We have had several requests to recap Nick Houle’s presentation on the Top Estate Planning Mistakes that Farmers Make presented at the Commodity Classic last week.  There are several of them, so I am going to break them down into three or four on a daily basis over the next week or so.  The first three are as follows:

• Procrastination – This is something I see all the time.  Having unsigned or outdated documents.  If you do not have your own will, the state has written one for you and you may not like its terms (assets going to your parents when you wanted it to go to your siblings, etc.).  Farming’s complex issues can make this difficult to execute, but make sure your will is updated and you are at least doing your annual gifts.  With several kids and grand-kids, it is easy to give away $2 million or more in value over a ten year period without touching your lifetime exemption amount.
• Property Transfer Rules – A lack of understanding these rules can be fatal.  Most farmers assume their will is in control of transfers.  However, IRAs, life insurance, etc. have beneficiary designations and these control.  What happens if you get a divorce and forget to change the ex-spouse to your new spouse.  The ex-spouse will inherit the life insurance proceeds if you do not fix this.  Jointly held property skips probate, but is this what you want or need.
• “I love you” wills – Leave everything to my spouse upon death.  With larger estates, this may cost your surviving spouse extra estate taxes upon their death.  Should probably still have provision for a bypass or credit shelter trust, even with the new portability rules.  You still love your spouse, but by fixing your will, you love them even more.

One of the new features of the federal estate laws passed back in December, 2010 is the concept of portability.  Under the old law, if a husband passed away with an estate of $500,000 and the lifetime exclusion was $3.5 million (the 2009 rules), the $3 million excess that was not used at his death is forever gone.  Let’s assume his wife passed away after him in the same year and she was worth $6.5 million.  Under the old law, her estate could offset $3.5 million against the $6.5 million and the estate would owe tax on $3 million.

Under the new law, the $3 million not used by the husband is carried over to the wife and her combined lifetime exclusion is now $6.5 million and none of her estate is taxable.

This is how the new law works, however, the estate must make an election to transfer the remaining lifetime exclusion not used over to the surviving spouse.  This election must be made even if there is no estate tax due.  All estates are required to file an estate tax return within 9 months of death or get an extension.  Many estates did not make the election for deaths occurring in 2011 and there has been some concern that they were too late to make the portability election.

The IRS has just announced that estates of married individuals where the spouse died between January 1, 2011 and June 30, 2011 now have an automatic 15 month period to file an estate tax return to make the portability election.  This extended time is available even if the estate did not properly file for an extension of time to file.

If this applies in your case, please make sure to review it with your estate tax advisor.  In most cases, making the portability election is the correct thing to do, however, every situation is unique and you need to understand your options.

We got the following question from one of our readers:

“ I made profits on commodity trades in 2011. The amount was $20,000. The 1099 from MF Global shows $20,000. However, I have received only $14,000 and probably will not get the entire $20,000. How much do I have to pay tax on?; the $14,000 that I received in 2011 or the 1099 showing that I made the entire $20,000?”

This situation is really two separate tax issues.  The first issue is the reporting of the gain on the 2011 commodity trades.  This $20,000 will be reported in 2011 just like any other year.  The taxpayer had gains of $20,000 in the account and they are taxable as realized (we are assuming these are speculative trades; if a hedge, the amounts may be different).

The second issue is whether there is a “theft” loss due to MF Global’s actions.  If it is finally determined that there is a loss and it is considered theft, then it should be fully deductible in 2012, not 2011.  The tax laws indicate that if the amount of the theft loss is not known by the end of the tax year, the loss is not deductible until the amount is known.  In the MF Global case, that will be 2012 at the earliest and could be 2013.

This is a very complex case, but the bottom line is the loss is not deductible in 2011.

Congress late last week passed a new bill (and President Obama has already indicated he will sign it) to extend the 2% payroll tax cut from February 29, 2012 till the end of 2012.  This means that your employee’s FICA contribution will remain at 4.2% for the rest of the year instead of the schedule return to the normal 6.2% rate.

For self-employed farmers, your total FICA contribution will be 10.4% instead of the normal 12.4%.  As normal, it appears that election year politics is in play here and we would not expect this to continue into 2013.

I have seen several taxpayers calculate their employee’s paychecks for 2011 incorrectly and hope most of our farmers have already updated their payroll system to deduct and pay the proper amount.

With the March 1 farm tax return deadline rapidly approaching, I want to remind our farmers to make sure they actively review their tax return to see if farm income averaging will save them money this year.   Farm income averaging allows you to smooth out your income tax liability for the current year if this year’s income spikes from the previous three years.  Without farm income averaging, a farmer may end up paying tax in a much higher tax bracket than they need to.

For example, let’s assume a farmer had exactly zero taxable income for 2008, 2009,  and 2010.  In 2011, the farmer has taxable income of $270,000.  At this level of taxable income, his income tax for the year would be approximately $66,500 and he would be in the 33% tax bracket.  With farm income averaging, we could assign between $65,100 and $68,000 of income to 2008, 2009 and 2010.  This would soak up the 15% and 10% tax brackets for those years.  We then pretend the farmer paid the respective tax for each year and add those taxes to  the remaining amount taxed in the current year.  This results in  all of the taxable income being taxed at either 15% or10% for a total tax of about $37,200.  By making this election in 2011, the farmer permanently saves over $28,000 of income tax for the year.

This is a great provisions for farmers, but you must review the return to make sure you or your tax advisor took advantage of it.  If you don’t; it can cost you a lot of money.  The rules can be complicated so you need to review it with your tax advisor.

Many farmers want their farm to continue as farmland as long as possible.  In many circumstances, they will donate an easement to a conservation charity that will restrict the land to farming and not allow it to be developed.  In these cases, the tax laws allow the farmer to take a deduction for the “value” that has been lost due to the granting of the easement.

The tricky point is how to you value this easement.  There have been many battles with the IRS over these values and in a recent tax court case involving Esgar Corporation et al, the IRS won.  In this case, the taxpayer argued that the highest and best use for their irrigated farmland in Colorado was for gravel mining since there were gravel pits operating in their immediate vicinity.  The IRS argued that the highest and best use was as irrigated cropland and that is what the court decided.

The Court maintained that the highest and best use for any land is its current use unless the taxpayer can show a compelling reason for a different use.

In this case, the deduction that the taxpayers claimed on their original tax returns was in excess of $2 million and the final number that the court allowed was approximately $100,000.

If you are considering these types of conservation easements, it is very important that a reasonable valuation be obtained and if the conclusion that the highest and best value for your farmland is for other purposes, be prepared for a fight with the IRS.

At the Top Producer Conference, I received several questions for my opinion regarding if Congress will extend bonus depreciation or if they will increase it from 50% to 100% for 2012.  President Obama has already proposed increasing it to 100% for 2012, however, a more major issue is what happens if bonus depreciation stops?

In reviewing several of the farmer tax returns that I have been working on lately; I have noticed that most of them are running out of any depreciation except for what they get from placing equipment in service in the current year.  Therefore, if Congress suddenly stops bonus depreciation in 2013, many farmers will be in the situation of having little or no depreciation deductions, large equipment loan payments and much higher income taxes.  This is what I would call a triple whammy.

I think if they do eliminate bonus depreciation it will be over a couple of years to give the farmer enough time to plan accordingly or there will be an adjustment to Section 179 deduction back to the $500,000 range.  However, we are dealing with Congress and the President, so any prediction is not worth much at this point in time.

If you have never been to a Top Producer Conference, you should go.  It is both informative and entertaining and is well worth attending.

Today was the Tomorrow’s Top Producer at the Chicago Hilton.  Several speakers gave great presentations on various subjects.  Chris Barron of Carson and Barron Farms, Inc. gave a very interesting hour and half seminar on creating effective collaborations of multiple generations of farmers and farms.  This collaboration does not utililize a formal partnership for the operation, but rather gets like minded farmers together that will take advantage of cost savings and efficiencies, while still maintaining what is the most important such as family, friends and relationships.

Most of the partnerships that developed in the 1970s and 1980s to take advantage of cost savings failed since the most important object for them was purely financial.  For Chris and his “partners”, the other non-financial considerations are more important.  That is why I think we will see more and more of these type arrangements, especially with new combines in excess of $350,000, etc.

There were several break-out sessions and I attended one on the quest for 300 bushel yields.  There are 7 key components that get you to this number and some are more important than others.  Since in our area, irrigated corn is consistently in the high 275-300 bushel range, these numbers are very realistic.

I did one break-out session today and I look forward to Thursday when I do three of them.

I will keep you posted.

The Self-Employment (SE) tax rules for 2011 tax returns are different than the rules for 2010 tax returns, which were different than the rules for 2009 tax returns.

The Job Creation Act of 2010 reduced the Social Security tax component of the SE tax from 12.4% to 10.4%, for 2011 only.  Therefore, the SE tax rate on the first $106,800 of 2011 net SE income is “only” 13.3% (10.4% for FICA and 2.9% for Medicare) versus the normal 15.3%.  Since the temporary SE tax reduction only affects the first $106,800 of 2011 net SE income, the maximum amount that a farmer can save is $2,136 ($106,800 times 2%).

What you may not know is that the 2011 above-the-line federal income tax deduction (most states allow the deduction also) remains unchanged.  Before 2011, the deduction was a straightforward 50% of the SE tax bill.  For 2011, the deduction equals 57.51% of the SE tax amount, as long as the amount does not exceed $14,204 (the SE tax on $106,800 of net SE income).  If the SE tax exceeds this amount, you multiply it by 50% and add $1,067.

The effect is to allow a SE tax deduction equal to 50% of what the SE tax bill would have been if the Social Security tax component was the normal 12.4% (instead of the temporary 10.4%).

There has been an extension of this until February 29, 2012 and it may get extended, but we are dealing with Congress on this subject and who knows what will happen.

Also, one additional comment is that the self-employed health insurance premiums allowed as a deduction against SE income for 2010 in arriving at net SE tax owed has been eliminated for 2011.  This means that your SE tax bill will be higher this year than 2010 assuming the same amount of health insurance premiums.

Many of our clients operate their farm operation as either an S or C corporation and in many cases the only employee of the corporation is the farmer and perhaps their spouse and children.  Many of these farmers do not report any wages to them until the fourth quarter of the year.  In these cases, the wages reported in this quarter can easily exceed $20,000.

What many farmers do not realize is if the wages reported for any quarter exceed $20,000, the corporation is now subject to paying Federal Unemployment taxes (FUTA) and in most cases state Unemployment taxes (SUTA).  Although FUTA can be fairly minor (perhaps $42 per person), it can increase to around $400 per person if SUTA is no handled or paid correctly.

In many states, once you are subject to SUTA it can take a minimum of two years to get out of paying it since it requires you to be under the $20,000 quarterly threshold for the current year and the previous year.  Also, these states usually require you to be in the highest rated pool and your tax rate can exceed 3.5% and you would owe SUTA on up to $35,000 in wages or more.

Let’s look at an example, assume the farmer pays himself $50,000 per year in wages all in the fourth quarter.  Let’s assume his SUTA rate is 3.5% on the first $35,000 of wages.  His SUTA liability would be $1,225.  His normal FUTA liability would be 6% of $7,000 or $420, however, since he paid into the State, he is allowed a credit to reduce this liability down to $42 (some states do not get the maximum credit.  We recapped that in a post about two weeks ago).  Therefore, his total SUTA and FUTA liability for 2012 is $1,267.

Now, if the farmer has spread out his wages evenly over the four quarters, he would not owe any FUTA or SUTA.  Also, the payment of commodity wages is exempt from FUTA and SUTA (although you need to check your state rules).

Every state seems to have different rules on the application of SUTA to shareholders of a corporation, but at a minimum if you keep your total wages under $20,000 per quarter, you can save some payroll taxes.