowed the rapid rise in farm prices.

The end of both booms were due to two primary factors:

1. A rapid drop in world demand, and
2. An increase in interest rates

Today’s boom is very similar.  World demand for our farm goods has increased dramatically, especially from China.  Interest rates are the lowest they have been since at least the 1960s.  Real US farm income has increased dramatically with 2011 being the first year that farm net income was in excess of $100 billion.

Despite these two similarities, farm capital investment presents a striking difference from the last two booms.  In those booms, farmers took aggressive advantage of low interest rates and expanded their farm operations rapidly with more debt.  In contrast to these past farm booms, non-real-estate investments in agriculture have not soared to the highs of previous farm booms.  In addition, farmers have not used much debt to fuel their capital improvements.

During the 1970s, annual farm capital expenditures surged 71%, as farmers tripled their capital spending on tractors, farm buildings and land improvements.  Even in 1919, farmers more than tripled their spending on tractors and farm buildings as compared to the pre-WWI high.

This debt accumulation in both decades was a critical factor in the bust that happened in the succeeding decade.

As long as farmers continue to avoid the use of massive debt to fund their capital investment, this boom may continue and although we know their will be a correction, it may end up not being a bust.  We shall see.

Every five years the USDA performs an agricultural census of the farms in the US.  The last census was performed in 2007 with this year being the next census.  We have already seen some of the census forms received by our farm clients.

We were curious how many counties in the US had more than $1 billion in farm sales in 2007.  We accumulated the list as follows:

 As you see, California was the most dominant state with twelve counties exceeding $1 billion in farm sales.  California also had a couple of other counties that were very close to the billion dollar level.

Only two other states had at least two counties (1) North Carolina and (2) Washington. 

Our guess is that this list will easily double in the next census to come out later this year.  Several states had at least two to four counties there were in excess of $750 million of farm sales and with the current high prices,we would guess this will push those counties over the $1 billion mark.

We will keep you posted on how the next census numbers end up.

Most farmers are on a calendar year basis for reporting their income taxes and one of the items that came about back in early 2010 is not available until they file their income tax returns for 2011.  This credit is called the “HIRE” credit and is available to any taxpayer who meets the following requirements:

• Hired a new employee after February 3, 2010 and before January 1, 2011,
• The employee was employed for at least 52 consecutive weeks,
• The employee’s wages in the last half of that period was at least 80% of the wages in the first half,
• The employee certified on form W-11 or an equivalent that they were not employed for more than 40 hours in the 60 days before being hired,
• The employee hired was not a replacement of another employee unless they voluntarily left, and
• The employee is not related to you.

If you meet all of these requirements, then you qualify for an additional $1,000 income tax credit that may offset your income tax on a dollar for dollar basis. 

Now is a good time to review your employee’s records to see if you qualify for this credit.