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June 23, 2016 Volume 16, Issue 6 Edited by Will Snell & Phyllis Mattox
Economic & Policy Update
Is Tax Avoidance Holding Your Operation Back? The years leading up to 2015 were some of the most profitable times for production agriculture. Producers in the Kentucky Farm Business Management Program saw record profits. However, significantly lower commodities prices and a decline in farm income occurred last year. During the winter processing season I had a conversation with a local banker discussing the wide differences in both net farm earnings and balance sheet performance across the producers with whom we work. It would be easy to assume that most farmers would have a strong financial cushion in place to weather the recent downturn following the record profits over the last few years. However, this banker (and many other bankers) and I were realizing that there are some producers who are struggling with liquidity. There are producers who do not have money to pay current operating bills.
Is Tax Avoidance Holding Your Operation Back? - Rush H. Midkiff U.S. Ag Trade Balance Deteriorates - Will Snell Estimating Costs for Produce GAP Certification - Brett Wolff - Paul Vijayakumar - Mark Williams How Much Cushion is There in Corn, Soybean and Wheat Stocks for 2016? - Todd Davis
There are many factors that influence an individual’s balance sheet. Age is a big factor, since a balance sheet is a snapshot of what assets, liabilities and net worth are at a given point in time (usually December 31st of each year). A young producer simply has not had as much time during his/her life and business cycle to accumulate assets and retire debt. Family financials, off farm investments and income, or even a day at the horseraces can impact a balance sheet either in a positive or a negative way. However, we noted one thing in this discussion that many producers are doing regardless of their age or experience. Furthermore, unlike some of the others factors that are out of the individuals control (such as being born wealthy), the producer can control this practice. The issue is tax avoidance. Make note, this is not about tax planning but tax avoidance. The majority of taxpayers seek to pay as little tax as possible. I have yet to have a producer get excited during a tax planning visit when it was estimated that their tax liability was higher than they were expecting. Farmers using a cash basis accounting practice are fortunate to have tax planning tools available to prepay expenses and/or defer crop sales. These practices were put into place within our tax code for the simple reason that farmers historically have a lot of variance in their incomes. As many factors can influence yield and commodity prices, farmers can see themselves moving from no income tax liability following a disaster and then swinging to a high tax bracket the following year after a bumper crop. The point of tax planning is to avoid the ebbs and flows and average the liability to most efficiently use the tax brackets. Tax Code Section 179 and Bonus Depreciation are additional tools available to allow business owners (this is not specific to farmers) to accelerate depreciation on capital purchases. The idea behind the tax code here is to encourage businesses to make capital investments, not avoid taxes. Following a great year, a farm family is faced with a sizeable taxable income. They generally start looking at ways to lower their tax obligation. They realize they can greatly reduce their liability by purchasing more inputs, equipment or other farm expenses. However, they often forget these are not a dollar for dollar tradeoff. It is more often a $1.00 for $0.41 trade off. A dollar of additional deductible expense will only save you the marginal tax rate percent. So if you are in the 35% federal and 6% state tax bracket, your $1,000 dollar purchase saved you $410 dollars in taxes. PAGE 2
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Educational programs of Kentucky Cooperative Extension serve all people regardless of race, color, age, sex, religion, disability, or national origin. UNIVERSITY OF KENTUCKY, KENTUCKY STATE UNIVERSITY, U.S. DEPARTMENT OF AGRICULTURE, & KENTJCKY COUNTIES, COOPERATING.
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This is a great planning tool for any item you truly need for your operation. If your equipment line is updated and all of next year’s crop inputs are covered, you just reduced your cash available to service debt or pay rents, payroll, or other operating expenses by $590 dollars for the crop year. A tax adverse producer will look at the tax savings and believe that justifies the purchase. A producer trying to protect working capital will realize the real cost of this purchase to their operation and balance sheet. The previous example was when the purchase was incurred through a cash purchase. However, many “tax avoidance” purchases are done with credit. Doing this just compounds the issue. Let’s assume this farm family wishes to reduce their tax liability by making a purchase with a loan. Working capital is reduced (now there is a current liability), income will have to be generated to service the debt in the next year and the “expense” of the item was taken on the previous year’s tax return. The “tax avoidance” cycle will often be maintained, leading to another purchase the following year. If the above farm family had studied the overall situation at tax time and forecast their upcoming year’s budget, they would have realized that they would have been money ahead and better prepared for the challenging year if they had paid the tax bill and left the cash in their operation. This is true for all farm expenses. Producers should carefully consider before spending money to reduce taxes. Producers should base all farm expenses on making the operation more profitable. After that is decided, use tax planning to take proper advantage of the various tax planning tools. Our industry has historically been one of booms and busts. It is possible for there to be consecutive years that producers will not be profitable, just as we have seen consecutive years at record incomes. By all means producers should make investments in their operations during high profit years, but they need to pay SOME tax and keep cash on their balance sheets. Decisions made with sound agronomic and economic information will always provide the best long-term returns.
Rush H. Midkiff, Pennyroyal Farm Analysis, rush.midkiff@uky.edu
U.S. Ag Trade Balance Deteriorates USDA recently reduced their estimate for U.S. agricultural exports to $124.5 billion for FY 2016, 18% below the FY 2014 record of $152.3 billion. The combination of lower exports and continued growth in U.S. agricultural imports resulted in the U.S. ag trade balance falling to $9.7 billion, its lowest level since 2006. Weak global economies, a stronger U.S. dollar, and abundant world ag supplies have all contributed to the slumping U.S. ag trade environment. Canada is expected to regain its position in 2016 as the world’s largest export customer for U.S. agriculture, replacing China.
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Estimating Costs for Produce GAP Certification For produce growers selling to larger buyers, assuring food safety has become another cost of doing business. Complying with standards will likely require additional training and financial investment. The Food Safety Modernization Act is federal law and will affect different producers in different ways, but it is not the focus of this discussion (for more information see IP-78). GAP certification (via third-party audit) is a buyer-driven requirement — not a legal one — and different buyers have different standards. Note that this is different and more rigorous than the “GAP Training” delivered through a KDA-CES partnership. Producers who are interested in accessing larger markets should ask their target buyers if they require GAP Certification (most now do) and which certifications they accept. Common standards include Primus, GFSI, and the USDA Harmonized GAP audit. In this discussion, we focus on the USDA certification. The costs of a USDA GAP audit can be broken down into two categories: on-farm changes, and the audit itself. On-farm changes will vary widely by farm and the associated costs will also be highly variable. Many are simple, common-sense, and low-cost adjustments. Some examples of these costs from a UK GAP-certified demonstration operation are:
Item Washwater Sanitizer, Test Strips & Pump Shut off Valve Food Grade Lubricants, Bleach Labels Lidded Bins & Plastic Pallets Pest Traps
Total Upgrades
Cost* $431.00 $30.00 $48.00 $75.00 $616.00 $47.97
$1247.97
*Costs are specific to UK GAP demonstration facility. Actual costs for your operation will vary. This does not account for labor costs of record keeping & training.
The costs of the audit itself are considerably more predictable. In the case of USDA audits, producers have to pay (1) a flat fee of $50 and (2) the auditor’s time — including travel — at a rate of $92 per hour. Audits are scheduled during harvest, and most growers in Kentucky will be audited 1 to 3 times during each growing season. Those producing a single short-season crop (i.e. strawberries) may only need 1 audit while those growing multiple crop-types (leafy greens, tomatoes, potatoes and apples) across a long growing season may need 3 or more audits per season. The amount of time the auditor spends on a farm will depend on how prepared the grower is and the complexity of the operation. Travel times will depend on the farm’s location. Conservative estimates of 2-6 hours for the audit and 3-4 hours round trip travel would mean a projected cost of $500-1000 per audit. In the case of the UK GAP-certified demonstration facility the first audit took 4.5 hours with 3 hours travel, and cost $690. The follow-up audit took 1.5 hours and 1.5 hours travel and cost $276, for a total annual audit cost of $966. Growers in a similar geographic area can coordinate their GAP audits to share the cost of travel and reduce individual economic burden. There may also be funding available through a KY Department of Agriculture cost-share to further defray the costs. Questions on this program should be directed to Josh Lindau (joshua.Lindau@ky.gov) Assuring food safety is a vital component of today’s food marketing system. As producers evaluate different marketing options, it is crucial that they investigate the food safety requirements of their buyers, and factor those costs into their profitability estimates. Dr. Paul Vijayakumar is leading produce food safety programming at the University of Kentucky. Contact him for questions at paul.v@uky.edu.
Brett Wolff, Senior Extension Associate, brett.wolff@uky.edu Dr. Paul Vijayakumar, Extension Specialist UK Animal & Food Science, paul.v@uky.edu Dr. Mark Williams, Professor of Horticulture, mark.williams@uky.edu
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How Much Cushion is there in Corn, Soybean and Wheat Stocks for 2016?
22% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0%
12.6%
The USDA Baseline released in February projected corn stocks-use at 14.4% which would have been the largest since 2005. Current projected stocks-use of 14.2% would still be the largest since 2005 but the forecasts are moving in the right direction to provide some price support.
DEC Baseline
How quickly the grain and oilseed fundamentals can change. Throughout the 2015 corn and soybean harvest and the winter Extension meeting season, corn and soybean fundamentals were bearish as both domestic and global stocks for 2016-17 were projected to build to a near burdensome level to dampen price. Drought in Brazil impacting their second corn crop coupled with flooding in Argentina reducing the soybean crop has breathed new life into those markets.
The corn market has adequate cushion to withstand a slightly below-trend yield shock. For example, if the 2016 corn crop is reduced by 591 million bushels (4%) from the June estimate, the 2016-17 stocks-use ratio could drop to 10% assuming no other changes in the supply-demand balance sheet. The point being is that a 4% smaller crop could reduce stocks to a level that could start to support higher prices.
15.2% 14.4%
May WASDE
June WASDE
FEB Baseline
2014
2015
2013
2011
2012
2010
2008
2009
2006
2007
2004
2005
2003
2001
2002
14.2%
Figure 1. Historical and Projected U.S. Corn Stocks – Use Ratio from 2001 to 2016 (Forecast).
Figure 2 illustrates how the soybean market converted from a bearish story of building domestic and global stocks to one with shrinking domestic and global stocks. PAGE 8 PAGE 5 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0%
11.4% 8.0%
10.9%
Figure 2. Historical and Projected U.S. Soybean Stocks – Use Ratio from 2001 to 2016 (Forecast).
June WASDE
May WASDE
FEB Baseline
DEC Baseline
2014
2015
2013
2011
2012
2010
2009
2007
2008
2006
2004
2005
2003
2001
2002
6.6%
The tightening soybeans stocks-use ratio has been dramatic from the February Baseline estimate to the June report. The soybean market was expecting the 2016 stocks-use ratio at 11.4% which would have been the largest ratio since 2006. The strong crush and export demand coupled with fewer acres planted than projected in February has dropped the ratio to a projected 6.6% in the June report. As projected ending-stocks tighten, there is a smaller cushion for a production shock in soybeans. For example, a 2.5% smaller crop (93.4 million bushels) than currently projected could bring the stocks-use ratio to 4.2% which is at the theoretical pipeline minimum level for the soybean market.
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Precision Conservation Management Program Announced 55% 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0%
47.3%
49.5% 49.3%
Figure 3. Historical and Projected U.S. Wheat Stocks – Use Ratio from 2001 to 2016 (Forecast).
May WASDE
June WASDE
FEB Baseline
2015
DEC Baseline
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
42.8%
The story for wheat is not as optimistic as for corn or soybeans. While the USDA has made marginal adjustments to the stocks-use ratio since February, a massive production problem or massive surge in use is needed to drop stocks to a level more in line with projected use to support higher prices. For example, if the 2016 wheat crop was reduced by 519 million bushels (25%) from the June projections (and all other supply/demand factors remain unchanged), the stocks-use ratio would drop to 25% which is slightly larger than the stocks-use ratio for the 2013-14 marketing-year. The winter wheat crop is looking to be high yielding so that type of a production loss doesn’t appear to be likely for 2016.
The take away message is that a weather market could have a dramatic impact on the soybean market as it currently has the smallest projected cushion in ending-stocks. Farmers should consider pricing some expected corn and soybean production at profitable prices but recognize the next month will impact the corn crop while August weather will drive soybean production. Todd Davis, Assistant Extension Professor, todd.davis@uky.edu
University of Kentucky Department of Agricultural Economics 315 Charles E. Barnhart Bldg. Lexington, KY 40546-0276 Phone: 859-257-7288 Fax: 859-257-7290 http://www.uky.edu/Ag/AgEcon/extbluesheet.php
Economic & Policy Update View all issues online at http://www.uky.edu/Ag/AgEcon/extbluesheet.php
Educational programs of Kentucky Cooperative Extension serve all people regardless of race, color, age, sex, religion, disability, or national origin. UNIVERSITY OF KENTUCKY, KENTUCKY STATE UNIVERSITY, U.S. DEPARTMENT OF AGRICULTURE, & KENTJCKY COUNTIES, COOPERATING.