Each month in Wallaces Farmer magazine, the Timely Tips panel answers questions sent by readers. Members of the Timely Tips panel are Alejandro Plastina and Wendong Zhang, Extension economists, Iowa State University; Leslie Miller, Marion County Savings Bank, Knoxville; and Rob Stout, Master Farmer, Washington, Iowa.
A lot of government income has flowed to farmers in 2020 and could be causing tax problems for some. The issue of income tax liability around crop insurance indemnity payments, government payments, and property or casualty claims are front and center for many Iowa producers. What are the key questions I should ask my tax preparer before the end of 2020? In order to manage income taxes efficiently, what options are available to manage income?
Stout: You are asking about ways to reduce your 2020 tax liability. If you have a lot of crop insurance payments, you can delay the income until the following year, as long as you are a cash-basis taxpayer. I believe payments from the Coronavirus Food Assistance Program, Market Facilitation Program, and the Agriculture Risk Coverage and Price Loss Coverage programs will be taxed in the year received.
If you have property damaged such as machinery or buildings, the casualty insurance gain could be substantial if your basis is low because of partially or fully depreciating the items in the past. If you replace the items, then you can take Section 179 or a faster method of depreciation that would balance that some. If you are in a federally declared disaster county, there are special rules that allow you to not have to replace the property with like property and still use it for tax purposes.
For instance, you could replace a destroyed building with a tractor. Check with your tax preparer for details before you assume this for sure. Other things you can do are to defer any crop sales payments you haven’t yet received until after the first of the year. You can also pay for 2021 crop inputs such as seed, fertilizer and chemicals in 2020 to lower taxable income. Meet with your tax preparer as soon as possible to make plans.
Plastina: Consulting with your tax adviser before the end of the year is the right thing to do. There is no one-size-fits-all income tax management strategy. The alternatives to contemplate depend on whether you are a cash-basis or an accrual-basis taxpayer. Prepaying expenses and deferring income from grain sales and crop insurance indemnities are possible alternatives for cash-basis taxpayers, but not for accrual-basis taxpayers.
Section 179 and bonus depreciation, contributions to retirement plans and college savings plans, and gifting grain (bushels, not cash) to charity are options to contemplate by both types of taxpayers. A tax adviser should explain the applicability of each alternative and its consequences for federal, state, and self-employment taxes.
For example, Section 179 can only be used to expense new assets, and it reduces the federal and state taxable incomes, while bonus depreciation can be used to expense new or used assets, but it only reduces the federal taxable income in the state of Iowa. An article by Charles Brown, ISU Extension farm management specialist, discusses the alternatives in more detail. Read Income tax problems in 2020?
Miller: Increased prices coupled with government payments have created the potential for greater income for many farmers. It would be a shame to allow too much of that income to disappear because of higher income taxes. I agree with the idea of minimizing your tax obligation, but I can also recall problems I’ve seen when borrowers try to minimize their tax bills.
Use of Section 179 depreciation seems like it might save you from income taxes, but if you borrow the money to buy that piece of equipment, you will wind up repaying the principal on the loan with after-tax dollars — which could make the cost of that item 15% to 20% higher when you are done paying for it. Thus, it seems to me the best way to minimize the tax bill is to defer income and increase the amount of prepaid expenses.
If you prepay crop expenses now, you might be able to negotiate a discounted price that offsets the cost of borrowing money for those inputs. Don’t overlook paying interest before year-end, paying property taxes or cash rent due next spring.
Will 2021 land rents decline?
Price rallies for corn and soybeans this fall improved the picture for 2020 actual crop budgets. My cash rent landlord wants to raise the rent. I paid $250 per acre in 2020, and plant half corn and half soybeans on his 300-acre farm. Looking at 2021 using current budget projections, even after the recent price increases, the net return is still substantially below the expected average cash rent. If I’m going to hang onto this 300-acre tract, I need to consider how much I’m willing to lose based on 2021 budgets. What should I do?
Stout: I don’t know where you are located, but in much of Iowa with reduced yields, $250-per-acre rent was plenty high for 2020, too. If you look at October 2021 prices, soybeans are over $1 lower and corn over 40 cents per bushel lower than cash prices as of this writing in mid-November. Just remember that you have nearly a year to price the grain, and more if you have storage available, so there is time for prices to improve for 2021 and also take advantage of carry in the market.
Another aspect to consider if you give up the 300 acres is that it raises your fixed costs, such as machinery over fewer acres, so you have to figure that in your budget. There are only a handful of counties in Iowa that had a cash rent average of over $250 per acre, so unless this land is exceptional, you have a good argument not to have an increase in rent. Above all, have a friendly negotiation with your landlord making your case.
Zhang: In general, cash rent tracks land values fairly closely. Our research shows, on average, gross cash rent accounts for about 3% of land values. The recent commodity market rallies have further stabilized the land market, and several recent surveys such as the Chicago Fed Ag Credit Survey as of October finds a 2% increase in Iowa land values. Applying the same percentage could meat an extra $5 per acre for your cash rent.
Do some scenario analysis and see how this $5 increase in cash rent could impact your cash flow and bottom line, and what other changes you could make such as refinancing or incremental grain sales. Also, look into how your cost of production might change if you do not rent the 300 acres. Another option is to negotiate a flexible cash rental contract with your landowner, which could let you both share the risks and benefits of changes, such as late-season rallies. CHeck out ISU Extension Ag Decision Maker File C2-22, Flexible cash rent lease examples, by William Edwards.
Miller: In Iowa, landlords should notify tenants and tenants notify landlords by Sept. 1 if a change in rent is desired. Fortunately, from a renter’s perspective (and their banker’s), grain prices had just started to rally by that date. I think subsequent increases in grain prices, coupled with the government payments, might make it difficult for any renter to negotiate lower rents for 2021.
This doesn’t mean that your rents are correct for the yields you got or the quality of land you are renting. Try negotiating with your landlord to see if a flexible rent lease can help you both. I’m guessing if you used price examples from this year coupled with a more normal crop yield, it would show the landlord receiving a reasonable rent. But these prices and normal yields aren’t guaranteed for next year, so that flexible lease might help you save money if the actual prices or yields for 2021 are lower than used in the example you showed your landlord.