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

One of the great options open to farmers is to pay their employees in-kind wages.  In-kind wages are the payments of the crops that a farmer grows.  For example, a farmer could pay their employees either cash wages of $10,000 or 1,000 bushels of soybeans worth $10,000.  The reason that a farmer would want to do this is that in-kind wages are not subject to self-employment taxes.  On $50,000 of these types of wages, the savings to the farmer and employee would total about $7,500.

Generally, we suggest using these types of wages where the farmer has a C corporation set up to do the farming operation and it will pay some of the farmer’s wages in-kind.  The structure of these wages is very important since if the IRS determines these are a cash equivalent, then the wages are subject to payroll taxes.

Wages paid in-kind are crops that are transferred from the employer and put into the name of the employee.  The employee then has the risk and reward due to the fluctuations in the value of the crop.  For example, the employer may transfer 1,000 bushels of beans to the employee at $10 per bushel or a total in-kind wage of $10,000.  This amount is reported to the IRS on the employee’s W-2.  After receiving the 1,000 bushel of beans, the employee will determine when and if they want to sell the beans.  If the beans go up in value by 50 cents a bushel, the employee will report a short-term capital gain of $500 (if held more than a year, then it is long-term).  Conversely, if the beans drop in value by 50 cents, they will report a short-term capital loss of $500.

The highlights of what is required to qualify is as follows:

• Did your employees perform agricultural related work?
• Did you pay the employees in commodities raised and harvested on your farm?
• Did you pay them a partial cash wage?
• Did you have an employment contract with the following:
  • Was it written
  • Was the employee’s duties defined as Agricultural labor
  • Did it state the employee would be paid a commodity wage
  • Did it state the type of commodity
  • Did it state the quantity of the commodity
  • Was it signed by both the employer and employee
  • Was it notorized on the date of the agreement
• Did the employer remove the lein, if any, on the commodity paid to the employee?
• Was the grain in open storage and not a warehouse receipt?
• Was the grain readily marketable and not contracted for sale?
• Did the employer notify the warehouse to transfer the commodity to the employee?
• Do you have bill of sale for the transfer
• Will the employee be responsible for the following:
  • Assuming the risk of loss due to price fluctuations, damage, death, etc.
  • Assuming the costs of owning and maintaining the commodity
  • Holding the commodity long enough to prove ownership and control
  • Marketing the commodities themselves

Again, these wages normally work best between a corporation owned by the farmer and the farmer as employee.  You still should make sure to pay enough cash wages to provide four full quarters of credit for social security purposes.

This is a complicated part of farm employment and make sure to review this with appropirate legal and tax advisors to enjoy the benefit.

Kiplinger magazine has an article on a great way to borrow money from the government on an interest-free basis and, then pay it back and start getting extra benefits.  This method applies to all people who apply for social security.  It allows them to start their benefits at age 62, collect and invest the money until age 70.  If they do not need the money to live on, they can invest the monthly payments, collect interest and then simply pay the principal back.  Once they pay the principal back, they can then start receiving a much larger monthly benefit

For example, assume someone starts social security at age 62, receiving $750 per month.  From 62 to 70, they would receive a total of $72,000.  If they invest this at 8%, they would have a total of $101,000 at age 70.   To complete the do-over, they would repay $72,000, have a profit of $29,000 and start receiving a  new monthly benefit of $1,320.  If they live to age 85, they would get total benefits of about $237,600 with the do-over versus about $135,000 without.

The amount that they pay back also qualifies for an income tax deduction.  This provision has been around since at least the 1940′s, however, with the Baby Boomers starting to retire, this will become much more prevalent.

If you have started social security or are approaching retirement age, please review this option with your financial advisor.  Read the rest of this entry »