Weathering Tough Times Drought Management Considerations

1. Weathering Tough TimesDrought Management Considerations

2. What Are Your Goals? • Protecting your equity? • Minimizing losses? • Staying in production agriculture? • Orderly liquidation?

3. What Is Your Ability To Tolerate RISK? • Personally?? (time and tolerance) • Financially?? (position and constraints)

4. Identify Problem(s) • Are you able to pay bills and debts when due? • Would you be able to pay them given an extended repayment period? • Does the farm/ranch typically generate income for family use? • Could the money tied up in the farm earn more in another investment?

5. Identify Problem(s) • Do you have sufficient savings to weather several years of severe crop or livestock losses? • Would you be able to borrow money to cover cash shortfalls in an emergency?

6. Take Stock of Your Situation... • Financial statements • Farm cost of production by enterprise

7. Now, You’re Ready To... • Evaluate options and potential outcomes • Cash flow • Profitability • Solvency • Tax • Look ahead • 6 months • 1 year • 5 years

8. Strategy: Buy Feed or Hay • Increases production costs • Reduces income earned per cow • Equity position is slowed or reduced • Increases tax deductible expenses • Potentially reducing tax liability • Decreased income • NOL that can be carried back or forward

9. Strategy: Renting Additional Pasture • Able to maintain herd • Longer term commitment • Increases outflows • Reduces earnings • Increases tax deductions • If net negative farm income, equity will decrease

10. Strategy: Calf or Cow Sales • Reduce forage use and stretch forage supplies • Early weaning • Early or additional culling of cows • Additional complications • Poor calf crops • Poor herd reproductive performance

11. Sell Now or Later? Increase in Cow Value Needed to Justify Waiting to Sell 2 mths 5 mths 1 year 181 No losses 64 69 83 89 101 Losses = $20 per cow 139 151 133 Losses = $70 per cow 219 231 Losses = $150 per cow 213 5 % opportunity cost on funds. Five month and one year projections includes additional net earnings from renting out land (or cost savings from not leasing land) of $2,400 per year.

12. Strategy: Adjust Family and Farm Withdrawals • Living within a budget • Minimize spending • Pay down debt • Delay investments

13. Strategy: Adjust Family and Farm Withdrawals • Outcomes • Reduces cash outflow • Retain more farm earnings, increase owner equity • May increase future demands on farm income

14. Strategy: Adjust Family and Farm Withdrawals • Reduction in family withdrawals • No impact on farm profitability. • No impact on farm income tax. Could reduce itemized deductions.

15. Strategy: Adjust Family and Farm Withdrawals • Reduction in farm withdrawals • May increase farm profitability in short run, decrease it in long run • Fewer deductible expenses, more income tax, but more after-tax profit

16. Strategy: Control Costs • Negotiate input purchases • Fixed asset utilization • Consider leasing versus owning • Consider share lease rather than cash lease

17. Strategy: Control Costs • Outcomes: • Less cash outflow • Increased profitability • If result is positive net farm income, owner equity increases • Less deductible expenses, more income tax, but likely more after-tax profit

18. Strategy: Increase Returns • Improve marketing techniques • Improve production practices • Use underutilized resources

19. Strategy: Increase Returns • Outcomes • More cash inflow • Increased profitability • If result is positive net farm income, owner equity increases • More income, more income tax, but likely more after-tax profit

20. Strategy: Change Enterprise Mix • Review farm plan enterprise by enterprise • Budgets for new alternatives should be evaluated with whole farm plan • Goals • Facilities, equipment • Skills • Market

21. Strategy: Change Enterprise Mix • Impact on cash flow, profitability, taxes paid depends on enterprise selected • Risk environment changes

22. Trading Land Paymentsfor Rental Payments Annual principal and interest payments with a 30 year loan Interest Rate Land Price 8% 9% 10% $300/a $29 $30 $32 $400/a $36 $40 $43 $500/a $45 $49 $54 $600/a $54 $59 $65

23. Strategy:Change Asset Ownership • Use leases to combine and effectively use resources--land, labor, capital and management--of both parties • short term, long term • cash, share • flexible • sale/leaseback • Risk environment changes

24. Strategy:Change Asset Ownership • Outcomes • More cash now • Decreased outflows in long run (and increased profit) if cost of custom hire, renting or leasing is less than fixed ownership costs, including loan payments

25. Strategy: Supplemental Income • Recapture of depreciation taxed at ordinary income tax rates. Capital gains taxed at 15% (or 5% is individual is in lower tax bracket) • More cash • Decreased profitability if time away from farm leads to decrease in productivity

26. Strategy: Supplemental Income • If off-farm income offsets any change in farm profitability and is invested in farm, owner equity increases • More income, more income tax, greater after-tax income and cash flow

27. Strategy: Reschedule Debt • Spread principal payments over a longer period • Defer principal payments • Must have willing lender • Increases length of time obligated • Could be paid off in original time frame if loan permits early payoff without penalty

28. Strategy: Reschedule Debt • Reduces cash outflow • Increases profitability in short run due to lower interest expenses, but decreases profitability in years to which debt is rescheduled • Less deductible interest expense, more income, more income tax (if not operating at a loss), more after-tax income

29. Strategy: Restructure Debt • Principal or interest write-down • Tarnished reputation regarding repayment • Improves potential to remain solvent

30. Strategy: Restructure Debt • Less cash outflow • Increases cash flow and profitability • Forgiven debt is taxable • Unless in bankruptcy or insolvent

31. Strategy: Investment by Outsiders • Cash and/or equity infusion • Outcome • Increased inflows • Increased profitability if applied wisely • Improves potential to remain solvent • Future management and returns are shared • More record-keeping. Repayment of principal not deductible--more tax when investors repaid.

32. Strategy: Liquidate • End the drain on equity • Must identify new occupation • Must decide what to do with proceeds • Impact on others • Tax repercussions • Depreciation recapture • Capital gains

33. What Should You Do? • Develop written goals and prioritize them • Assess your willingness and ability to tolerate risk • Develop financial statements and analyze the current situation • Take corrective action when and where necessary, sooner rather than later! • Develop and implement a plan Call if you need assistance, at any stage!!!!

34. 2006 Income Tax Issues Laws Applicable to Livestock Producers

35. Tax Management Objectives • After tax profit maximization - general objective • Must consider tax as a cost, like any other cost of doing business • Minimizing taxes can result in over- investment • Tax management = minimum legal tax

36. Tax Management Concepts • Depreciation = method of allocating cost • Tax vs management • Depreciation is a deferral • MACRS fixed life, fixed method • 1/2 year in year of purchase or sale • Except 40% rule mid-month convention • Section 179 expense election

37. Depreciation Options • MACRS (Modified Accelerated Cost Recovery System) • GDS (General Depreciation System) • ADS (Alternative Depreciation System) • Sec 179 Expensing Election • Sport Utility Vehicles • Other Property

38. Section 179 Expense Election • Purchased capital assets - depreciable • Fixed life: 5, 7,10,15, 20, 27.5 years • Up to $105,000 current depreciation expense ‘06 & ‘07 ($25,000 in ‘08) subject to limit > $420,000 property placed in service • Must not create a loss

39. Section 179 Expense Election • Treated as depreciation subject to recapture, if • Converted to personal use • Business use is less than 50 percent • Pickup • GVWR > 6000 allowed • Cargo bed 6 ft or more in length

40. Section 179 Expense Election • Sport Utility Vehicle’s • 2006 maximum $25,000 • GVRW > 6000 lbs & ≤ 14000 lbs

41. Tax Management ToolsTo Level Income • Cash method of accounting • Accelerate taxable income or expenses • Pre-paid expenses up to 50% • Depreciation straight-line, accelerated • Income averaging • Net operating loss Carryback 5 years • Net operating loss Carryforward 20 years

42. Cash Method • Easy to keep • Include in income in year when actually received • Include in expenses in year when actually paid • Postpone income and/or accelerate expenses

43. Prepaid Expenses • Amount paid during the tax year for items not used until the next year. • Deduction for prepaid expenses is limited to 50% of other deductible farm expenses. • Exceptions: change in business practice or not a customary practice for the previous 3 years. • Farm related taxpayer: main home on farm or principal business is farming.

44. Depreciation • Accelerated vs Straight Line vs Section 179 Deduction (expense election) • Quicker write off of depreciation in year when income is high • Slower write off of depreciation for periods of low income

45. Income Averaging for Agriculture • Use Schedule J, Elected Farm Income • Schedule F, capital assets not land • Individual, Partner, & S Corp Shareholder • Not C Corporation, Estate, or Trust, • Elect any part or all farm income • Spread equally over last 3 years • Pay increase in income tax only • Does not change SE Tax or NOL

46. Net Operating Loss • 1997 Net Operating Loss farm or business • Carry back losses to previous 2 tax years • Carry forward losses for 20 future years • 1998 Special Farm Rules allow losses • Carry back 5 previous tax years • Could generate immediate tax refunds

47. Tax Basis Purchase, gift, or inheritance? • Purchase = Cost • Adj basis = Cost - depreciation • Gift = Donor’s tax basis • Inheritance = Fair market value (date of death)

48. Recapture vs Capital Gain • Purchase cow • $500, 5 year life, straight line depreciation ($100/year) • After 2 years, adjusted basis = $300 • Alternative sale prices, tax implications • Sale price $300, no gain or loss • Sale price $400, $100 recapture ord. income • Sale price $600 • $200 recapture ordinary income • Capital gain = $100, marginal rate 5% or 15%

49. Capital Gain Land, machinery, breeding livestock • Sale price in excess of purchase price • 5% capital gain tax rate for 10 % and 15% tax bracket (0 in ‘08) • 15% capital gain tax rate for 25% bracket and above • Tax shelters: Raised breeding livestock • Current deduction = cost of raising • Capital gain on sale

50. Weather Related Sales of Livestock • 1997 Taxpayer Relief Act • Any weather related, not just drought • Eligible for Federal assistance • Declared by Secretary of Agriculture