The Kansas City Federal Reserve just released a workpaper entitled “Farm Investment and Leverage Cycle: Will This Time Be Different?”. 

The article describes the four major farm cycles that have occurred since 1900.  The first cycle begin in 1910 and ended in 1940.  The First World War caused farm prices to rise dramatically which led to an increase in farmland prices.  Once the great depression started, this increase in farm land prices was mostly wiped out and many farms went bankrupt.

The second cycle began in 1940 with the start of World War II and continued to until 1960.  Real farm income tripled from 1940 to 1943 causing a resulting increase in land prices.  However, unlike any other farm boom cycles of the last 100+ years, this cycle did not end in any type of bust.

The third cycle started in the early 1970s and ended in the late 1980s.  With the rapid increase in crop prices due primarily to the US-Russia grain pact, farmland prices started to rise dramatically.  There were other inflation pressures during this period that also help cause the increase.  As prices rose, farmers continued to expand with more debt than was proved prudent.  This led to the crash of the 1980s that really took at least 15 years or more to recover from.

This brings us to the latest cycle that started in 2005.  Many factors led to increased crop prices (ethanol, China, etc.) and this cycle is still in process.  The authors indicate that things still look good, but if there is a dramatic drop in land prices and if the debt to asset ratio crosses over 20% again (like the 1980′s), then we will have a bust to end the cycle.  However, if this ratio stays at 17% or lower, then we will not have a bust (similar to the 1940-60 cycle).  The ratio (using their definition) is currently at 10% which is the lowest it has been since the mid 1950s.

The authors are not predicting a bust but are letting us know the parameters that may cause one.  It will be important to watch these signals and be ready to respond accordingly.

Paul Neiffer, CPA

There is a provision in the Income Tax Code that disallows certain farm losses that are in excess of $300,000 (or the aggregate farm income for the last 5 years).  This excess amount is not allowed in the current year, but is carried forward and allowed as a deduction in the next tax year (assuming you still meet the requirement in that year).

This provision only applies if the farmer is receiving any direct or counter cyclical payments under Title I of the 2008 Farm Bill (as extended last year).  The proposed 2013 farm bills by both the Senate and Congress eliminates these payments, so there is a strong chance that after passage of this farm bill and full implementation that this provision will no longer apply.

We have seen several of our clients that were unable to fully deduct their current farm loss even though they had received less than $5,000 in direct payments.  The farmer does not lose this deduction, but simply carries it forward.

Also, with the drought last year, any expenses that are a direct result of the drought are not included in the calculations for this limitation.

We will keep you posted if this provision no longer applies.

Paul Neiffer, CPA

After the House passed their Farm Bill today, it appears that their version on the Senate version are not too far apart.  The key points for both are:

• An elimination of all direct farm payments
• A reduction in CRP acreage to either 24 or 25 million acres
• Consolidation of many farm programs
• A Price Support program that guarantees a farmer a minimum price for their crop, or
• A Revenue Program that a farmer can elect (they have to elect one or the other).

The Price Support program is either based on a price set by Congress (the House version) or based on the average Olympic average of the prior 5 years of prices (the Senate version).  If a farmer elects the Price program, they cannot participate in the Revenue program and vice versus.

A couple of key differences is a payment limitation in the Senate of $50,000 per person for the Senate and $125,000 for the House.

The Senate also eliminates these payments if your adjusted gross income is over $750,000 while the house boosts this to $950,000.  This will most likely make the accounting simpler than it is now since you will most likely only need to look at the bottom line income shown on the bottom of your Form 1040 page 1.

We would guess that a final farm bill will be ready for a vote in the  next week or so, but with Memorial Day only a week from Monday, who knows long Congress will take off for that Holiday.

We will keep you informed.

Paul Neiffer, CPA

I was doing a google search on the House Farm Bill today and the 10th item that showed up in my search was this article.  With a title of “House Ready to Make Draconian Cuts to Food Stamps in House Bill” I was interested in what these “draconian” cuts were.  As you read the article, you will note that the author point out that the House Farm Bill is proposing cutting “Food Stamps” by about $2.5 billion per year or $25 billion over the 10 years.  This compares to the Senate Bill which calls for lower cuts of about $4.1 billion in total over 10 years.

On the face of it, $2.5 billion might be a lot of money, however, the total “Food Stamp” portion of the Farm Bill is close to $60 billion per year.  The proposed $2.5 billion cut equates to a 4% reduction.  I would normally not consider that to be “Draconian”.  The House is most likely battling this issue as I write this post and it will be interesting to see what final number they pass onto the floor for a vote.

It also appears that the Dairy margin management program is still part of the Bill, but this may get eliminated or changed in the committee between the House and Senate.  We will keep you posted on any material changes in both versions.  So far, the Senate Bill appears to mostly follow the bill passed last summer.

Paul Neiffer, CPA

Creighton University produces a monthly index called the Rural Mainsteet Index (RMI) indicating the overall economy for several rural states in the Midwest and Mountain states.  The May Index was recently released and I thought this month I would recap the index for each of the states covered.

Any value greater than 50 indicates economic growth.  The Index values by state are as follows:

• Colorado – 73.1 down from a strong 75.2 in the previous month
• Illinois – 56.7 down slightly from 56.9
• Iowa – 62.3 an almost 3 point dip from 65.2
• Kansas – 61.8 a full 9 points higher than an almost neutral 52.8 reading
• Minnesota – 66.7 almost no change from 66.8
• Missouri – 71.7 a substantial increase from 56.3
• Nebraska – 57.3 up from 54.9.  In January the index was actually under 50
• North Dakota – 78.8, as would be expected this state has the highest index reading (shale oil and low unemployment will do that)
• South Dakota – 57.2 a small decrease from 58.8
• Wyoming – 55.1 a good increase from 52.8

Many of the states farmland indexes appear to be having more swings both up and down versus a more sustained increase in several previous months.  Are we seeing a crest in land prices (leading to a dip) or is this just the start of the next wave.  We shall see.

Paul Neiffer, CPA

I spent today in Spokane attending the Washington Bankers Association agriculture conference. I gave an update on the possible new farm bill provisions along with an update on the new tax laws.

After I spoke (never a good thing to give the farm bill and tax update right after lunch) Alex McGregor of The McGregor Company gave a talk entitled “Good Times, Tenacity and Teamwork”. The McGregor company started as a farm raising sheep over 100 years ago and is now one of the largest distributors of fertilizers and chemicals in the northwest.

He indicated what worked for our farmers three generations ago will work now. This is comprised of their work ethic, tenacity and character. But he reinforced that we need to get your message out to the general public about the vital function we perform.

After that message Brian Hefty of Hefty Seed Company in South Dakota gave a similar message. He told a story about a water issue that came up in his county that required public hearings. At the meeting were close to 200 or more people. About 4 people spoke in support and four spoke against the issue. Brian at the end of the meeting asked the audience to indicate whether they supported the issue or not. All of the people there were against the issue other than the four that spoke in favor. Without asking the question most people would have thought the support was about equal based on the numbers speaking.

This is why these people against Ag are called activists. They are Active. The question is: Are we just as active in telling our message.

WARNING – THIS IS MY LONGEST POST EVER

The House Ways and Means Committee just issued a proposal to “simplify” the treatment of small business (including most of our farmers).   I will attempt to summarize it:

Core Changes:

• Permanently expanding Section 179 from the current $25,000 level (for 2014) to $250,000 with a phase-out starting at $800,000,
• Allowing all taxpayers to use the cash method of accounting if their annual sales are less than $10 million (most farmers can use this already),
• Somehow they believe making partnership tax returns have a due date of March 15, S corporations have a due date of March 31 and C corporations have a due date of April 15 will help tax compliance (this assumes a calendar year-end and individuals remain at April 15)

There are two options regarding S corporations and partnerships:

Option #1 offers changes as follows:

For S Corporations:

• Reduce to five years the built-in period (GOOD),
• Increase to 60% the portion of an S corporation’s earnings that may be passive without triggering an entity-level tax and eliminate the rule that terminates an S corporation if it has excess passive income for three consecutive years (GOOD),
• Simplify the procedure and extend the time for making an S corporation election, permitting it to make the election on its first tax return (GOOD).

For Partnerships:

• Repeal the rules relating to guaranteed payments to partners, replacing with treating payments as either payments in their capacity as partners or as non-partners (MAYBE GOOD),
• Require mandatory adjustment of partnership’s basis in partnership property when a partner distributes property or transfers his interest (Normally anytime the word mandatory is in the law, it is BAD),
• Clarify that all distributions of inventory are treated as a sale between the partnership and partner (most likely BAD),

Option # 2 – New Simple, Unified Pass-through Rules

This option would repeal current Subchapter K (partnership rules ) and Subchapter S and replace it with one uniform set of rules.

• It would encourge the formation of new businesses by allowing contributions of property and money on a tax-free basis (GOOD),
• Maintain the current relationship that the character of the income and loss pass through to the owners (NO CHANGE),
• Reduce the use of complex structures to engage in tax avoidance by permitting only net ordinary income or loss, net capital gain or loss and tax credits to be specifically allocated (THIS IS WHEN YOU HAVE TO WATCH OUT),
• Close the tax gap while also “simplifying” owner’s current quarterly estimated tax responsibility by requiring entity-level withholding on the pass-through income (THIS MEANS THEY WANT THEIR MONEY SOONER AND YOU HAVE TO WAIT TO GET YOUR MONEY BACK IF DO NOT OWE ANY TAXES),
• Prevent owners from gaming the system by using losses to reduce tax liability by limiting deductions for losses to an owner’s basis in the pass-through interest, but allowing excess losses to be carried forward indefinitely (WHEN THEY USING THE WORD GAMING “WATCH OUT”),
• Ensure that taxes are paid on real, economic gains (but not on returns of capital) by limiting tax-free distributions to the owner’s basis in the business (MOST OF THIS IS IN EFFECT NOW),
• Prevent the use of pass-through entities to shift gains and losses by requiring pass-through entities to recognize gain on all distributions of appreciated property (OUCH FOR PARTNERSHIPS),
• Conform to the basis rules that currently apply to partnerships by allowing owner’s basis in their ownership interests for entity-level debt (both recourse and non-recourse) (THIS IS GOOD)
• Provide certainly with respect to owners who actively participate in the business by allowing them to be treated as employees (COULD BE GOOD).

As you can see, I probably just set my new record for longest post ever, but in my opinion these rules are the first step in Congress taking away the flexibility that farmers have enjoyed for the last several decades on the proper use of partnerships, corporations and limited liability companies.

The proposal does not address the employment and self-employment taxes of partners and shareholders and with this year’s implementation of the 3.8% Medicare/net investment income tax on all income except pass-through income from material S corporations, it would not surprise me that all business income will become subject to this tax very soon.

It seems like every time Congress uses the term “Simple” it simply means an easier way for them to get more money from farmers.  We shall see.

Paul Neiffer, CPA 

The Kansas City Federal Reserve issued their latest Agricultural Credit Conditions report for the 4th quarter of 2012.  Due to the widespread drought in their area, irrigated cropland values saw a 13 percent jump in the 4th quarter alone and up 30% for the year.  Cash rental rates for irrigated cropland also surged more than 20% from the prior year.

Although fourth-quarter incomes were better than expected, but there is concern about the drought affecting certain areas in the months ahead.  Capital spending rebounded in the 4th quarter although loan demand remained low.

More non-farmers appear to be buying farmland for recreation and residential development than the prior year, although levels are still much lower than previous years, primarily due to farmers snapping up most of the available land.

Crop land surged by more than 25% compared to the previous year in Kansas and Nebraska with Missouri not too far behind.

Paul Neiffer, CPA

Four Senators (two Democrats and two Republicans) this week introduced a bill “The Farm Program Integrity Act of 2013″ to place a cap on farm payments that an individual farmer can receive and try to close “certain perceived” loopholes in the farm payment program.  This bill closely follows language that was included in the original 2012 Senate farm bill proposal.

The bill would establish a per farm cap of $50,000 on all commodity program benefits plus $75,000 on any loan deficiency payments and marketing loan gains.  This would result in an overall $125,000 per farm cap which is doubled for a husband and wife.  The $50,000 cap would apply to any new farm programs that are developed as part of the final 2013 farm bill (assuming one gets done).

The bill tries to close the perceived loophole that currently allows “non-farmers” to qualify for federal farm payments.  This provision will prevent non-farmers from being able to use the management “loophole” that is in the current law.  The bill would clearly define the scope of people who qualify as actively engaged in farming by only providing management for the farming operation.  However, like most law, it is our opinion that “clearly define the scope” will not be quite as black and white as the Senators would like.

Both the National Farmers Union and the National Sustainable Agriculture Coalition support the bill.

On another related note, as part of the Sequester talks, there is a chance that 2013 Ag payments may be reduced.  The discussion right now is an 8% haircut, but we know anything is possible in this process.

We will keep you posted.

Paul Neiffer, CPA

February sets the price level for crop insurance on Corn, Beans and some of the other major crops.  Last year’s spring price was $5.68 for corn and $12.55 for beans.

We have had 4 trading days for this month out of 20 total and so far the average corn price is $5.89 and the average bean price is $13.40.  After coming off of the large harvest prices, these levels may seem low, but they are still higher than compared to the same 2012 numbers.

We have 16 trading days to go and this Friday’s USDA report may provide a dramatic swing either way.

We will keep you posted.

Paul Neiffer, CPA