Since the June crop report came out, wheat has rallied over a $1 per bushel, corn is up about 50 cents and soybeans have rallied also.  Now, it appears that the world wheat supply is looking at drought issues around the world (except for our hemisphere it seems) and this is continuing to help wheat prices rally.

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.

The large health care act passed earlier this year had an up to 35% credit available to farmers who paid for health insurance for their employees.  The credit is based upon the percentage amount of health insurance that a farmer pays times 35%.  As long as you pay at least 50% of the premiums for your employees, then the credit is based upon the amount paid times 35%.

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.

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.

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.

Dave Kohl is an ag economist who writes the Road Warrior of Agriculture for Corn and Soybeans Digest.  His columns are usually very insightful regarding economic issues related to agriculture.  Back in March, he had an article regarding working capital being the financial shock absorber for farms and business.

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.

TierOne Bank of Lincoln, Nebraska was closed by the FDIC on June 4, 2010 and then sold to Great Western Bank of Sioux Falls, South Dakato which is a subsidiary of National Australia Bank, a large agricultural lender that has expanded its farm-based lending in the United States and appears ready to continue to expand into this sector.

TierOne Bank had 69 branches and about $1.9 billion in assets.  After the purchase, it appears that Great Western Bank will be about $7.5 billion in assets and most of this is based in the ag states of South Dakota, Iowa, Nebraska, Kansas and Missouri.

They are quoted as saying that they continue to want to acquire other farm-orientated banks in the Midwest.  With Bank of the West being owned by a French bank and the large Dutch bank RaboBank expanding in the US, this trend of banking to the farm sector by foreign owned banks will continue.  If the foreign banks have large capital cushions, then this will probably be a good thing for farmers.  If there capital cushion is low, then at the first sign on trouble, these banks may be the first ones to be sold or liquidated.

I had a post from about two weeks ago about the USDA predicting that Russia would become a larger exporter of wheat than the US by about 2019.

Bloomberg Businessweek just wrote an article on how Russia is fighting for World Dominance – in Wheat!.  The article recaps that Russia is able to sell their wheat to Egypt for about 7% cheaper than what the US can sell it for.  During the last 11 months, they have garnered about 58% of the Egypt market versus about 40% for the year before.  Our share fell from 13% to 8%.

During the 1990′s, Russia was actually a net importer of wheat due to their farms being so inefficient from decades of ruinous Soviet practices.  However, starting in 2002, the region emerged as major exporter by selling about 600 million bushels of wheat.

During the 2008 global grain rally, Swedish, British, Chinese and Korean investors have piled into Russian farmland.  Today, Russia exports about 14% of the world’s wheat, up from 0.5% in 2000.  The US share has slipped from 26% to 19%.

Russia created a new state company, United Grain in 2009 to modernize the storage and shipment of wheat in a $3.3 billion overhaul.  United Grain is also pursuing more deals in Southeast Asia and Latin America which have long been strongholds for US and Australia growers.

Valars Group which is the third largest wheat exporter in Russia has spent $250 million on farmland and $108 million on equipment since 2006, the year it was founded.  One of their farms is about 100,000 acres and last year it yielded on average about 65 bushels per acre which is on par with our yields here in the US.  They are using New Holland tractors and combines instead of the old Russian machinery which now sits in storage all rusted out.

However, the Russians did buy their land and equipment at the peak of the market and they indicate that they are struggling to pay off their debts and may have to sell shares in the market to pay down the debt.  During the last year, wheat growing brought “zero” profit after the plunge in prices.  The Grain Union is asking for $320 million in subsidies to improve the profitability of exports.  Such state aid could help Russia’s growers compete even more ferociously with the US on price.

My post from yesterday resulted in several comments and questions that I would like to respond to.

One comment is that code section 4975 deals with prohibited transactions regarding you and your pension plan or IRA.  There are severe penalties for not obeying the rules regarding these transactions.  However, if you obey the rules, the penalties do not apply to you.  I sometimes find that other tax advisers are not comfortable with these rules and would rather not have to deal with these types of transactions, however, if you follow the rules and use a company that is extremely familiar with the rules, you should be in compliance.

The majority of these rules do not allow you to sell or rent land, equipment, etc. between your pension plan or IRA and yourself.  However, in my post yesterday, the transaction described involved the purchase of the employer’s stock directly from the employer to the pension plan.  This is one of the transactions allowed by the code as long as you follow the rules.

Another question was whether you can use an IRA to do this.  The general answer is no, however, in most cases, once you set up your 401(k) or other pension plan with your new corporation, you can roll over your IRA to the pension plan and then have it purchase the stock.  This will allow you to use the IRA in an indirect way.  Certain types of IRA rollovers may not work, so like in call cases with my posts regarding tax laws, talk this over with your qualified tax advisor. 

Another question asked if you could purchase farm land using this method.  The answer is yes, no and maybe.  For it to be yes, the corporation would need to purchase the land if you are going to farm it.  If you are simply purchasing the farmland to rent out to a non-related third party, you can use the IRA or pension plan to purchase the land directly.  However, if you fund any of the purchase with debt, there are several rules that come into play.  You can not personally guarantee the debt.  In most cases, it would need to be seller financing for the deal to work.  If you personally are going to farm the land, then you can not have the IRA or pension plan own the land and rent it to you.

I know that many of our readers currently have jobs not related to farming, however, you would like to leave that job and start farming on a full-time basis.   One of the major drawbacks to doing this is the lack of capital.  However, many of you could have a substantial asset that you could tap to create the working capital needed to get started in farming.  This asset is your 401(k) plan.

Here is how it works:

• You will need to create a corporation (generally taxed as a C corporation).
• This corporation will establish a 401(k) plan.
• You will roll over your current 401(k) at the old employer into this new 401(k) plan.
• The new 401(k) plan will then purchase shares in the new corporation and will become an owner of the corporation (this is very similar to an ESOP).
• The money put into the corporation becomes the working capital that the corporation can use to purchase equipment, plant crops, etc.

There is no limit on how much stock the 401(k) can purchase.  This means, that unlike borrowing money from a 401(k) plan which is limited to $50,000 or cashing in the plan and paying taxes and a 10% penalty on the funds received, you are able to maximize the amount of capital you can put into the farm business.

There is a recent article in Bloomberg Businessweek concerning this type of transaction.  The primary topic of the article is that the IRS has noted some abuses in this type of transaction.  Some taxpayers have set up a corporation simply to purchase a motor home, etc.  This will most likely get disallowed on an audit.  However, if you are using the cash to create a farming entity and will be actively farming, there should be no issue with using your 401(k) to fund it.

As in all cases, you need to discuss this with your tax advisor.  Also, the article does refer to a company that has helped do several hundreds of these transactions.

In my post yesterday, I indicated that maximizing your net return per acre was more important than the most yield per acre.  One of our readers wrote a great comment regarding how their operation tries to maximize their yield to achieve the most net revenue per acre.

My post should have stressed that your farm operation should try to maximize your yield up to what I call the point of diminishing returns.  For example, if you can increase your yield by an extra 10 bushels (for corn) by spending $15 on good seed or fertilizer, then your return at $4 corn is $40/$15 or 2.67 to one.  As you do your analysis for your farm, anytime this number is greater than 2, it makes sense to spend the extra money.

If the number is between 1 and 2, then you need to crunch your numbers and get comfortable with your probability of the extra yield happening.  For example, if you think you can make an extra $20 per acre by spending $10, your ratio is 2 to 1, however, if the chance of this happening is 50%, your expected ratio becomes 1 to 1.  At this point, you are simply at the break even point and you are not receiving any extra to cover your overhead related to this extra cost.

If you were to chart your options related to maximizing your yield compared to your input costs, the return yield to cost would look very similar to the horsepower chart on my BMW motorcycle.  As I add RPM, the horsepower output increases at about a 45 degree angle up to about 8,000 RPM.  At this point, as I add more RPM, the horsepower output slightly increases and then as I get near the redline, the horsepower starts to drop off dramatically.

In your farm operation, try to determine where the extra yield maximizes the return to the bottom line.