I was watching Agday yesterday and noted in the business section that Mark Gold of Top-Third Marketing was the guest and had a discussion on how gross revenue per acre was more important than yield per acre.  His insight is that it can be more important to budget for getting top marketing dollars for your crop than to worry about the greatest yield per acre.  With the improvements in technology, a farmer can get great yields on their crops, however, if they end up with the bottom third for their price, they will end up net losers for the crop year.

I believe that you need to take this concept one step further and key in on net revenue per acre, not gross revenue.  My definition of net revenue per acre is to take your gross revenues from crop sales and government payments and then subtract all direct input costs related to this crop.  For example, lets take two farms.  One farmer is able to achieve 175 bushels of corn per acre and sells it for $3.75.  The farmer spends $300 per acre on direct inputs (fertilizer, oil and gas, labor, etc.).  The other farmer only gets 160 bushels per acre, however, they sell it for $4.00 per bushel and only spends $250 per acre on direct input costs.  Which farmer makes the most money?

The answer is the second farmer.  Farmer number 1 has gross revenue of $656.25 per acre and net revenue per acre of $356.25.  Farmer # 2 only has gross revenue per acre of $640.00 per acre, however their net revenue is $390.00 per acre which is about $34 higher than farmer number 1.

As you can see, a farmer needs to key in on maximizing their net revenue per acre, not just the yield per acre.

It is projected by 2019 that Russia may become the world’s largest wheat exporter and Russian, Ukranian and Kazakhstan (RUK) wheat exports collectively may double the United States wheat exports according to the June 2010 issue of Amber Waves.  This growth in wheat exports may help mitigate global food security concerns and help offset the the shift in US acreage to corn, soybeans and other more profitable crops.

USDA is projecting that wheat exports by there three counties could increase by about 50 percent to over 50 million metric tons by 2019 or about 1.9 billion bushels.  The region may account for over half of the increase in wheat exports and could supplant the US as the “wheat breadbasket of the world”.

The US has been in second place since World War II but could easily slip to second place especially if the trend to more corn and bean acres at the expense of wheat production continues.

The US share of wheat exports may drop from the current 24 percent range for 2001-09 to an estimated 16 percent by 2019.  The European Union, Canada and Argentina will also lose market share while Australia is expected to remain flat.  The three former Soviet Union counties should see their market share go less than 20 percent to over 33 percent by 2019.

There are two main reasons why RUK have become larger wheat exporters.

1. The region’s transition from planned to market-orientated economies that began with collapse of the former USSR in the early 1990s.  During the late Soviet period of 1987-91, the USSR imported 35 mmt of grain, while in 2009, the former USSR nations exported nearly 55 mmt.  This is a turnaround of over 90 mmt or about 3 billion bushels of grain.  Also, the large contraction in the livestock sectors led to market driven importation of meat and exports of grain.
2. The region’s yield has risen steadily during the 2000s.  During the 1990s, wheat yields actually decreased primarily due to bad weather and a lack of inputs, especially fertilizer.  However, during the 2000s, wheat yields have risen about 32 percent in Russia and about 25 percent in Kazakhstan.  A lot of this increase is due to the large vertically integrated enterprises that are in charge of the crop from the very beginning to the final wheat sale.

If the world market for grain was expected to remain steady, this increase in Soviet production could lead to much lower prices, however, the world will add another 750,000 or so people over the next 10 years and they will eat a lot of wheat so wheat prices may actually rise over this period.

The April 29, 2010 issue of Bloomberg Businessweek had a good article on how the seed companies are developing drought resistant corn seed that may expand the corn belt farther into Kansas, Nebraska, and Oklahoma.

Another benefit of the seed is a reduction in the amount of irrigation that is needed.  This can lead to reduced crop insurance premiums and can boost the value of this crop land.  Also, the article states that agriculture accounts for 70% of global freshwater use and the single biggest issue facing agriculture is the availability of water.  By creating seed that uses less irrigation water or requires less natural water, a farmer can increase their net income, and in some cases, substantially.

Dupont indicates that in their test trials, the new seeds are creating yields that about 6% better than the old seeds.  Syngenta is aiming for a 10% increase in yields.  The seed companies believe that by 2020, over 55 million acres of corn will be planted with the new drought resistant seed. 

If a farmer’s old corn yield was 120 bushels per acre and they can create a 10% yield increase at $3.50 bushel price, this would increase the net bottom line by about $42 per acre less any increase in seed cost plus any reduction in irrigation costs.  This can be a substantial increase to the bottom line.

Congress recently passed the Hiring Incentives to Restore Employment (HIRE) Act.  This act provided a couple of new credits that in a lot of cases will help our farmers.

The first credit is basically a direct reduction in the 6.2% employer FICA cost for new employees hired who have been un-employed after March 18, 2010 and before the end of the year.  This credit will be claimed on your form 941 (or in most cases, the form 943 filed by farmers at the end of the year).  In order to claim the credit, you must get a Form W-11  from the employee that states they have not been employed for the previous 60 days.  This credit can add up fairly fast.

For example, assume a dairy farmer hires three new employees making $3,000 per month who were un-employed.  For the nine months ended December 31, 2010, they would have been paid $81,000 in wages and the employer’s FICA portion would have been $5,022.  This cost is completely eliminated by the Act.  This also allows you not to have to make this deposit during the year.

The IRS has a nice question and answer page regarding this new credit.

The other credit is a general business credit of up to $1,000 per employee hired that you can claim on your 2011 tax return.  To claim this credit, you must have retained the employee for 52 consecutive weeks and the credit is equal to the lessor of $1,000 or the 6.2% of wages paid.  If you pay wages of at least $16,129, then you will qualify for the maximum credit.  Again, this is a business credit, so you are not guaranteed an immediate benefit and you will need to reduce your wage deduction by the amount of the credit.

Again, the IRS has a question and answer page on this particular credit.

Although I am usually on the other side from the IRS, I will admit that their web-site is one of the best sites I have used for accessing tax information.  The recent Health Care Reform law enacted a new employer credit for certain employers who pay for their employee’s health care premiums.  I would estimate that 90% or more of the farmers will qualify for this credit if they pay their employees premiums.

To be eligible, you must be a small employer as follows:

• You employ on average less than 25 full-time equivalent employees during the year.   The way to calculate this is to take your total paid employee hours (but subtract any hours for employees that work more than 2,080 hours in the year) and then divide by 2,080 (number of hours in a 52 week / 40 hour per week).  If the number is less than 25, you qualify, if more than 25, you do not qualify.
• The average wage paid to your employees is less than $50,000 per year.  Again, you will most likely have to do this calculations using the FTE examples.
• The employer must pay the health insurance premiums under a “qualifying arrangement”.

A qualifying arrangement” is where the employer pays at least 50% of the employees health insurance (assuming a single employee).  The amount of the premium that is eligible for the credit is based upon the actual premium paid by the employer.  This amount is also subject to a cap based upon what the employer’s premiums would have been for the small group market for their state (or states).  Also, if the employer pays 80% of the premium, then this cap is based upon 80% also.

The maximum credit for years 2010 to 2013 is 35%.

Let’s take an example for 2010.  If the farmer employs 10 employees and pays and average wage of $24,000 and pays $45,000 in health insurance premiums for the year and this amount is more than 50% of the total health insurance premiums, the credit would be 35% of $45,000 or $15,750.

This credit is reduced if you employ more than 10 FTE or your average annual wage is more than $25,000.

In determining your FTE for the year, you do not include any seasonal employees which is based upon working less than 120 days during the year.

You do not include yourself or any of your family in arriving at determining FTE, however, you also do not get the credit for any of these premiums paid.

This credit is treated as a general business credit which means you have to have income tax to offset the credit.  If the credit is not used completely, the amount not used can be carried back one year and forward 20 years.

Another negative to the credit is that you must reduce your health insurance deduction by the amount of the credit.

For 2010, all employee health insurance premiums paid qualify for the credit (even though paid before the law was enacted).

In my opinion, a farmer who has more than $200,000 in taxable income will generally take advantage of the credit since they will normally be able to offset the credit against their income tax.  For those farmers with taxable income between $100,000 and $200,000, the credit will probably be better than the deduction, but certainly not in all cases.  For farmers under $100,000 of taxable income, in many cases taking a full deduction will be better than the credit since it will reduce self-employment income and in most cases, the farmer will not have enough regular income tax to offset the credit.

You will need to review this each year to determine which method works best for you.

The IRS has a more detailed question and answer memo on the credit.

For the last couple of years, farmers and other taxpayers have enjoyed a very low tax rate on dividend income.  This income used to be taxed at regular income tax rates (as high as 50% when combined with some state and city taxes).  However, starting a couple of years ago, the top rate on dividend income was 15% for federal and if you were in the 15% tax bracket, this rate was zero.

Beginning January 1, 2011, this special rate is scheduled to disappear.  The problem is that we are not sure what the new rate will be.  There is a chance that dividend tax rates will continue to be taxed the same as capital gains.  These rates are currently scheduled to go from 15% to 20%.  There is also a good chance that dividend tax rates will go back to the regular tax rates.

Under this scenario, the top tax rate on dividends would probably by 39.6% in 2011 and beginning in 2013, this top rate would go up another 3.8% if your income exceeds $200k or $250 for married couples.  This extra rate is due to the new Health Care Reform Law that was recently enacted.

In that law, the current Medicare tax of 2.9% on wages and self-employment income is scheduled to increase by .9% for people earning more than $200k or $250k for married couples.  In addition, Congress decided to make the Medicare tax due on almost all unearned income for those taxpayers making the same amount of money.

Therefore, there is potential for the top tax rate on dividends to go from 15% federal to a minimum of 43.5% (plus there are some other phase-outs that might get the top rate over 45%).

What does this mean for you for 2010.  The key thing is to review your income tax situation and if you have a C corporation, determine whether you need to distribute retained earnings a s a dividend to take advantage of the current low rates.  If you are in the 15% tax bracket, make sure to distribute enough dividends to soak up this tax bracket since they would be tax free.

Let’s take an example of a farmer with a C corporation who is nearing retirement and wants to liquidate his corporation.  Lets assume there is $400,000 of retained earnings.  If they distribute the income in 2010, there total tax bill would be $60,000 (assuming no state income taxes).  If they wait until 2011, and pay the maximum rate, then the tax bill might be about $158,000 and if they wait until 2013, then the tax bill might be as high as $174,000.  As you can see, it makes sense to consider distributing the income this year.

We should know in the next few months what Congress plans to do, however, the surest thing I know now is that the dividend tax rate will most likely be higher in 2011.

I have taken a couple of days off from writing a post due to tax season ending on April 15.  As a CPA, you tend to build up a large adrenalin rush until April 15 and then it takes a big dump and all you want to do is nothing and get a lot of sleep.  I now seem to be recovered and should get back to my normal posting schedule.

I also want to let my readers know that I will be taking my BMW motorcycle on a cross country trip beginning on or around May 10 and returning on or around May 23.  I will be traveling from Washington state to a wedding in Kansas.  From Kansas I am going to Los Angeles and then heading north back to Yakima.  I will try to write a few posts about the trip while I am gone assuming I get good access to a computer.  These posts will probably be more of a personal nature, but I will try to incorporate some tax or farming issues if they are pertinent.

Now for the blog post.

About a year ago, I had a client that was involved in a small sub-division in the local area.  He was a 50/50 partner with another person.  The lots were listed for sale for about $45,000, however, the project was not quite complete.  With the downturn in the economy, the client decided to sell his 50% interest in the LLC back to his partner.  The consideration was no cash and the other partner would take over the debt.

The client went on his merry way until he got a call from the State of Washington wanting the excise taxes that he owed on the transfer.  In our state (and there are many others just like it), if you sell a 50% or more interest in an LLC during a 12 month period, then you owe the real estate excise tax on the full fair market value of the property excluding any debt.  Even though you only sold 50%, you owe the excise tax on the full 100% of value.

In this case, there were let’s say about 50 lots advertised at $45,000, so the state assessed the excise tax of about 1.9% on $2,250,000 or about $42,750.  He had to pay  the whole excise tax even though not one of the lots had ever sold and the actual value of each lot was probably closer to $25,000 at that time.

Now, what I think is even more of money grab by the state is when the lots are actually sold, then the excise tax of 1.9% is, you guessed it, owed again.  There is no credit to offset any of the tax previously paid.

I now recommend that any of my clients that are involved in a 50/50 LLC and want to get out of the LLC, to only sell 49.5% of the LLC and wait over a year to sell the remaining .5% interest.

For many of our farmers who are doing succession planning to their children, they need to make sure to watch out for these excise taxes.

In my previous post, I discussed a situation that applies to many farmers where there was joint ownership of land and whether a partnership tax return is required to be filed.  In that post, I indicated that in many cases, a partnership tax return is required and if one is not filed, then the penalty starting this year is much higher than it has been in the past.

With this post, we will review how to elect not to file a partnership tax return and the advantages to doing it.  In many cases, the mere co-ownership of farm land that is rented to a farm will not be classified as a partnership, however, it is very easy for the landlords to get tripped up in the process.  If the ownership is set up in an new LLC, then usually the IRS is going to assume the entity is a partnership.

The benefits of electing out of a partnership are as follows:

• The owners may make tax elections that are different from each other;
• The loss limitations at the partnership level will not apply;
• You will not be required to file a partnership income tax return.  This can not only save you the cost of preparing a return, but in certain states such as California, the fee to file a partnership tax return (structured as an LLC) can be in excess of $5,000 annually.

If you have determined that you do not want to be a partnership, then the election must be made with the tax return in the year that you want to elect out of the partnership rules.  The partners must all consent to this election.  Even if you fail to make the proper election, it may nonetheless be deemed to have occurred if your facts and circumstances indicate that you intended to do this from the entity inception.

Another important rule is that this election is only available for passive farm rental operations.  If you are a farm partnership performing farm services, you can not elect out of the partnership rules.

My next post, however, will discuss allowing husband and wives to elect out farm operating partnerships.

I think that most farmers know that the residential and commercial real estate markets have gone through dramatic changes in the last few years.  I know that in our area that residential prices peaked out about three years ago and in many of the cities near me the price is at least 50% below the peak.

Many would ask how that might affect you as a farmer.  The affect may come when you get your real estate tax bill for this year or next.   Most think that if the value of your property increases, then your property tax bill with increase or vice versus.  The reality is that it is the change in value of your property versus all other properties that determines your property bill.  Most of the taxes that are raised and paid by real estate taxes are of a fixed nature.  Therefore, the value of the property is just a mechanism to allocate the total taxes owed.

Lets take an example:

Suppose the county is raising $1,000 in taxes for the year and you have a farm worth $500,000 and your neighbor has a house that is worth $500,000.  This means that 50% of the total taxes raised will be allocated to each of you.  You are your neighbor will each pay $500.  Now lets say that your farm increases in value to $750,000 this year and your neighbor’s house drops in value to $250,000.  Then your tax bill will go from $500 to $750 and your neighbor’s bill will drop to $250.

In many states with large farmland concentrations, this valuation adjustment has already happened or may happen this year.  This means that your property tax bill may go up even more than the value of your land has risen.  There may not be much you can do about it, but you need to know that it can happen.

Bruce Johnson of the Department of Agricultural Economics from the University of Nebraska has a very good power point presentation on this issue for Nebraska farmers, however, the concepts apply to any farm operation.

For many years the IRS battled with taxpayers regarding whether Conservation Reserve Program (CRP) payments received by retired taxpayers were subject to self-employment taxes.  The taxpayers argued that once a farmer is retired, the payments are simply rent payments and not subject to these taxes.

The IRS countered that the payments are still subject to SE tax in many cases.  This argument went on for many years with various court cases deciding the issue one way or the other.

Congress finally decided to stop part of the argument by passing a law a couple of years ago that stated if a farmer is collecting social security payments, then all CRP payments are exempt from self-employment tax.  This is true even if the farmer is still actively farming.  This law is in effect for any payments received after December 31, 2007.

When you prepare your form SE to show your income subject to self-employment taxes, you will back out these payments in arriving at your net SE earnings.

The argument is still alive regarding receiving CRP after a farmer retires and before they start collecting social security benefits.

If this situation applies to you, make sure to discuss it with your tax advisor.