October Don Nitchie Tonya Knorr Garen Paulson Allen Deutz. Inside this Newsletter:

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1 Don Nitchie Tonya Knorr Garen Paulson Allen Deutz Inside this Newsletter: What is a Fair Farm Rental Agreement? SWMFBMA Board Meeting December Prepare for your Tax Planning Appointment The New Qualified Business Income Deduction (aka QBID or 199A) with Income from a Coop What is a Fair Farm Rental Agreement? U of MN Extension is presenting these free, 2.5 hour long workshops throughout the state. Landlords and farmland owners, farmers and tenants, agri-businesses and ag professionals are all welcome to attend. October 2018 Does helping the next generation start farming improve their profit potential? What is MNsure? What can we learn? Understanding Liquidity and Cash Flow Home Equity Interest Tax Deductibility Topics covered: Crop Budgets for 2019 Farmland Rental Rate Trends Land Values Tenant Worksheet Fair Rent Program A Rental Rate that works; Excel spreadsheet Flexible leases Rental Lease Examples What is a fair rental agreement? No registration is required. Make plans now to attend one of these free informative meetings.

2 SWMFBMA Board Meeting December The annual business meeting of the Southwest Minnesota Farm Business Management Association will be held Wednesday, December 5 th at the U of M Southwest Research and Outreach Center starting at noon. The meeting agenda includes: Installation of new board members Establishment of the annual budget and member fee schedule Review and approval of contracts Identification of educational priorities A U of M Extension representative also meets with the board. During the morning prior to the board meeting, the SWMFBMA staff meets to discuss and prepare for the upcoming 2018 farm analysis/ closeout effort in January-February. The board also meets briefly after the annual meeting/profitability Conference in March. If you have any questions or issues for the board to consider, you are welcome to contact the board president Wes Beck, secretary/treasurer Ian Sandager, field staff Don Nitchie, or any board member. Prepare for Your Tax Planning Appointment By Don Nitchie As usual, we will be sending you an appointment letter with instructions in the next few days for members enrolled in the membership that includes tax preparation. We realize the 2018 summer and fall weather caused challenges that have carried into fall harvest and field work. We appreciate your flexibility in helping us make our fall schedule work as there are limited days available until the end of 2018 for cash basis tax filers. You will receive a letter of instructions with your scheduled date, time and location. Please contact your field person in advance if you need to change your scheduled time. We schedule multiple members at each location for convenience of travel and time for both you and the association. Call your field person if you need to go earlier or need a pre-planning session. Remember to come prepared with: 1. Up-to-date records, on PCMARS, (Year-end Tax Detail report) or other system. This should include all cash income and expenses to date, including non-farm personal/living expenditures. 2. List of expected cash income and expenses yet to come (including pre-paid) that will have a 2018 transaction date and you will be required to enter into your 2018 books. (Non-farm living expenditures should be included.) 3. List of income/sales that could be deferred or could be taken in 2018 (optional) and possible pre-paid expenses you could use if needed. 4. List of capital asset purchases and sales YTD, including anything you may be considering by years end. PCMARS users: your capital purchases and sales are incorporated into the Year-end Tax Detail report. 5. Additionally for 2018, if you have received any correspondence or notices from agricultural cooperatives that you have sold to in 2018, please bring that information to your tax planning appointment. Specifically, any information on how they plan distribute or handle the new IRS Sec 199A Qualified Business Income Deduction (QBID). Some cooperatives may pass the deduction through to members for 2018 while others may choose to retain it with hopes of eventually improving patronage dividends to members. It is always good to have a plan in place prior to Dec. 31 st to allow for tax management planning. Feel free to call with questions. The New Qualified Business Income Deduction (also known as QBID or 199A) with Income from a Coop By Don Nitchie The IRS, as of this writing, has not yet released the specific guidance for the portion of Code Sec. 199A pertaining to cooperatives. What follows is information gained from tax preparation trainers and the tax education community.

3 As you recall, the QBI deduction from federal income taxes is 20% for a qualified pass-through business such as a schedule C, schedule F, partnership, LLC, and Subchapter S corporations filing as a partnership. These entities/businesses do not pay taxes on their own but instead passthrough their taxable income to the owners who file and pay taxes on their individual federal form The deduction is limited to the lesser of 20% of qualified business income (QBI), in our case Schedule F Net Farm Income or 20% of taxable income minus capital gains before any QBI deduction. The deduction is made after adjustments to income such as for a health savings account, self-employed health insurance, IRA contributions, college loan interest, etc., so that QBID reduces your taxable income. In hopes of simplifying and in the interest of promoting general understanding of one of the more complex portions of the Tax Cut and Jobs Act (TCJA), I will limit this discussion to the lower income thresholds for the QBID. The lower thresholds are $157,500 of taxable income for single and head of household filers or $315,000 for married filing joint taxpayers. Unfortunately in agriculture during the last few years, except for some years for livestock operations or farm liquidations, net farm incomes have been substantially lower, thus many typical farms are not likely to surpass the lower thresholds in The QBID above the taxable income thresholds are also limited by the type of business it is, W-2 wages paid, unadjusted basis of qualified business property. Needless to say it gets more complicated and we will save those examples for another day. If you sell grain, milk or other products to a specified agricultural or horticultural cooperative your Total QBID is reduced by the lesser of: 1. 9% of your QBI attributable to net income received from coops, or 2. 50% of the amount of W-2 wages you paid attributable to net income from coops Example 1: for a Coop Patron who paid no wages. Pat Patron, a single taxpayer, is a member patron of Big Co-op. In 2018, he sold all his grain through Big Co-op. Big Co-op paid Pat a $230,000 per-unit retain paid in money (PURPIM) and a $20,000 endof-year patronage dividend. Thus, in 2018, Pat received $250,000 ($230,000 + $20,000) from Big Co-op for his grain sales. Pat also had $200,000 in expenses, which did not include any W-2 wages. Pat had no capital gain income in 2018, but he received wages from an outside job. His taxable income was $75,000. Pat s 2018 QBI is $50,000 ($250,000 $200,000). Pat calculates a $10,000 (20% $50,000) tentative QBI deduction. Pat s taxable income is below the $157,500 threshold for single taxpayers so his QBI deduction is not limited by the W-2 wages limitation. Because all of Pat s tentative QBI deduction is attributable to qualified payments he received from Big Co-op, Pat must reduce his QBI deduction by the lesser of; 1. $4,500 (9% $50,000), or 2. $0 (50% of $0 W-2 wages attributable to Pat s co-op payments) Because Pat paid no wages for his grain business, he does not have to reduce his QBI deduction. Pat claims the $10,000 QBI deduction. Example 2: for a Coop Patron who paid wages The facts are the same as in Example 1, except that $25,000 of Pat s $200,000 in expenses were W-2 wages that he paid to an employee. Pat s tentative QBI deduction is still $10,000 (20% $50,000). However, he must reduce his QBI deduction by the lesser of the following: 1. $4,500 (9% $50,000) or 2. $12,500 (50% $25,000) Pat has a $5,500 QBI deduction ($10,000 $4,500). Note: Examples 1 & 2 were duplicated from Agricultural Tax Issues, Land Grant University Tax Education Foundation, Fall 2018 Also, note that the normal patronage dividends that a coop may distribute will continue to be reported as schedule F income as always. They will

4 also count towards the total income received from a coop for purposes of calculating your QBID. The Coop(s) you sell to may also decide to distribute (pass through) a share of their QBID (Sec. 199A) to all members. In this case, the amount of QBID they distribute to you will be combined with your calculated QBID to determine your total deduction. As you recall, many cooperatives were doing this with the Domestic Production Activities Deduction (DPAD) in the previous legislation. Sources: IRS Tax Cut and Jobs Act, provision Section 199A- Qualified Business Income Deduction FAQs. Reviewed or Updated Oct. 5, 2018 Agricultural Tax Issues, Land Grant University Tax Education Foundation, Fall 2018 Does helping the next generation start farming improve their profit potential? Joleen C. Hadrich and C. Robert Holcomb Farmers are entrepreneurs and finding the resources to start their operation can have direct implications on their financial success over time, which is the topic of the second installment of the Top Farmer newsletter series. Of the 334 survey respondents, 18% of the farms started independently without any help from family, 47% reported receiving help from their parents while operating their own farm independently, 25% are currently farming with family members in a partnership, and the remaining 10% used other strategies to start farming. These statistics differ when we split the sample between the 20% most profitable and 20% least profitable farms, measured by the adjusted net farm income ratio. Thirty percent of the least profitable farms reported starting their farming operation on their own, while only 13% of the most profitable started on their own without assistance. Over half (60%) of the most profitable farms received help from their parents while only 39% of the least profitable farms received similar assistance. These two statistics demonstrate a very important fact starting points matter. Having a family member provide assistance to a beginning farmer help facilitate capital accumulation, farm management decisions, and the overall success of the farm. The average age of the survey respondent was 52 years old with 28 years of experience. The participants in our survey who received assistance from family members tended to have higher profit levels over time. Surprisingly, only 22% of all survey respondents indicated they had a formal transition or succession plan in place. As farmers are making long-term plans it is recommended they consider how they might incorporate the next generation into their farming operation to create a competitive advantage for their farm legacy. In 2019, University of Minnesota Extension and the Minnesota Farm Business Management (FBM) Team is providing 12-one day workshops and 3-two day retreats across Minnesota on this very topic. The overall objective of the, Farm Transition and Estate Planning: Creating Your Farm Legacy, program is to provide participants with individual, family, retirement, and business goals to create a foundation for the farm transition process. Transition plans provide a planning horizon, which may last anywhere from 5-15 or more years. This program will cover an array of transition strategies, financial implications of multiple generations on the farm, in addition to tax and estate planning strategies. More detailed information regarding this program, including dates and locations, are available at: What Is MNsure? By Tonya Knorr The number one question is: Is MNsure an insurance company? The answer is no. MNsure is Minnesota's health insurance marketplace where individuals and families can shop, compare, and choose health insurance coverage that meets their needs. Additionally, MNsure is the only place you can apply for financial help to lower the cost of your

5 monthly insurance premium and out-of-pocket costs. Most Minnesotans who enroll through MNsure qualify for financial help. People with incomes up to 400 percent of the federal poverty level are eligible. In 2019, the top income threshold for tax credits is $48,560 for an individual and $100,400 for a family of four. These incomes limits are based on your modified adjusted gross income. Also available to those who qualify are low-cost and free health insurance options provided through government-sponsored health insurance programs Medical Assistance and MinnesotaCare. If you qualify for and enroll in one of these programs, your health coverage is managed through the Department of Human Services. Many Minnesotans who purchase individual health plans through MNsure will be eligible for federal tax credits that lower the monthly premiums they must pay. Eligibility for the tax credits is determined when applying to purchase a plan through MNsure. There are four companies Blue Plus, Group Health, Medica Insurance Company and UCare that offer plans through MNsure. Consumer protections required in all individual market plans include coverage for preexisting conditions and free preventive care, as well as coverage for prescription drugs and substance abuse and mental health treatment. Remember: Open enrollment is where you shop, compare and purchase individual health plans between November 1, 2018 and January 13, Additionally, health plan companies, brokers, agents, navigators, and MNsure will have specific plan information, including provider network information, available for consumers in October. Every county will have at least one health plan company with several plan options. Because of health plan companies capacity limits, Minnesotans should shop and make their selection early to have the most options available. Compare plans to find the one that offers the best value for your health needs and budget. For continuity of care, carefully review the provider networks offered by plans to see what doctors, clinics, and hospitals are included. If you depend on specific prescription drugs, review the plan s drug formulary (which is a list of covered medications). If you go to the MNsure website (mnsure.org) you will be able to see if you are eligible for federal premium tax credits that automatically reduce monthly premiums. Remember, the premium tax credits are available only for policies purchased through MNsure. People with incomes up to 400 percent of the federal poverty level are eligible. Remember in 2019, the top income threshold for tax credits is $48,560 for an individual and $100,400 for a family of four. Again, remember these limits are based on your modified adjusted gross income amounts. Information cited from MN Sure website What can we learn? By Garen Paulson In SW MN where I live, 2018 will be remembered as the most challenging year since I started farming in Every step of the way has been a challenge due to the weather, markets, trade disputes, repairs, etc. They all have seemed to fight us. Challenging times are when management decisions are most important. As you are harvesting, be thinking about decisions that worked and did not work out as well. Here are some examples: Is your good land, with higher land costs, more profitable than poor land with lower land costs? Could less tillage with lower fuel, machinery and labor costs still provide a good crop? Were the grain prices available earlier in the growing season better than selling this fall? Would more preventative maintenance eliminate costly machinery repairs? What ideas can you come up with from this year? We can help evaluate your ideas. For instance, keep track of yields from different landlords. By doing this, we can break down your crop on landlord or field basis. I am ready to be done with 2018, but first we need to evaluate and learn from this year. Be safe as you

6 finish up the harvest. Remember things are not as bad as they seem. Understanding Liquidity and Cash Flow By Don Nitchie In today s environment of tight profit margins, everyone is concerned about the declining liquidity of farm businesses. While on average, SWMFBMA member farms still have healthy liquidity positions at the end of 2017, the average position is substantially lower than five years ago. This is true across U.S. farming operations in general. At the same time, more lenders are requesting projected cash flow statements from farm borrowers and you hear conversations such as As long as it cash flows. This is frequent enough that I sometimes question if there is always an understanding of the differences between liquidity measures from the balance sheet and cash flow comparisons from a projected cash flow budget. A good cash flow projection simply helps you look ahead at the liquidity of the business in more specific detail. Sometimes, there are also individuals who seem to confuse positive cash flow with net farm income or profitability. First, all liquidity measurements indicate how easily a business can pay its current liabilities (obligations for the next year such as an operating loan, annual machinery and land loan payments, accounts payable etc.) out of cash that can be readily generated in the next year. Liquidity measures taken from your balance sheet, such as the current ratio and working capital, tell you if you sold your current inventory of grain and/or market ready livestock, would the cash generated be enough to pay all your current liabilities. These balance sheet measurements of liquidity do not account for crops, livestock, custom work, and other income that will be produced and available to produce cash inflows during the coming year. Neither do they account for new cash outflows for obligations/expenditures that will be incurred, such as for production inputs, capital purchases etc. If you are an agricultural lender and are working with a customer who has a current ratio (current assets/current liabilities) of 2.0 or higher, you probably will not need to request a cash flow projection from that customer unless your supervisor or loan committee insists on it. This customer has $2 of inventory of market ready products that can be immediately converted to cash for each $1 of upcoming liabilities due in the next 12 months. This is very good. The same would be true if their working capital (current assetscurrent liabilities) were 30% or more of their annual gross revenue. However, if the borrower s current ratio were close to 1.0 or their available working capital was only about 10% of their gross revenue, it is very likely the lender will require a projected cash flow budget as additional loan documentation before they are able to make a loan decision. This cash flow projection should also help the borrower with feasibility, timing, and business plan execution - so it does more than just satisfy your lender. Some investment/financial experts will focus on the Operating Cash Flow Ratio as what they consider as the best measure of the liquidity of a business they are considering investing in. They use cash flows from operating activities (gross cash income-cash expenses) divided by current liabilities from the balance sheet. So, it is possible that when a balance sheet measure of liquidity such as the current ratio or working capital as a % of gross revenue are not the strongest, such as 1.0 or 10%, the business could still have a more positive operating cash flow ratio when the annual net cash flows of the business are considered. These liquidity measures can differ substantially by the type of farming operation. A grain farm or cattle feeding operation can have significant inventories on their balance sheet at years end. Whereas, a dairy farm or a custom hog feeder will not have a significant amount of marketable products on their balance sheet at any one time but maybe reasonably expecting to have significant cash inflows in the very near future from on-going operations. Even though their Operating cash flow ratio may indicate an operation has better liquidity than their

7 balance sheet ratios indicate, I would not advise a manager to over rely on cash flow measures. Having a healthy balance sheet liquidity measure allows best for the unexpected shock that comes along and interrupts expected cash flows such as a severe herd health or weather issue in livestock production. Liquidity Snapshot of SW & So Central MN Farms in FINBIN same time also produce a projected income statement, balance sheet, and financial trends. Sources: Understanding Cash Flow Analysis, Ag Decision Maker, Iowa State University Extension, Updated November 2016 Current Ratio: Measuring your farm business liquidity, Farm Financial Standards Council as published in Farm Futures, April 2015 FFSC=Farm Financial Standards Council SW includes SWMFBMA plus MNSCU program farms For the record, don t confuse a positive cash flow statement with a positive net farm income or profitability. Over time they are related but in a given year they may not be. As you know from your annual farm analysis, net farm income (economic profit) is cash income minus cash expenses adjusted for the non-cash items of inventory changes and depreciation. This is true because cash can also flow into an operation not just from selling production but, also from selling assets, borrowing money and from off-farm income. Cash can also flow out of an operation by purchasing assets, making loan payments and paying living expenses and taxes. As a member of the SWMFBMA who receives a complete financial analysis of your business each year in FINPACK, you can request a cash flow projection for your operation. As your data file already contains much of your historical information it is not difficult to do. Different than some other cash flow projection tools, with FINPACK, we can generate an annual, monthly or long range planning version for you. In addition to a Projected Net Cash Flow FINPACK will at the Home Equity Interest Tax Deductibility By Tonya Knorr Can you deduct interest paid on a home equity loan for college education and, if so, how is this done? The following is an example and how it will be handled on your tax return: Example: Chip and Joanna take out a home equity loan on their principal residence to pay for their son s college tuition in They will claim their son as a dependent under the qualifying child rules. In general, under the Tax Cuts and Jobs Act of 2017, interest on home equity debt is not deductible as an itemized deduction for , unless the proceeds are used to buy, build, or substantially improve the taxpayer s home that secures the loan. However, interest on a qualified education loan (including a home equity loan secured by real property) is deductible as an adjustment to income if the borrower certifies that the debt proceeds are being used, or will be used, solely to pay for qualified higher education expenses (Notice 98-54). Mixed-use loans do not qualify. Make the certification by giving the lender

8 Form W-9S, Request for Student's or Borrower's Taxpayer Identification Number and Certification. Thus, if Chip and Joanna only use the loan to pay for their son s college tuition and make the certification, they can deduct up to $2,500 of student loan interest paid during the year, subject to phase-out based on their modified adjusted gross income. Information cited from NATP Overview of SW Minnesota Farms in FINBIN by Age of Operator