Author: Ryan Loy

Historically, low commodity prices, high input costs, and expensive financing have been some of the most significant issues farmers have faced in the last few years. Luckily, some financial relief may come in the form of lower interest rates from the Fed reducing COVID-era rate increases (Wright, 2024). The Fed aggressively moved in September to cut 50 basis points, bringing the target Federal Funds rate to 4.75 – 5%, with indications for at least another 50 basis points before the end of 2024 (Fannie Mae, 2024). This article explores a hypothetical situation of a producer leveraging lower interest rates to consolidate debt to improve short-term liquidity. 

Consider a farmer’s debt obligation for 2024 (Table 1). In this scenario, the farmer holds a land loan with an original principal balance of $450,000 at a fixed interest rate over 20 years. As of 2024, the remaining principal stands at $330,000, with 12 years left in the repayment period. Additionally, the farmer has a machinery loan with an original principal balance of $180,000, structured over a 7-year term. The outstanding balance on this loan is currently $110,000, with 4 years left until maturity. 

The farmer also faces a $50,000 operating loan, due at the end of this year. Unfortunately, this year has not been profitable, and he cannot cashflow all his debt obligations. 

Table 1. Current Debt Obligations – Before Consolidation

The farmer’s total current debt obligation amounts to $123,000 for the year (Table 2). To address this financial strain, the producer meets with their lender to explore options for restructuring their debt. They discuss the possibility of consolidating existing debt into a longer-term, more favorable interest rate structure. The lender agrees to consolidate the remaining principal balances on all three loans ($330,000 + $110,000 + $50,000) into a new 10-year note totaling $490,000 (Table 3). The lender agrees to secure this loan using the equity in the farmer’s financed land as collateral. 

Table 2. Debt Financing Structure Before Consolidation

Table 3. Consolidated Debt Structure

Under this new debt structure, the farmer not only relieves the burden of the current year payments, but also reduces the ongoing obligation from $73,000/year to $63,000/year.  While debt consolidation offers advantages, it’s also important to consider potential drawbacks. For example, under the original debt structure, the annual debt service obligation would have dropped to $40,000/year, after the machinery loan was paid off in 4 years.  Under the consolidated note, the producer is committed to $63,000/year for a full 10 years.  Longer-term debt obligations also potentially lead to paying higher total interest expenses, even with an interest rate lower than their original loan(s) due to the extended accrual period. Additionally, creating a new loan comes with closing costs and fees that could offset the immediate financial benefits. Every situation is unique, and the pros/cons are not always clear.  Those looking to consolidate existing debt should meet with their lenders and determine the best strategy for their farm’s short-term viability and long-term sustainability. 

References

Wright, Andrew. “Lower Interest Rates Create Opportunities for Managing Debt on the Farm.” Southern Ag Today 4(37.3). September 11, 2024.

Fannie Mae. (2024). Fed Cuts Interest Rates Amid Sluggish Existing Sales but a Rebound in Starts Activity. Retrieved November 5, 2024, from https://www.fanniemae.com/research-and-insights/forecast/fed-cuts-interest-rates-amid-sluggish-existing-sales-rebound-starts-activity#:~:text=The%20Federal%20Open%20Market%20Committee,rate%20of%202.75%2D3%20percent.

The United States Department of Agriculture National Agricultural Statistics Service (USDA-NASS) releases monthly indexes for input prices paid and output prices received. These indexes include collecting survey responses for output and input prices for agricultural production, crops, livestock, and food commodities. The spread between these two indices often helps understand where farmers are getting price squeezed and how their profit margins are impacted. Current farm income instability from inflationary pressures, high interest rates, and several supply chain disruptions (e.g., the Russian-Ukraine war and Panama/Suez Canal) are forcing farmers to pay higher input costs while receiving lower commodity prices, emphasizing the need to consider these indexes into the future. 

These price indices measure the change in prices paid (and received) relative to a point in time—2011 in this case (Figure 1). The base year is often chosen during a time without prevailing inflation or major supply chain disruptions (Schulz, 2022). 2011 was a good year for agricultural production and profitability. As such, using 2011 as a base year is a way to highlight how better or worse-off agricultural producers are compared to a good year. 

Figure 1. Crop Output Prices Received vs. Input Prices Paid

Figure 1 compares the annual index value from 2000-2024 for the two indices with 2011 as the base year. The price received index in 2012 was 102.8%, meaning that the crop price received, on average, in 2012 was 2.8% higher than in 2011 (base year = 100%). The red circle in Figure 1 shows the beginning of a divergence between input and output prices. In 2013, when writing the 2014 farm bill, the index for input prices paid was almost exactly the index for output prices received. This is where most of our current farmer safety net support stems from, and since then, we’ve seen a major divergence in the two indices, with the widest gaps between 2014 – 2020 (USDA-NASS). From 2021 – 2022, we saw both indices increase, but the gap remained, and the divergence has grown wider in 2023 and 2024 due to declining commodity prices. 

Another way to view the indices is to calculate how they change year to year. Figure 2 plots the same indices as Figure 1 but shows the yearly change between the index values. Using this percentage change helps producers understand 1) the volatility of crop output prices and 2) the magnitude of change as compared to the previous year. A key takeaway is that input prices are less volatile (in terms of yearly % change) than output prices. Secondly, the percentage change in crop output prices between 2023 and 2024 (-13.8%) is much larger than the percentage decrease in input prices (-1.38%) during that period.

Without any relief in the form of improved crop prices received, figure 1 suggests farmers will continue to suffer from cost/price squeezes and eroding profit margins. Further, figure 2 shows the magnitude of that spread between the indices in Figure 1; if input and output prices continue this trajectory, an improved farm safety net will be warranted. This will be at the forefront of every producer’s mind, with ongoing Farm Bill debates in 2024.  

Figure 2. Year-over-Year % Change in Input and Output Crop Prices

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References

Schulz, L. (2022). Disentangling Input and Output Price Relationships. Retrieved from: https://www.extension.iastate.edu/agdm/articles/schulz/SchSep22b.html

The Observatory of Economic Complexity (OEC). (2024). Fertilizers in Russia. Retrieved from: https://oec.world/en/profile/bilateral-product/fertilizers/reporter/rus

USDA-Economic Research Service (2024). Farm Sector Income & Finances: Highlights from the Farm Income Forecast. Retrieved from: https://www.ers.usda.gov/topics/farm-economy/farm-sector-income-finances/highlights-from-the-farm-income-forecast/

USDA- Economic, Statistics, and Market Information System. (2024). Agricultural Prices. Retrieved from: https://usda.library.cornell.edu/concern/publications/c821gj76b?locale=en

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Loy, Ryan, and Hunter Biram. “The Disparity Between Crop Prices Received and Input Prices Paid.” Southern Ag Today 4(28.3). July 10, 2024. Permalink

With tax season in full swing, knowing how to properly report crop insurance premiums and indemnities is important to ensure accurate tax reporting. Many producers have CPAs or accounting firms that manage their finances and taxes. However, understanding how to report crop insurance proceeds is a great on-farm skill when maintaining accurate financial records.

The Schedule F, “Profit and Loss from Farming,” is an Internal Revenue Service (IRS) form that allows producers to report net profit (or losses) from their agricultural production (IRS, 2022). The Schedule F shows income and expenses pertaining to principal farming activities, such as grain and livestock sold, any income from cooperatives, program payments, and federal crop insurance distributions. Crop insurance proceeds (or indemnities) must be included on a Schedule F as farm income regardless of how much proceeds a producer receives to cover the producer premium. Importantly, crop insurance proceeds can be reported in several ways depending on when you sell your grain. 

1. Reporting crop insurance indemnities – not deferred

Assume a producer received $50,000 in crop insurance indemnities this year and would receive a 1099-MISC form from the crop insurance company confirming that indemnity amount. The producer’s normal business practice is to sell their crop in the same year as production (i.e., crops produced in 2023 are sold in 2023). Therefore, the producer must report the indemnity on the tax return for the year the crop was sold and produced. The $50,000 indemnity would be reported on lines 6a and 6b.  

Figure 1. Reporting a $50,000 Crop Insurance Indemnity

2. Reporting crop insurance indemnities – deferred

Again, assume a producer received $50,000 in crop insurance indemnities this year. However, the producer normally reports income from crops in a following tax year under their normal business practices. Therefore, the producer can defer the crop insurance indemnities to next year. The $50,000 would again be reported on line 6a. But now, the producer checks the box on line 6c to defer the indemnity until next year (Figure 2). To defer, a producer must submit a statement containing 1) producer’s name and address, 2) declaration that the producer is making the deferral, 3) identifying crop and damage information, 4) declaration that crop income is normally included in the following year, and 5) name of the insurance carrier. For more information on how to compile this statement, please consult a tax professional.

Now, let’s assume the producer deferred a $30,000 indemnity in 2022 and must report it on their 2023 taxes (Figure 3). The producer would follow Figure 2 and then report the $30,000 on line 6d. 

Figure 2. Deferring a $50,000 Crop Insurance Indemnity

Figure 3. Reporting a Deferred Crop Insurance Indemnity from 2022

3. Reporting crop insurance premiums

Lastly, the premium paid is reported as expense on the Schedule F. The full amount of premium paid must be reported regardless of how much indemnities cover the premium cost. In this case, premiums reduce Schedule F profit and lessens the tax burden on their farming enterprise. Assume a producer paid a total of $40,000 in premiums for 2023, they would report this amount on Schedule F, Part II, line 20, effectively reducing taxable Schedule F profit by $40,000. 

Figure 4. Reporting a $40,000 Crop Insurance Premium

It’s worth noting that we are not tax accountants, and every farm’s situation is unique. Therefore, you should always consult with a tax professional when preparing your farm’s taxes. 

References

Internal Revenue Service. (2023, July 13). About Schedule F (Form 1040), Profit or Loss From Farming. Retrieved September 25, 2023, from https://www.irs.gov/forms-pubs/about-schedule-f-form-1040.

Loy, R. and Biram, H.D. (2023). Cultivating Financial Security: A Guide on Farm Finances, Taxes, and Crop Insurance. University of Arkansas System Division of Agriculture, Cooperative Extension Service Fact Sheet No. FSA80.

Tidgen, K.A. (2019). Special Rule for Taxing Crop Insurance and Disaster Payments. Iowa State University Center for Agricultural Law and Taxation. Retrieved September 25, 2023, from https://www.calt.iastate.edu/blogpost/special-rule-taxing-crop-insurance-and-disaster-payments.

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Loy, Ryan, and Hunter Biram. “Tax Reporting for Crop Insurance.” Southern Ag Today 4(11.3). March 13, 2024. Permalink