Some of my fondest memories as a child was going to my grandparent’s house for Thanksgiving.  My mother was the oldest of 12 kids and many times we would have 30 to 40 people at the house.  The best thing was my grandmother’s pumpkin and apple pie.  I know if she was still alive and making pies, I would be 20 pounds heavier.

I just want to wish everybody a safe and happy Thanksgiving.

On my last post, I got an e-mail regarding a clarification that the children need to be under age 18 to be exempt from FICA taxes and under age 21 to be exempt from FUTA taxes.

Also, the income that the children earn can affect their financial aid if they elect to go to college and wish to receive financial aid. 

As with any of my posts, you need to check with your tax or financial advisor before implementing any suggestions that you might see on the site.  I hope to help all farmers with their finances, but want to make sure the advice is followed correctly.

While growing  up on the farm with my brother and sister, we worked in spring and fall planting plus doing the summer harvest.  Most of the time, my parents never did pay a wage to either my brother or I, however, they did purchase a car for us and put us through college.  This means that I think we probably earned at least what we were worth, however, from an income tax standpoint, they probably did not maximize their tax savings.

Currently, if you run your farming business as a sole proprietorship (which most farmers do) and have children that help you operate the farm such as my brother and I did, you should consider paying them a wage for this work.  When you pay wages to your children for doing work, many good income tax savings happen:

1. First, any wages that are paid to the children are deductible by you as the farmer. 
2.  Second, if the wages paid to the child are less than the standard deduction (currently $5,700), the wages are completely tax free to the child. 
3.  Third, the wages paid are  not subject to FICA or other federal payroll taxes and are generally exempt for state payroll taxes.
4. Fourth, the wages paid to the child qualify them for either a regular IRA or a Roth IRA.  As we have stated here previously, the sooner you can put money into an IRA, the more money you will have at retirement age.

I plugged into my tax estimator software what the total savings would be using the following assumptions:

1. Married farm couple living in Iowa with 4 children younger than 18,
2. Net farm income of $106,000 before any payments to the children,
3. The children each were entitled to wages of $5,700 for the year,
4. The farmer took the standard deduction.

The total taxes owed for the year with out any children wages was about $28,320.  This includes the federal tax of $5,949, the self-employment tax of $14,977 and the state of Iowa tax of $7,394.  If total kid’s wages of $22,800 were paid during the year, then the total combined taxes would be $20,016, or a savings of $8,304.  This is equal to federal tax savings of $$3,180, self-employment tax savings of $3,221 and state of Iowa tax savings of $1,903.  The net percentage reduction in taxes is about 29%.  This percentage savings would hold true if your farm income before children wages was in the range of about $50,000 up to maximum wage base ($106,800 for 2009).  Once you go over the wage base amount, you self-employment tax savings drop from about 15% to about  3%.  Below $50,000 of farm income with four kids, you are most likely not paying any income taxes and your federal tax savings would be minimal.  However, if these wages would qualify you for the earned income tax credit, then you might be entitled to another $3,000 or so of tax relief.

Remember, the wages must be based upon actual work done and at a rate similar to rate charged for work done in a farm in your area.  You should keep accurate records of the work performed and make sure that you follow all child labor laws for your state and region.  Also, the savings may be less in a state where the wages paid to the child would make the income taxable for that state.

I believe that is by far one of the best income tax savings available to farmers with minor children and also helps provide for their college education.

You will need to make your own calculations regarding your savings.

If you wish, I would gladly run the numbers for your situation.  All you would need to send me is the following information:

1.  Estimated farm income before children’s wages

2.  Estimated amount of wages to be paid

3.  Total other income and deductions if you do not take the standard deduction

4.  State that you live in

5.  Total number of kids and their ages.

The National Agricultural Bankers Conference is meeting in San Antonio, Texas this week.  Marcia Zarley from DTN/The Progressive Farmer has a good overview of what the bankers are talking about. 

Farmers who are in the dairy and pork industry are really feeling the pinch of low milk and pork prices right now.  Many of the farmers are liquidating their assets now since filing chapter 11 or 12 bankruptcies does not make sense.   Under a chapter 11 or 12 bankruptcy, you mut be able to show income to pay off lower levels of debt.  With the current pricing of milk, they can not show any income left over for debt service.  It makes more sense to liquidate and retain what equity they do have.

Most of the dairy industry experts seem to predict that milk prices in 2010 will average closer to $15 to $16 which is up substantially from the $9-$11 range per hundredweight that they have gotten for most of 2009.

“This downturn has damaged the dairy industry so badly that there will be a certain number of dairymen who will never recover, no matter how good prices are going forward” said Curt Covington, senior vice president and agricultural division credit administrator for Bank of the West in Fresno, CA.  The average California dairy lost about $6 per hundredweight through the first half of 2009.  Contrary to past experience, it is the dairy with about 1,000 cows, older facilities and low debt that have weathered the crisis better than the mega-sized operations.

Eastern Pennsylvania with their large concentration of Amish and Mennonite dairy farmers have been extremely hard hit.  I have visited this area with my sons on East Coast trips and I can say this is some of the prettiest farm county in the whole USA.  These farmers have been under assault by the collapse in global protein demand and high feed costs for the last 24 months.  Many of the bankers are urging their farmers to liquidate the farm land while prices are still high.  They can at least net cash, a home and some savings.  However, for many of these farmers, this is their way of life and that may be extremely hard to do.

The key to survival is getting the dairy’s expenses down as low as possible.  Bankers indicate if you can get those expenses under $15-$16 per hundredweight, you may be able to make to 2010 and beyond.  However, if they can not get it under $17, it is better to liquidate now and save what they can.

There is some glimmer of hope in 2010 for the dairy industry, but the worry is can they get there from here.

For 2009, a taxpayer can leave an estate of $3,500,000 tax free to his/her heirs.  They can also leave an unlimited amount to their spouse.  With proper planning, this means that most farm families will be able to shelter $7,000,000 or more in farmland values from the estate tax. 

A benefit that the IRS provides to estates that have a large amount of real estate wealth such as most farmers would have is to allow the estate tax to be paid over a fourteen (14) year period.  For the amount of the estate that is represented by land values, the estate can elect to pay interest only for the first four years and then spread the principal payments over the next ten years.  The first $1,000,000 of tax related to these values is allowed an interest rate of 2% with the remainder at a rate that is still fairly low.

This election does have some drawbacks since the property needs to remain in the family and in production as a farm.  But for most farm families, this is normally the goal.

Please check this election with your estate tax advisor since it may allow you to keep the farm in the family.

After two years of steep increases, it appears that farmland values are either flattening out or starting to drop, according to the Federal Reserve Bank of Kansas City.

For example, Nebraska farmland values fell in the third quarter compared to a the third quarter of 2008 by about 5%.  The regional change was slightly lower at about a 2% negative change compared to last year.

In the third quarter, more District bankers reported weaker farm incomes primarily due to sagging protein demand and a summer decline in prices.  With shrinking margins, livestock producers have been cutting supplies by culling herds and consolidating feedlots.  In response to a special survey, bankers estimated that livestock returns would be about 10% lower than a year ago.

With lower incomes, farm credit conditions deteriorated in the third quarter.  More bankers reported lower loan repayment rates and a rise in loan renewals and extensions.  They expect this trend to continue to at least the end of the year.  However, bankers also indicated rising farm loan demand and they have plenty of money to lend to creditworthy borrowers.

Since farmland valuations spiked in the third quarter of 2008, year-over-year comparisons will show flat increases or moderate decreases.  This trend most likely will continue as long as farm income is lower than the previous year.

In the third quarter, the farm index fell to below 50, which is the lowest since 2003.  Closely tracking this index was the capital spending index, which also reached a survey low.  As you can see from the chart, these indexes peaked out in late 2007 early 2008 at levels which are about three times higher than the current levels.

 These trends need to be watched and make sure you have a good relationship with your banker and it may make sense to have at least another bank in waiting.

Important Message to Readers

In the last few days, it has become apparent that I was not setting up the comments section for my postings.  In most cases, this probably means that you were either unable to make a comment or could not find where to comment or it was just too confusing to post a comment.

I believe that I have fixed this since I am now getting some comments.  I want to stress that I really like getting your comments since they help me decide what you as my readers feels is important or worthwhile to this site.

Please leave as many as you can or want.

I was at a local two hour seminar this morning on how the banking and real estate economies are doing.  Our area here is very much like most of my readers I am presuming.  It is very much agriculturally based and when the boom times in the housing market in 2002-2006 were going on, we were left behind.

However, when the major downturn came, we have not been affected too much yet.  Also, we have had a large amount of federal stimulus money put into the local economy and that seems to be holding up pretty well.  It is creating construction jobs and demand for new housing.

I am curious as to how the economy is in my reader’s area and would welcome any comments which will be posted on the site.

Many farmers do a good job of benchmarking their operations to other operations in the same state of region.  By doing this benchmarking, they are able to see where they are either behind or ahead of other farmers.  Some get discouraged trying to get out of the middle range into the top 20%.  Most think that it is too hard to get there.

What I would like farmers to key in on is what I call the 5 + 5 + 5 = Home Run concept.  This is obtained by doing the following:

• Increasing yields by 5%,
• Increasing the price received for your crop by 5%, and
• Decreasing total costs by 5%.

Lets see how these objectives would apply on a typical farm. 

Lets assume that the average corn yield is 150 bushels with average price of $3.50 per bushel and the farmer has total costs of $2.50 per bushel.  His current net income is equal to 150 bushels times his net margin of $1 equals $150 per acre.

If we increase the yield by 5% to 157.50 bushels, the price to $3.675 per bushel and decrease costs from $375 per acre to $356.25 per acre his total return per acre will equal 157.50 times 3.675 or $578.81 per acre of revenue less $356.25 equals net return of $222.56.  By doing these 5 + 5 + 5 adjustments, the return goes from $150 per acre to $223 per acre or an increase of $73.  This equates to an almost 50% increase in profits.

As you can see, it does not take a large change in the three major production centers to yield a large increase in net income.  I suggest you review your numbers and set these 5% targets and even if you only hit 2 of them, you will be many dollars ahead.  Good luck.

There is a saying in business that a company does not go out of business from a lack of net worth, but from a lack of cash.  An important measure of this “business cash” is to determine your working capital divided by your gross revenues.  The higher this number is, the more “business cash” you have.  Working capital is the “blood” that flows through the business to keep it well lubricated and operating properly.  If you run out of this “blood”, then the business will freeze up and die just like a bearing without the right grease.

Working capital is measured by taking all of your operating assets:

1. Cash,
2. Marketable securities owned by the farm that can be converted to cash quickly,
3. Receivables from the sale of crops and livestock,
4. Inventory of crops and livestock.

From this total you subtract your operating liabilities such as:

1. Accounts payable,
2. Accrued liabilities such as interest, wages, taxes, etc.,
3. Operating lines of credit,
4. Current portion of long-term debt.

Most farmers forget to include the current portion of long-term debt which can dramatically distort your net working capital.  For example, lets take a farm with the following operating assets, liabilities and gross revenues:

• Cash                         $25,000
• Receivables                15,000
• Crops                        175,000
• Accounts payable      20,000
• Operating line           50,000
• Accrued costs            10,000
• Total revenues        400,000

Based on the current information, total working capital is equal to assets of $215,000 less liabilities of $80,000 or $135,000.  This number divided by $400,000 of gross revenues equals the working capital divided by gross revenue ratio of 33.75%.

Most financial advisors would suggest that if this ratio is less than 10%, then the business is in trouble, between 10 to 25% is average and over 25% is very good.  In the case of this sample company, the ratio is greater than 25%, which is very good.

However, lets assume that the farm has financed a bunch of equipment and some land on a fairly short term basis.  For the current year, the farm will be paying off $90,000 of principal on these loans.  How does this effect the ratio.  We would take working capital of $135,000 less the $90,000 of debt being paid equals net working capital of $45,000.  This number divided by $400,000 equals 11.25%.  This number is very close to being marginal.  Make sure to include this number in your working capital calculation.

There are several ways to increase this ratio on your farm.  The key ones are:

• Control your family spending.  If you take all of the net income of the farm to live on, then your working capital will usually erode over time due to inflation.
• Watch your cash capital purchases.  If your working capital ratio is too low, you will most likely want to finance any required equipment purchases over a longer period of time to allow you to build up your working capital.
• Don’t finance equipment with your operating line of equipment.  This decreases your working capital and liquidity and you may not be able to refinance the equipment at a later time.
• Try to set aside some investments outside the farm.  Each month if you can, put money into mutual funds, savings or other non-farm assets.  As these items build up, they provide a cushion for harder times later on.

Most of the wind turbines located in the United States are probably located on farm land or near farm land.  DTN – The Progressive Farmer just posted a recent article on “living in the shadow of wind generators”. 

This posting had several points regarding putting wind turbines on your land.  Some of the key thoughts were:

• It may be a good idea to have legal advice, especially if the attorney has experience in this area.  Many of these leases last for over 20 or 30 years and if you do not address both the near-term and far-term issues in the lease, it may be impossible to fix after the lease is signed.  Remember that a good lease will spell out both the good things, such as the rent income to be paid to the farmer, and the bad things, such as how is land maintained during and after construction.
• Make sure to address how construction will be handled.  Most of the roads that are put in for construction are 40′ wide and after construction, they are reduced to about 15′.  How the contractor takes care of that extra 25′ will determine how good the farmland becomes again.  Remember, if there is massive compaction or the roads are not terraced property, this may negatively effect your farm for many years.
• Wind energy does not appear to be a fad.  It is already producing enough power for over 7 million homes.  Most of the issue with wind energy is the total variability of when the wind blows which effects how well the energy is moved through the electric grid.  However, with the low price of natural gas, many wind farms are now combining wind farms with natural gas generators that will kick in when the wind dies.  This can make the wind farms even more efficient.
• If you lease the farm land, you maintain your rights versus giving an easement to the wind farm.  Know your rights on this subject.
• The rent income can in many cases far exceed the income that you can generate off of the farm.  For example, in the article, each wind turbine generates $5,400 of rental income per year with a 1% inflation increase.  If a wind machine takes up 10 acres, that is net rental income of about $540 per acre.  Believe me, most farms in the mid-west would love to net $540 per acre on any crop.  Also, some companies will pay both a fixed annual rental plus a percentage of the energy produced.  Make sure to determine what the correct market rate is for your area.
• Wind companies want to be good neighbors since they know that good public relations and working relationships will allow them to keep operating.
• Wind turbines need maintenance.  If you think once the machine is up and running, you will never see a maintenance worker again, you are wrong.  Most wind farms have some number of full-time employees that manage and maintain the wind turbines and towers.  They will be using these roads on a daily basis.  They will become your neighbors.   Make sure the are good neighbors, not bad ones.