The IRS on June 21, 2012 released a report regarding their review of S corporation tax returns filed during the five year period ending in 2011.  During this period, the IRS audited 53,544 S corporation tax returns.  This was a 54% increase over the previous five years.  For each return audited, the IRS generated about $105,000 of net adjustments to the returns.

However, when the IRS did a more thorough audit on DIF (their way of pulling statistically valid samples) selected returns, about 62% of those returns showed no adjustment at all.  This means that the substantial majority of S corporation filers are accurately filing their income tax returns. 

Some statistics from the report are interesting.  There are now 4.5 million S corporation tax returns, double the rate of C corporation returns.  These returns generate gross income of almost $6 trillion.  Net aggregate profits averaged about $350 billion and net aggregate losses were about $100 billion for each year.  Total gross property was about $3.4 trillion which almost doubled over the preceding 10 years.

One area of focus is on S corporations that reports three consecutive years of losses will be more closely scrutinized for potential audit.

The report is only 23 pages long, but even most tax geeks would consider it not the most interesting read other than the statistics shown above.  If you really want to read the report, you can access it here.

Paul Neiffer, CPA

The Wall Street Journal issued a report today on how Midwest Ethanol makers are getting squeezed by the rapid increase in corn prices (to read the article, you may need a subscription).  Production earlier in the year was running at about 950 million barrels per day.  The current run rate is about 800 million barrels down about 16%.

Meanwhile, margins have shrank from about 31 cents per gallon in the first quarter of 2011 to about 11 cents in this year’s first quarter.  Archer Daniels Midland just reported that their ethanol margins are now negative by the “high 20′s” per gallon.

The article indicates that the ethanol industry consumes about 40% of the annual corn crop, however, for 2012, this percentage may increase closer to 50%.  The one statistic that never seems to be mentioned in these articles is that the ethanol industry also produces about 1.5 billion bushel equivalent of dried distillers grain that used as livestock feed.  Therefore, the net 40% used by the ethanol industry is really closer to 25% or less.

If corn prices rally much more, we may see Congress reduce the mandate, but more likely, we will see continued decreases in Ethanol production and reduction in these inventories to meet the mandate.

Smithfield Foods, the world’s largest pork producer, said Tuesday it will import corn from Brazil.  This is most likely a result of Brazil soybeans being cheaper to import by ship than to transport them by rail to the East Coast.  Also, in another report, it appears the Southern Brazil crush operators may run out of beans before the season is finished.

This is due to most of the beans produced up north already being sold on the world market.  With the Brazil Real depreciating against the US Dollar this year, Brazil farmers are receiving about 15% more than last year in their local currency plus the high increase in world prices have caused most Brazil farmers to sell their beans.  Normally, at this time, less than 50% of the crop would be sold.  The report indicates that more than 90% of Brazil beans have already been sold.

USDA predicts about 200 million bushel carryover for this year’s crop, but I think it will be very hard to find any of those beans.

Paul Neiffer, CPA

We periodically quote publication issued by the Kansas City Federal Reserve.  Last month, they issued a report entitled “Building U.S. Agricultural Exports: One BRIC at a Time”.  The report is only 10 pages long, but has a lot of good information.

Here is a recap of what I found interesting:

• A chart showing the amount of meat consumption on a daily basis was shown.  The US is right at the top (along with Argentina most likely) with about 40 grams per day.  Of the BRIC (Brazil, Russia, India, and China), Brazil was the largest at about 30, then Russia at 20, China at about 17 and India was less than 2 grams per day.
• The increase in meat consumption is higher for lower income nations as their income rises.  For example, if mean income increases by 1%, in low income nations, their meat consumption goes up by .78% while higher income nations, it only goes up by .36%.
• More than 50% of high income nation’s food supply is packaged, while low income nations, it is less than 25%.
• We spend $144 per year on soft drinks while the BRIC’s spend only $33 per year
• We consume an average of $191 per year on fast food (my sons are well in excess of that) and middle income nations, it is less than $15 per person.
• There seems to be four stages of Meat Imports for BRICs.  Stage 1 occurs as their income starts to rise, imports will rise.  Stage 2 is an acceleration of corn and bean imports to produce more meat, however, meat imports rise dramatically.  Stage three is accelerating corn and bean production with decelerating meat imports.  Stage 4 is where the country goes from net importer to net exporter. 
• Brazil is now in stage 4, Russia is entering stage 3, and China appears to be repaidly moving through stage 2.  The  question is will India follow the other 3.
• In 1990-94, our share of meat exports was 2.2%, it is now over 8%.
• BRIC nations are boosting pork and poultry production, not beef.
• Our share of Oilseed exports to the BRICs have increased from 2.1% in 1990-94 to about 45% now.

There is some other good information in the report, but these are my highlights.  These trends should still bode well for the American grain farmer.

Paul Neiffer, CPA

Every month the IRS posts a listing of the required interest rates that parties must put into loan contracts to prevent imputing of interest.  For several months, these rates have been dropping lower and lower.  For the month of August, short-term notes (less than 3 years) now require an interest rate of .25%.  Mid-term loans (3 to 9 years) require a rate of .88% and long-term notes (over 10 years) a rate of 2.23%.

I believe these are the lowest rates ever and provide farmers the ability to loan money to children and their corporations at very low rates.  The benefit is to transfer the use of funds from them to their children at a very low cost to the child.  With the lifetime gift exclusion being $5.12 million this year only (reverting back to $1 million on January 1), now is the time to consider using these low interest rates in your succession planning.

Paul Neiffer, CPA

The Wall Street Journal published a front page article (you may need to be a subscriber to read the full article) today on how many small and large businesses are passing up the chance to take advantage of certain tax benefits due to the hassles and costs associated with IRS compliance.  We have seen many cases where the work involved in determining the amount of credit available can outweigh the benefit.

For example, the small business health tax credit for providing health insurance to your employees decreases as the number of employees increases and decreases as the employee’s salary increases.  In order to calculate this credit, you need to plug in all of the earnings of your employees, the total hours worked by each employee, back out part-time employees, owner’s wages, etc. and after you do all of this work you might find out that you qualify for a $100 credit.

Many times we can ballpark what the credit will be and have the actual number come close.  Other times, the calculation is so complicated that any estimated number would simply be a guess.

The bottom line is that some of these credits can be complicated and a hassle; however, in many cases the actual credit can be substantial and far outweigh the costs.  Only by reviewing these credits with your tax advisor can you determine which are most effective for your tax situation.

Senate Democrats removed any mention of the estate tax in a Bill that is currently headed to the floor.  This propsed Bill will now extend the 2001 and 2003 “Bush” tax cuts for families earning $250,000 or less.

An earlier version of the Bill would have included a maximum estate tax rate of 45% while dropping the exclusion level to $3.5 million.  With the new changes to the Bill, the maximum rate will be 55% with only a $1 million exclusion amount.

This new Bill would set the top rates for dividends and capital gains at 20% (plus the Medicare Surtax of 3.8% if applicable); reinstate the phaseout of personal exemptions and certain itemized deductions for higher income households; and extend certain credits such as the education credit, child tax credit and earned income credit for another year.

The Section 179 expensing limits would be set $250,000 for 2013 and probably most important, it would provide for another one-year “patch” to the alternative minimum tax for 2012.

As with any legislation started in the Senate these days, it is mostly for political posturing since any chance of the Bill passing the House is a remote as a 70% high in the Corn Belt these days.

Paul Neiffer, CPA

Based on this year’s drought, we know that this will most likely be the largest amount of crop insurance claims ever processed.  With proper planning, you may be able to structure when to report these crop insurance proceeds to achieve the best tax advantage for this year.

Crop insurance proceeds due to crop damage (not price drops) are taxable in the year of receipt.  However, the tax laws do allow a farmer to make a deferral until the next year assuming that the farmer meets the following:

• The crop insurance proceeds are for the current year crop, i.e. crop insurance proceeds for 2012 crop damage received in 2012 can be deferred to 2013.  If the proceeds are received in 2013, then no deferral is available, AND
• The farmer normally has a history of reporting more than 50% of their crop sales in the subsequent year.  For example, if the farmer harvests 50,000 bushels in 2010 and sells all 50,000 by the end of the 2010, then he cannot defer his crop insurance.  If, however, he normally would sell 25,001 or more bushels in 2011, then he can defer his crop insurance proceeds.

The election to defer is made on the tax return.

If you are a farmer that normally sells all of his crop in the year of harvest, you still may be able to “defer” by working with your crop insurance agent and company to not make the claim until late in the year and receive your check after year-end, otherwise you will need to report in 2012.

We have worked up a Crop Insurance Matrix that can step you through the process.

 Paul Neiffer, CPA

The IRS just announced a formal change in the long-held position on the deductibility of Medicare premiums (normally withheld from Social Security Benefits).  Until about 2009, the IRS position was that a self-employed taxpayer (including partners and more than 2% S corporation shareholders) could not deduct Medicare premiums above the “line” as part of the self-employed health insurance deduction.

Starting in 2010, the instructions for form 1040 and other related forms had added a sentance or two indicating you could deduct these premiums above the line, but there was no formal announcement.   This has changed with the release of CCA 201228037.  Now, you can include these Medicare premiums paid with your other normal health insurance premiums and deduct it above the line.

However, for S corporation shareholders and partnerships, a notice issued previously by the IRS requires that these premiums actually be reimbursed by the corporation (or paid directly by the employer which is not normally applicable with Medicare premiums).  This requires a check be issued by the employer to the employee paying the Medicare premiums.  These payments would then be included in the income of the employee (deducted by the employer) and then deducted on page 1 of form 1040.  If these guidelines are not followed completely, then the deduction is not allowed.

If you have not deducted these premiums on any return before this year, you can go back and claim the deduction by filing an amended tax return.  Most likely 2009-2011 returns are still available to be amended..

Paul Neiffer, CPA

In response to the bankruptcy filing of Peregrine Financial Group this week and the MF Global filing last year, these are some of red flags to watch out for in picking a broker (or continuing) to handle your futures trading and hedging:

• Review the financial information that is available regarding the financial health of the brokerage company.  If the financial statements are audited by a CPA firm that you have never heard of or cannot easily find in doing an Internet search, this can be a red flag.  Peregrine’s auditor appears to be a very small firm in Illinois.
• If the owner of the brokerage is located in your community, review their lifestyle.  If the owner has the largest home in the area, flies private jet, and appears to be consuming a lot of money to fund their lifestyle, this can be a red flag.  Peregrine’s owner had a private jet, donated lavishly to the local college, opened a high end restaurant with a lavish wine offering and probably had one of the largest homes in Cedar Falls, Iowa.
• Talk to other farmers using this broker and other brokers.  Many times, areas of concern can be communicated this way.
• Review the disciplinary actions that may have been taken against the broker.  If there are several, this can be a red flag.
• If the broker ever tries to tell you that you may need to wait a day or two to get your money, get it all out as fast as you can.  This is a huge red flag.
• Remember that if you have money invested in stocks and bonds at a regular investment company such as a Merrill Lynch, their is SIPC insurance to protect this money.  As of yet, there is no protection for funds invested in commodities (there may be some funds available at times).

Remember, the bottom line is that it is your responsibility to determine if your commodity broker is sound.  Don’t assume somebody else will bail you out  (You are not Bank of America, Citibank, etc.)

Also, this advice can be used for almost picking any professional financial advisor.

Paul Neiffer, CPA