This cost relates to there being no step up in basis of the assets that are inherited by the heirs.  They can elect to step up $1.3 million in assets or an extra $3 million going to a surviving spouse.  Lets see how this might affect a farmer with a decent size estate.  Lets assume that a farmer dies with land valued at $10 million and equipment valued at $2 million.  Assume there is no other assets and the basis in these assets is only $1 million.

There will be no federal estate tax due, however, most likely about $1 million of state estate will be due.  Now lets assume the heirs elect to step up the equipment by $1.3 million and then they sell the assets in 2011.  The capital gains rate for the land including state income taxes will be about 30% so, they will owe about $2.7 million of federal and state income taxes.  On the equipment, there will be a gain of $700 thousand and assumption top bracket of about 50% for federal and state taxes will result in total taxes on this gain of about $350 thousand.

Therefore, in total, the estate and heirs have paid estate taxes of $1 million and income taxes of about $3 million for total taxes of $4 million.  Under the law in effect for 2009, there would have been estate taxes of about $4.5 million and no income taxes. 

So you can see that even there is no federal estate tax for this year, a farmer who passes away with certain tax facts can almost pay the same amount in state estate and related income taxes. 

Please make sure to review your situation with your tax advisor.

Also, these laws are most likely to change during this year or next and we will keep you posted.

Although I am not a marketing expert, as a CPA, it is always good to review your farm budget for the year and I believe that for most of our farmers, especially wheat farmers, your estimated crop price is less than what the market it now.  Therefore, you should review with your marketing expert what options you have right now such as taking advantage of forward hedging, buying a call, etc.

I remember when I was in my teens and wheat prices had rallied about a $1,50 and I was talking with my uncle.  He had not sold any of his crop yet and the market price was very near a round number such as $6.00 a bushel.  He told me he was going to sell when it hit that number.  As you can guess, it never got to that number and he rode the price decrease all the way down to the very low of the market when he sold.

Make sure this does not happen to you this year.

I thought I would use this post to give our farmers a quick update on how income is taxed for C corporations and S corporations.

First, a C corporation simply refers in the part of the Internal Revenue Code dealing with corporate taxation (C).  Almost all farm corporations are C corporations unless they elect to be taxed as an S corporation (to be discussed below).

A C corporation will each year compute it taxable income and then pay an income tax based upon the bottom line.  If the taxable income is less than $50,000 the tax rate is 15%, however, as the income increases over this amount, the tax rates increase substantially and for income between $100,000 and $335,000, the rate is 39% plus whatever the state income tax rate will be.

After this income is computed and the corporate tax paid, the shareholder will be subject to a separate tax when this income is distributed to the shareholder as a dividend.  Right now, this rate is 15%, however, starting next year as discussed in the post, the rate will skyrocket to close to 40% or and starting in 2013, the rate may exceed 40% due to the new Medicare surtax on investment income.

Now, if the farmer would like to stop this so-called double tax, they can elect for the corporation to be taxed as an S corporation (again this is the section in the Internal Revenue Code dealing with these types of corporations, that is why it is called an S corporation).  This election allows the corporation to pay no corporate tax and have all of the income flow through to the shareholders who then pay the tax at their normal tax rates.  This means that when the corporation pays a dividend to the shareholders, there is no additional tax since the tax has already been paid on the income.

Why would a farmer ever want to be a C corporation if there is this double tax?  There are many cases where a farmer would want to be a C corporation.  For example, assume the farm only earns about $75,000 a year.  Under this scenario, the farmer using proper tax planning would most likely not pay any tax at all if they have two or more minor children, whereas, being taxed as an S corporation could result in several thousand dollars of tax (see previous posts on this).

The bottom line is that you need to review your income tax situation both for the current year and for future years and determine which corporation works best for you.

However, there is a cap on how much premium that you can use.  This cap is based upon the average premium for small group markets for each state.  The IRS just published revenue ruling 2010-13 that outlines what this cap amount is for each state.   The cap is based either on employee-only coverage or family coverage.  I will give you an example of how this cap might work for you as a farmer:

Suppose you have two employees.  One is single and one is married with kids.  Assume that you pay 80% of the medical insurance for each employee.  Also, assume you are a farmer in Iowa.

Lets calculate the maximum amount of the credit by assumimg that the cost of this premium is $500 per month for the employee and $950 per month for the family.  The credit that you could take is 80% of the premium times 35% for the year.  This would equal $500*12*.8*.35 or $1,680 for the single employee and $950*12*.8*.35  or $3,192 for the family employee or a total credit of $4,872.

Now, we need to determine how much of this credit is allowed by comparing it to the small group market tables from the IRS.  For the single employee, the maximum credit allowed for Iowa for a year is $4,652.  Since the farmer only paid 80% of the premium, this would equal a total allowed amount of $3,721.60 times 35% equals $1,302.56 maximum credit allowed for a single employee.  For the family employee, the state of Iowa maximum annual amount is $10,503 times 80% times 35% equals $2,940.84.  These two amounts added to together results in a maximum credit allowed of $4,243.40. 

Our original calculation resulted in a credit of $4,872.  The IRS only allows $4,243.40 based upon the small group market tables, so the actual credit you would use on your tax return is the $4,243.40.

A quick way of determining whether you need to worry about this is to look at your premium on a monthly basis and compare it to the table amount (after dividing by 12 to make a monthly comparison).  If your premium is less than the table amount, you can ignore it on the tax return, however, if your premium is greater than the table amount, you will need to limit your credit based on this calculation.

What this means to a farmer who has a C corporation that is in the top tax bracket both at the corporate level and at the individual level is as follows:

• For 2010, your maximum combined corporate and individual income tax rate will be 44.75%
• For 2011 and 2012, your maximum combined rate will increase to 60.74%
• For 2013 and thereafter, your maximum combined rate will be a whopping 63.21%.  This represents a huge 41% increase since 2010.

A tax planning tip is to review your current retained earnings and see how much you should drop out to you in the form of dividends.  If the corporation needs the working capital, you can always loan it back to it at very cheap interest rates.

Of the 2,401 Minnesota farms included in the “FINBIN” survey for 2009, the median farm saw a 63% decrease in net income from $91,242 to $33,417.  Each year, the Center for Farm Financial Management performs a survey of Minnesota farmers.  Their response for 2009 represented about 3% of overall farms and about 10% of the farms with total sales over $100,000.

A summary of the results for 2009 show the following:

• Median farm income peaked in 2007 at about $105 thousand and have declined in two years to about $33 thousand.   The 2009 numbers are also the worst net income for any year in this decade other than 2001 when the median net income was about $24 thousand.
• Incomes were down substantially for virtually every type and size of farm.
• Livestock farms of all types, on average, did not provide enough income to support family living expenses.
• While crop farms were more profitable than livestock farms, the median earnings of crop farms dropped 55% to about $60 thousand.
• Dairy farm profits were down substantially falling to an average of about $5 thousand per farm.  The average price for milk dropped from about $19 to $13 in one year.
• Hog farms eked out a small profit as their income dropped about 87%.
• The average return on assets dropped from 10.5% in 2008 to 3.1% in 2009
• The average farm’s net worth increased by about $60,000, however, almost all of this increase was due to increasing land prices and not earned net worth growth.
• The average farm spent $52,000 on living expenses and needed to generate $72,000 from farm and non-farm income to cover family living, income taxes and other ongoing non-farm expenses.

With the 2008 farm act, substantial changes were made to the USDA Conservation Reserve Program (CRP).  The major change was reducing the maximum enrollment acreage from about 37 million acres to 32 million acres which is about a 14% reduction in maximum acres.  Also, during this period, a substantial increase in commodity prices took place which has caused the CRP rent prices to increase dramatically in some areas.

The June 2010 issue of Amber Waves has a very good article on the challenges facing the CRP program.  A brief history shows that the CRP program began in 1985 and 1986 and the primary goal was to retire highly erodible farm land from production for a 10 to 15 year term.  Enrollment grew quickly, reaching about 33 million acres by 1990.  After the initial contracts were issued, program goals were modified to include water quality and wildlife habitat improvements in addition to reduced soil erosion.  To capture these multiple benefits, starting in 1990, program administrators used an Environmental Benefits Index (EBI) to rank competing offers received during periodic “general signups”.  The EBI computes a score using a formula that weighs such factors as soil erodibility, location within a priority zone, the proposed conservation practice and the requested rental rate – with offers only being accepted if an EBI score exceeds a cutoff value.

1n 1996, a continuous CPR was added to enroll parcels of land with high enviromental benefits outside of the EBI ranking process.

Between 1990 and 2008, CRP enrollment fluctuated around 33 million acres, with a high of 36.8 million in 2007.  As of February 2010, the total acres in CRP are about 31.2 million acres.  This includes about 4.5 million acres of continuous signup acres.

With the new farm bill coming up in the near future, it will be interesting to see what changes will be made to the CRP program.

The USDA released their June acreage report today and the corn and wheat market rallied substantially based upon this report.  The actual amount of expected corn acreage came in about 1.6 million acres less than the trade expected and the amount of corn on hand was about 300 million bushels less than expected.

Backing into the usage numbers for the quarter, it appears that the amount of corn used in the quarter was about 25% higher than last year which would be an all-time record for that quarter.  What seems to be happening is that global demand and ethanol use is soaking up any record crop that the US is able to produce and as the world economy recovers, this trend will continue to accelerate.  All in all, any weather scare for this corn market will most likely cause prices to increase substantially.

The bean crop is the recipient of the extra acres that did not go into corn, and thus, any rally there might be tempered by the extra acres.  However, there is little margin of error for any weather issues.

Although the wheat plantings came in a little higher than expected, the total amount of wheat acreage is the lowest since 1971.  Wheat rallied over 20 cents on the day and we will see how this carries over in the next few weeks.

For more coverage of the plantings and stocks, please see the analysis at ProFarmer.com.

I have written many times about how farmland has been a good investment for at least the last 10 years or so.  Most of this data has been gathered from sources directly related to farming, however, I have started to notice a trend about reporting on farmland as an good investment in mainstream sources such as Business Week. 

This trend continues with a recent article in the Wall Street Journal about buying farmland for income.  The article indicates that by buying farmland, an investor should receive a current 3-5% yield plus up to another 5% in annual price appreciation over the term of the investment.  This comes from R. Dennis Moon with US Trust, a unit of Bank of America.

One of the challenges right now is finding quality land.  The supply is smaller than usual since farmers and their heirs are keeping the land they otherwise might have sold, in order to book the rental income.  The number of qualify farmland for sale appears to be down about 30-40% according to Loyd Brown of Hertz Farm Management, Inc. of Nevada, Iowa.  Even medium quality land is down by this amount.

Now that these articles are now starting to appear in main-stream sources, my contrarian sense is that farmland may be starting to peak as an investment for investors.  This may end up being good for farmers if the speculative pricing gets eliminated from land values.  We can wait and see how it turns out.

Working capital is the excess of a farm’s current assets over it current liabilities.  Current assets are your short-term liquid assets such as cash, crop inventories, and receivables for crops sold.  Your current liabilities are what you owe on a short-term basis such as notes payable to banks, accounts payable, wages and taxes payable and your current portion of any long-term debt payments.  Many farmers forget to include this item when doing their current ratio calculation.

It used to be that the current ratio was very important to calculate.  This number is based upon taking your total current assets and dividing by your total current liabilities.  If this ratio was about 2 or higher, this was considered very good, between 1 to 2 was marginal to good and below 1 was bad.  However, we are now stressing that your working-capital to revenue is a much more important metric to measure and strive for.

The problem with the current ratio is that it does not indicate how much working capital is available to fund your farm operations.  For example, assume your annual farm revenues is $1 million dollars.  Assume you have total current assets of $250,000 and current liabilities of $125,000.  Your current ratio is 2 to 1 which is considered good, however, your working capital as a percentage of revenues is only 12.5%.  This means that you would need to have the ability to borrow from a bank to fund current operations until you are able to harvest your crop and convert it to cash.

Based upon information from FINBIN, the top 20% of crop producers had working capital divided by gross farm revenue ranging from 28% to 43% in the past four years.  The average producers ranged from about 20% to 33%, while the bottom 20% were in the low 20% range for these four years.

As more lenders use this metric in assessing farm operations, you need to know what yours is and what it should be.  I would suggest that you strive for it to be at least 30% for most crop farm operations.  Livestock operations would be about 5-10% lower.