We get this question from farmers approaching retirement age a lot:

“I have had very low income for most of my career and should I try to maximize my income as I approach retirement to increase my social security benefits”

Chris Hesse, who is one of my partners at CliftonLarsonAllen, LLP had provided me with an Excel spreadsheet that can calculate this answer fairly quickly.  It is based on the method that Social Security uses to determine your retirement benefits and the key issue for our farmer is what your average indexed monthly income has been during your career.

Social security benefits are calculated based upon the average of your highest 35 years of earnings indexed for inflation.  For example, the maximum wage that you could use for 2012 was $110,100.  In 1975 the maximum wage was $14,100, however the inflation index for that year was 4.98 so the equivalent 2012 number is about $70,200.  Therefore, you input all of your wages during your career and the computer then indexes them based on inflation.  It then takes the top 35 years and divides by 420 (35 years times 12).  This results in a very important number known as the Average Monthly Indexed Earnings (AMIE). 

The AMIE is then divided into three tiers.  The first tier (currently about $800) is valued at 90%.  The next tier (the next approximately $4,000) is valued at 32% and the remaining tier is valued at 15%.  Each of these tiers is then multiplied by these percentages and the cumulative result is your estimated monthly retirement benefit when you retire. 

Assuming a farmer has paid in the maximum amount for at least 35 years, the estimated monthly social security benefit at full retirement is slightly more than $2,500 per month.  However, the interesting part is how these tiers break down.

Tier 1 has a value of $712, Tier 2 $1,273 and Tier 3 is $565.  Tier 3 monthly earnings amount is calculated at about $3,800 which is almost 5 times higher than Tier 1, but the value of Tier 3 is about 20% lower than Tier 1.

The first step for our farmer is to maximize their Tier 1 AMIE amount.   If your average annual earnings have been less than about $10,000 indexed for inflation, then reporting greater farm earnings will dramatically increase your social secuity benefits.  For example. if a farmer during his career reported an average of $5,000 per year (in 2013 numbers), his current expected Social Security benefit is about $374 per month.  If over the next couple of years, he reports an extra $157,000 or so of earnings (does not need to be in one year), his monthly benefit will jump to about $712.  The extra social security cost will be about $24,000, but in return he will receive a lifetime annuity indexed for inflation paying $338 per month.  A simple calculation shows that he would fully recover his investment in about 6 years.

In our example, we are only trying to get up to the Tier 1 amount of about $800 per month.  As you go over Tier 1 into Tier 2, your return on investment drops dramatically.  Tier 1 has a 90% value, whereas Tier 2 only has a 32% value, therefore, as you enter Tier 2, instead of a 6 year payback, it becomes a 18 year payback.  Tier 3 amounts are even worse.  At that point, your payback period is in excess of 30 years.

In conclusion, if your earnings are still in Tier 1, it would definitely pay to pay in extra FICA tax to maximize your social security earnings.

Paul Neiffer, CPA

We had a reader ask the following question:

“On taxing options, you state that hedges apply to crops that you raise or feed. However, you say if you raise wheat but have no livestock an option would not be a hedge. I am confused. “

The tax definition of hedging is when a farmer has made a transaction to minimize or eliminate the risk of price action going against them.  For example, a wheat farmer may purchase a contract on the futures market to sell short their wheat at $7 per bushel.  This contract has locked in the price that the farmer will receive (subject to basis adjustments).  By entering into this contract, if the price of wheat goes up a $1 at the elevator, the farmer will get cash of $8 per bushel but lose $1 on the futures contract for a net of $7.  This is what the IRS calls a hedge.

Conversely, if a farmer only raises livestock and purchases a long contract to buy corn at $5 per bushel, they have hedged their feed costs by locking in corn at $5 per bushel (again subject to basis adjustments).

However, if a wheat farmer with no livestock operation, buys a long contract or a call option to purchase wheat at $7 per bushel, the IRS views this as not being a hedge, but rather speculation on where the price of wheat is headed.  In this case, the gain or loss on the sale of this contract is considered 60% long-term and 40% short-term.  If the farmer has a gain, this may work in their favor since 60% of the gain is taxed at a maximum 15% federal rate, however, if the farmer has a loss and no other capital gains, this loss is limited to $3,000 per year until it is fully used up.

This is why it is extremely important for a farmer to know what is a hedge and what is not for tax purposes and how it can affect them.

Just like a farmer coming to the last row of the last field of the fall harvest, today is my last day of what I call harvest time for CPA.  We have put in long hours since the first of the year (my last day off was on January 10), but this is my favorite time of the year.  Just like when I was growing up driving the combine was my favorite time.

I just want to wish my readers my thanks for their questions and feedback and now that things will be a little more back to normal, I will try to do more posts and keep the site going strong.

Thanks.

 The idea for this blog was a glimmer in my mind at the end of 2008.  While surfing on the web, I found the Golden Practices web-site that listed different industry specific blogs.  This spurred me to action and with their help, we had a fully up and running blog site in the first quarter of this year.  Some of the experiences and reflections that I have for 2009 are:

• 1.  Our readers are a very geographically diverse group.  I expected to have most of my readers from the corn belt of the US, while this is true, we seem to have many readers from India, Australia, Canada, Europe and all over the globe.  I assume most of them read English and I hope they have learned a lot about US farming.

2.  Altough I am a CPA by trade, I grew up on a farm and farmers are business people first, and taxes and finance and accounting is just part of the equation.  I have tried to balance my posts with operations, marketing, accounting, taxes and trends. 

3.  I believe that the mega trends are and will continue to support farming as a great business going forward.  All of the world has to eat and this requires farm.  Horse and carriage was replaced by cars which may be replaced by some other form of transportation a 100 years from now, but we will still be farming at that time.  China and India other growing countries will demand better food with more protein as they mature.  Our American farmers will be there to provide a lot of this food.

4.  I have set an ambitious goal for myself to get some type of online “Farmers Tax Guide” up and running by the end of 2010.  I have several parts of it done, but to be fully operational and run the way I want it to may require programming skills that I do not currently have.  Also, with tax season for me rapidly approaching, not much will get done between now and April 15.

5.  The best thing about this blog are the wonderful people that I have met or communicated with that are doing similar blogs.   A couple that you should check out at “The Exuberant Accountant“, “The Roth & Company Tax Update Blog“, and “Legacy by Design“.  You can not go wrong by checking these sites out.

6.  I thought I would get more comments on the postings and for several months, I did not get any at all.  Recently, I have started to get more comments and e-mails and I really appreciate the feedback.

7.  I also enjoyed trying to work up “White Papers” or “Tax Bulletins” on subjects that my readers have questions on.  I have already done several of these and I am planning on putting them in a little better format and posting them to the site early in 2010.

Last, but not least, we want to wish everybody a prosperous New Year in 2010 and we look forward to seeing what the year brings.

I would like to get some interaction going with my audience.  I would appreciate any questions that you might have about farm taxation, operations or any other questions that you might have.

Please feel free to send me a quick or detailed e-mail to paul@hansenneiffer.com.  I will promise to try to get an answer to you with 48 hours.  Let me know if you do not mind me sharing your question and answer on the FarmCPAToday site and I will try to post these on at least a monthly basis.