In the US Tax Court decision - Paul D. Garnett and Alicia Garnett v. Commissioner – rendered in June of this year, the court ruled that farmers who hold business interests in limited liability companies (LLC) and limited liability partnerships (LLP) are not passive investors.  This is a great victory for many farmers and entrepreneurs that own various farm and business interests.

Background

The popularity of the LLC and LLP have increased greatly in recent years.  For almost all of our farm clients, we recommend that the ownership of the land be held in a LLC or LLP.  These entities give you the legal protection of a corporation without the double tax of a C corporation or the extra potential liquidation tax of a S corporation.

This means that if the LLC is sued for business debts, the risk is to the assets of the LLC, not the home or other assets held by the members of the LLC.

The IRS has argued that the passive activity limitations automatically apply to these types of investments.  If the business activity is classified as passive, then you can only offset passive losses against other passive income.  Any excess is carried forward and can not be used to offset wage or business income.

The IRS has various tests to determine if your operation is passive or not.  Most rental real estate and limited partnership interests are presumed to be passive.

Facts of the new case:

A farm couple located in Nebraska owned either directly or indirectly seven limited liability partnerships, two limited liability companies and two tenancies in common.  These entities were involved in the production of poultry, eggs and hogs and it appears the farm was located in Iowa.  Under the LLC agreements, all partners were treated as active participants in the farm operations, however, the LLC agreement limited these responsibilities to a general manager.  All of the LLP and LLC were registered and operated under Iowa state law.

The couple claimed over $300,000 of losses from these operations.  The IRS disallowed the losses by claiming they were passive losses since the members were considered to be limited partners.

However, the Tax Court overruled the IRS.  The court stated that the limited partners in a limited partnership are considered to be passive investors since they are not allowed to materially participate in a business.  With respect to LLC and LLP members and partners, the Court ruled that under state law, the members are allowed to materially participate in the management of the company.  This would allow the members to deduct their losses.

Farmer’s Impact:

This means that if you are currently treating farm operations held in LLC interest as being passive, you may want to consider amending your income tax returns and deducting these losses as regular losses.  This would allow you to offset these losses against any other income that you have.  You can amend any 2006, 2007 and 2008 tax returns and you may be able to amend 2005 tax returns if you had filed for an extension.

Also, for any new investments that you make in farm operations with other farmers or investors, using a LLC or LLP will generally make these a material investment unless your fact pattern reflects otherwise.

Remember that this court case referenced operating LLC and LLP.  They did not involve only the rental of farm land which could still be considered passive.

In any case, make sure to discuss this with your tax advisor to see if this court case applies to you.

I know my readers are probably getting tired of me writing about the ACRE program, however, I think it is very important for you to review how it affects your farm operation and your landlords.  Marcia Zarley Taylor at DTN has several good postings on how the ACRE program works and how to communicate it to your landlord.

I suggest that you read her postings to get up to speed if you are not yet there.

Also, the National Corn Growers Association has a very good 4 page summary of how to communicate ACRE to your landlords.   Remember that as a tenant operator, you must have an agreement from your landlord to enroll in ACRE.  Since many of your landlords may be in the 70′s or 80′s, explaining this to them may be very hard to do.

I find that it is hard for me to completely understand the program and I am a CPA, so I also would think it is very hard for most landlords to understand.  I think to properly communicate this program to your landlords, I would try to work up a three or four page graphical presentation that shows how it would affect their bottom line under three scenarios.

First scenario would show the effect of never getting an ACRE payment over the next four years.  For corn, this would probably cost the farm operation about $20 per acre.  The cost to the landlord would be based upon your split of these payments.

The second scenario would show the effect of getting a decent ACRE payment in one of the next four years.

The last scenario would show the effect of getting two ACRE payments with one being a larger payment based upon lower prices.  The report from the National Corn Growers Association has already done the calculations for you, so you only need to recap this in a nice report for you and your landlord.

Remember, you only have until August 14, 2009 to sign up for the ACRE program.

There is now less than 3 weeks to make your final decision on signing up for the ACRE program.  You have until August 14, 2009 to sign up for the 2009 season which will lock you into the program through 2012.

There are many sites out there that have a review on how the program works.  One of the better sites is the Kansas State University Ag Manager.  Troy Dumler has written a series of articles updating the ACRE program over the last few months.  These articles are both in a paper format and an Excel spreadsheet to help you make your decision.

My personal feeling on the ACRE program is that I think there will be at least one payment over the next four years which will probably give you a break even return (especially on corn).  If there ends up being only one year of ACRE return, you would most likely break-even on the decision.  If there is more than one year of ACRE payments, you will be much better off with the ACRE program.  If there is no ACRE payment, you will lose about $2-$5 per acre per year in farm programs for corn, soybeans and wheat.

My bottom line is that I would probably sign up for ACRE since the 90% of previous year’s revenue gives you a floor that I think will be triggered at least once over the next four years.

We have several farm clients in Washington and Oregon that either are getting royalty checks from wind turbines or will be getting these checks in the near future.  In many cases, the income from wind turbines is substantially higher than the income from traditional farming.

In many cases, one turbine can generate in excess of $5,000 or royalty income per year and many are higher than this number.

The American Wind Energy Association recently gave their report card on how the industry is meeting its goal of providing 20% of the USA’s electricity by 2030.  Their overall grade was a B.  The major report card subjects were:

Technology – Grade A-

Turbine productivity has increased substantially over the last several years.  There are many towers now that are over 320 tall with the rotor diameters in excess of 300 feet.  These sizes allow the turbines to use the wind better and some of them are producing 3 mega-watts.

Manufacturing – Grade B+

Over 55 new facilities have either come online, were announced or expanded in 2008.  The domestic manufacturing content is approaching 50%, however, with out help from the government on regulations, etc., it may be difficult to exceed this number over the next few years.

Transmission & Integration – Grade C-

This is the biggest bottleneck for reaching the 2030 goal.  It is far easier to produce the power than to get it to the people and industries that can use.  Until this is fixed, there is no way the 2030 goal can be met.

Siting – Grade B

This area continues to improve with education of the public.  However, there is no national process for siting and almost all of the siting process is on the local and regional level.  This may be a good thing, however, to meet the 2030 goal, this may need to be streamlined.

 Some fun wind farm facts:

Texas is the number one state with current power capacity of 7,907 MW (mega-watts).  Number 2 is Iowa, with California, Minnesota, and Washington rounding out the top 5.

During 2008, the wind industry installed 8,500 MW of capacity bringing the total to 25,300 MW.

The top five potential wind states of North Dakota, Texas, Kansas, South Dakota and Montana could produce enough electricity to provide all of the electricity that the US is currently producing.

This is another one of my posts that is not directly related to farming.

When I was growing up on the farm, I was a great fan of Arnold Palmer in my very early days, however, when Tom Watson came on the scene I became a great fan of his.  He is from the Kansas City area and shows that great Mid-western humility and friendliness.

He is currently in first place at the British Open at the end of the third round.  If he wins tomorrow, he will be the oldest player to win a major by at least 10 years.  Also, I am not sure, but I have a feeling he is the oldest player to ever lead a major after the third round.

All I can say is GO TOM

At the Leading Edge Farm Conference held in Des Moines, Iowa this week, Drew Lerner of World Weather, Inc. gave a very informative talk on the current and future weather trends.

Some of the discussion focused on the Sun Spot activity over the last several hundred years.  In periods of lots of Sun Spot activity, you will normally see higher temperatures and with less activity, lower temperatures.  These cycles tend to repeat about every 12 years.  The peak Sun Spot activity was about 25 years ago and it usually takes about 25 years for this peak temperature to show up. 

Based on this, our temperature may have peaked last year and we may have lower temperatures over the next several years.

I think we need to remember that the Sun provides probably 99.99999999% of our heat and global warming may be more related to Sun Spot activity than mankind’s actions.

We shall see.

Also, based upon Drew’s analysis, we may have an El Nino effect coming on which might lead to lower temperatures and less rain in the corn belt this fall and winter.

Most farmers know that they can hedge their corn, wheat or beans (or about any other agricultural commodity) using various types of futures contracts.  You can use the regular contract, options – both calls and puts, spreads, etc.

However, many farmers do not know that they can hedge their operating loans interest rates using LIBOR futures.  The Top Producer site has a quick good article on how this might work.

I believe that short-terms rates are about as low as they can get right now and it might be very prudent locking in your operating loan rate for 2010 or 2011 at a fairly nominal cost.

 For many farmers, the new Average Crop Revenue Election (ACRE) program is about as easy to understand as learning a new language for the first time.  I have read several articles and listened to a couple of slide shows on the program.

You have until mid-August to make up you mind regarding the election for this year which will lock you in until 2012.

 At the FarmDoc site, they have a very good slide show that lasts about 20 to 30 minutes that gives a good synopsis of how the program will work.  Based upon their analysis, over the last 31 years, farmers growing corn would have had ACRE payments in about 10 of the 31 years.  This average payment would have been about $53 per acre.  Electing ACRE would cost you about $5 per year, so getting a $53 payment every three years might be a good deal.

For growing soybeans, the ACRE program would have resulted in an average payment of $37 per acre for only 5 out of 31 years.  For soybeans, the benefit of the ACRE program appears to be much less than corn. 

Also, with the higher corn and soybean prices for 2007 and 2008, these numbers may be actually higher since there is a 10% cap on the increase or decease in the revenue targets.

I think for many farmers this may be a very good put insurance on your crop.  There is no excuse for not understanding if it will work best for your farm.  You can elect this coverage on a farm by farm basis.

Summary:

Delayed corn plantings have allowed pre-plant forms of nitrogen to dissipate, leaving many fields with wide variations in their need for supplmental nitrogen applications.  One potential solution is tractor-mounted sensors which detects the amount of greenness in corn and reveals whether there is sufficient nitrogen or it needs additional side-dress application and the amount to apply.  Such a process may require a capital outlay for sensors and the controller, however, it may result in significant returns to the farmer in not having to apply nitrogen to areas where there is sufficient supplies already.

Details:

The late harvest of 2008 caused many farmers to run out of time before they could get any fall plow down nitrogen on their 2009 cornfields.  Then came a wet spring that prevented spring nitrogen applications for many farmers.  In the meantime, nitrogen was lost in millions of acres because it dissipated while corn planters were kept out of the field by incessant rain.

Missouri Extension agent, Peter Scharf indicates the solution may be to use sensor-guided sidedressing.  In a nutshell, nitrogen is applied between corn rows with an appropriate volume based upon the color of the corn leaves.  If the corn has a deep green color, then very little nitrogen is applied.  If the color is more yellow, then more nitrogen is applied .  A corn grower will save money by not applying nitrogen where there is already a sufficient amount of nitrogen.

 Scharf indicated that for 2008, corn that was side dressed with nitrogen out-yielded pre-plant nitrogen by about 44 bushels per acre.  At $4 corn, that is extra revenue of about $176 per acre which would more than pay for the side-dressed nitrogen.  With the warm soils and continuous rainfall in 2009, much of the pre-plant nitrogen for 2009 may have already leached out.  With soil and ponding variations in a given field, Scharf says the nitrogen available to the new crop could be widely variable and late planted corn may not be capable of rapid uptake until July, with additional losses of nitrogen expected.

Side-dressing using sensors will most likely incur an upfront cost of about $15-20,000 for the sensors and related controller.  This type of application is not good for just adding 30 additional pounds per acre, but works best when you need to a add “a little, a medium amount or a lot”.

With new nozzle technology, farmers can now get up a four-fold increase in pressure for applying liquid nitrogen.   Without that, your equipment may only allow a doubling of the pressure between the bottom and top rates of application and this would not be enough to maximize your return.  With dry application, changing the rate of applicaiton only requires the speeding up or down of the delivery belt and spinners.

Scharf believes that only three sensors are needed before you start the point of diminishing returns.  Some suppliers only sell them in packs of 4 or 6 and the newsletter addresses several different supplies of the sensors and related equipment.

During the late 1990′s and early 2000′s I was a part owner of a plastic packaging company.  We had always used a costing mechanism that relied upon standard costs and return for various products.  This usually resulted in accurate information except when the cost of the product got too high.

In many cases, we would have a product with a very large material cost and many of our managers did not want to produce the product since the percentage return was much lower than many of our other products. 

 However, after showing them what the bottom line return to the company would be on a per hour basis (almost all of our machinery returns were based upon an hour of production), these managers came to understand that the bottom line return to the company per hour of machine time was much more important than the percentage return.

This brings us to farming.  Many times, as a farmer, we want to minimize our cost of production, when in fact, we should try to determine what the bottom line return to the farm will be, not the lowest production cost.

The University of Illnois has produced their crop budgets for 2009 for corn, soybeans and wheat.  These budgets show what various farmers in Illinois have as a 2009 farm budget .  If you tried to minimize your cost of production, you would most likely either plant soybeans or wheat, however, the return for soybeans is actually less than the return for corn and planting wheat is budgeted to result in a loss.

Corn is most cases will cost the most to farm, but has the highest chance of returning the most to the farmer on a per acre basis.  This is what I call High Cost- High Return versus Low Cost – No Return.  Make sure that you are checking your budgets each year to determine what should provide the most to your bottom line.

There are many good spreadsheets at this site to help you with your farming decisions.  Farmers in other states should be able to use these budget tools and simply put in their respective numbers to come up with a good budget.