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Farm Finances, Taxes, and Crop Insurance

Federal Crop Insurance Workshop, Monticello, AR

February 20, 2024

Ryan Loy, Ph.D.

Assistant Professor and Extension Agricultural Economist

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Covering Chapter 8

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Roadmap

A Brief History
The Schedule F and Tax Implications
Crop Insurance and Debt Obligations
Practical Examples
Safety Net Tool (BETA)

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A Brief History

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Agricultural Finance and Crop Insurance

Financial Security Tool
Financial and Tax Implications

Assists with:

Informed Farm Planning
Debt Financing
Correct Taxable Income

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Agricultural Financial Crisis

Pre-1981:

Agriculture “Bubble”
Income Tax Deduction

1981 – 1986:

Most extreme financial crisis.
Three key factors:

1979 monetary policy, strong U.S. dollar, 1980 Soviet export ban.

Agriculture Bubble: During the decade prior to 1980, a bubble (similar to the 2008 housing crisis) was created in agriculture with sharp increases in debt levels, land values, and demands for U.S. commodities leading to increased production and investment in farmland. During this time, the real price of corn increased by 35% while farmland values rose by 88% (Bergman et al. 2020). In other words, the potential for high returns in a stable sector attracted more investment in agriculture
Tax code: Additionally, the U.S. tax code leading up to the 1980s created incentives for investment, with the “income tax deduction” being the most important incentive (Barnett, 2000). The income tax deduction incentive meant interest expenses could be used to reduce taxable income, thus dropping the “effective” interest rate a producer pays on a loan – creating an incentive to increase farm debt
With increasing inflation, producers and investors alike saw the need to invest their money in appreciating assets, such as farmland, rather than retaining cash reserves.
1981 by a combination of 1) tightening monetary policy by the Federal Reserve in 1979 that increased interest rates and raised the farm debt burden, 2) the strengthening U.S. dollar making U.S. commodities more expensive in the global market, and 3) a 1980 ban on grain exported to the Soviet Union that plunged export demand (Bergman et al. 2020). These factors exacerbated leveraging issues since producers had heavily invested in agriculture during the boom of the ‘70s. These producers faced declining markets resulting from reduced export demand due to a strong U.S. dollar coupled with sharp increases in borrowing costs following monetary policy decisions in 1979
Thus, the 1980s in agriculture was a period of financial distress from declines in farm income, steep declines in farmland values, and tight credit conditions (Bergman et al. 2020). For example, the average value of farmland and commodity prices dropped by 50% during the farm crisis. The effects of the crisis were felt well beyond the farm gate; over 100 agricultural banks failed during this period (Barnett, 2000).

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Crop Insurance and Risk Management

Fallout from the farm crisis increased interest in crop insurance.
Policies aimed:

Stabilize farm revenue
Provide more risk management tools

Revenue Protection (RP) Policies

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The Schedule F and Taxes

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What is the Schedule F?

Profit and Loss from Farming.
IRS form
Report net profit (loss) from agricultural production.
Let’s have a quick look…

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Tax Implications of Crop Insurance

Included on Sched. F as farm income
1099-MISC form (crop insurance company)
Can be reported in several ways.

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Practical Examples

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Reporting Indemnities – Not Deferred

A producer is awarded a $50,000 crop insurance indemnity
Crop is sold the same year as production.

50,000

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Reporting Indemnities –Deferred

A producer is awarded a $50,000 crop insurance indemnity
Crop is sold year after production (historically).

50,000

Next Year’s Schedule F will include the amount deferred from previous year (6d).

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Reporting Premiums

A producer paid $40,000 in total for premiums.
Schedule F – Part II, line 20.

40,000

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Crop Insurance and Debt Obligations

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Can Crop Insurance Cover an Operating Loan?

Use RP coverage to guarantee debt obligations.
Also consider Catastrophic Risk Protection Endorsement (CAT)
Let’s set the stage:

324-acre Soybean farm:

$105,000 Op. Loan

Using crop insurance to guarantee debt obligation coverage is one of many ways insurance can be used as a risk management tool. Operating loans are typically revolving lines of credit that assist in covering pre-harvest expenses (e.g., seed cost, fertilizer, fuel, etc.).
Catastrophic Risk Protection Endorsement (CAT) coverage that triggers in the event of a yield loss of 50% or more. CAT coverage provides producers with low-cost coverage on 50% of APH yield and 55% of the RMA projected price (Biram and Coble, 2023).
Consider a producer who finances an operating loan to cover their pre-harvest expenses (e.g., $105,000 based on a 324-acre farm). Additionally, they elect to use RP crop insurance to guarantee a level of revenue. For example, at a coverage level of 50% the producer would be guaranteed $102,060 based on an expected revenue of $204,120 ($204,120 * 0.50 = $102,060).

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How are revenue guarantees calculated?

Revenue Protection:

50% - 85% of total expected revenue guaranteed.

$204,120 * 50% = $102,060

CAT Coverage:

Triggers if yield loss is 50%+

50% of APH, 55% of RMA projected price

(50* 50%)*($12.60*55%)*324 = $56,133

Using crop insurance to guarantee debt obligation coverage is one of many ways insurance can be used as a risk management tool. Operating loans are typically revolving lines of credit that assist in covering pre-harvest expenses (e.g., seed cost, fertilizer, fuel, etc.).
Catastrophic Risk Protection Endorsement (CAT) coverage that triggers in the event of a yield loss of 50% or more. CAT coverage provides producers with low-cost coverage on 50% of APH yield and 55% of the RMA projected price (Biram and Coble, 2023).
Consider a producer who finances an operating loan to cover their pre-harvest expenses (e.g., $105,000 based on a 324-acre farm). Additionally, they elect to use RP crop insurance to guarantee a level of revenue. For example, at a coverage level of 50% the producer would be guaranteed $102,060 based on an expected revenue of $204,120 ($204,120 * 0.50 = $102,060).

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How are returns calculated?

Producer pays the operating loan in one lump sum.

Paid at the end of harvest (9 months).

Example: 50% RP, $105,000 op. loan:

$204,120 * 50% = $102,060 (Revenue Guarantee)

$109,003.77 total payoff (@ 5% over 9 months)

50% RP Premium (Drew County, 50b bpa soybeans, 324-acre farm, Optional Units): $7.64/acre

$102,060 - $109,003.77 - (7.64*324) = -$9,419.13

Using crop insurance to guarantee debt obligation coverage is one of many ways insurance can be used as a risk management tool. Operating loans are typically revolving lines of credit that assist in covering pre-harvest expenses (e.g., seed cost, fertilizer, fuel, etc.).
Catastrophic Risk Protection Endorsement (CAT) coverage that triggers in the event of a yield loss of 50% or more. CAT coverage provides producers with low-cost coverage on 50% of APH yield and 55% of the RMA projected price (Biram and Coble, 2023).
Consider a producer who finances an operating loan to cover their pre-harvest expenses (e.g., $105,000 based on a 324-acre farm). Additionally, they elect to use RP crop insurance to guarantee a level of revenue. For example, at a coverage level of 50% the producer would be guaranteed $102,060 based on an expected revenue of $204,120 ($204,120 * 0.50 = $102,060).

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RP Premiums

Assumptions:

Drew County

Optional Units

Soybeans

50 bushels/acre

324-acre farm

Coverage Level	RP Premium Per Acre	Total Premium
50.0%	$7.64	$2,475.36
55.0%	$9.94	$3,220.56
60.0%	$11.86	$3,842.64
65.0%	$16.09	$5,213.16
70.0%	$19.13	$6,198.12
75.0%	$24.90	$8,067.60
80.0%	$34.24	$11,093.76
85.0%	$48.45	$15,697.80

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Example Returns: $105,000 (operating loan), 324 Acres

	Revenue Protection (RP) Coverage Level
Interest Rate	50%	55%	60%	65%	70%	75%	80%	85%
5.0%	-$9,419.13	$41.67	$9,625.59	$18,461.07	$27,682.11	$36,018.63	$43,198.47	$48,800.43
5.5%	-$9,826.87	-$366.07	$9,217.85	$18,053.33	$27,274.37	$35,610.89	$42,790.73	$48,392.69
6.0%	-$10,235.97	-$775.17	$8,808.75	$17,644.23	$26,865.27	$35,201.79	$42,381.63	$47,983.59
6.5%	-$10,646.43	-$1,185.63	$8,398.29	$17,233.77	$26,454.81	$34,791.33	$41,971.17	$47,573.13
7.0%	-$11,058.25	-$1,597.45	$7,986.47	$16,821.95	$26,042.99	$34,379.51	$41,559.35	$47,161.31
7.5%	-$11,471.44	-$2,010.64	$7,573.28	$16,408.76	$25,629.80	$33,966.32	$41,146.16	$46,748.12
8.0%	-$11,886.00	-$2,425.20	$7,158.72	$15,994.20	$25,215.24	$33,551.76	$40,731.60	$46,333.56
8.5%	-$12,301.93	-$2,841.13	$6,742.79	$15,578.27	$24,799.31	$33,135.83	$40,315.67	$45,917.63
9.0%	-$12,719.25	-$3,258.45	$6,325.47	$15,160.95	$24,381.99	$32,718.51	$39,898.35	$45,500.31
9.5%	-$13,137.94	-$3,677.14	$5,906.78	$14,742.26	$23,963.30	$32,299.82	$39,479.66	$45,081.62
10.0%	-$13,558.03	-$4,097.23	$5,486.69	$14,322.17	$23,543.21	$31,879.73	$39,059.57	$44,661.53

A producer may look to cover their operating debt obligations to manage the risk of a catastrophic loss. Will the RP guarantee cover the entire operating loan obligation?
For this presentation, we assume a total yield loss (0 bushels per acre)
Tables 2 and 3 show that returns based on a 50% RP coverage level will be negative regardless of farm size. Increasing their coverage to 55% would mean a producer could guarantee covering their operating loan. In fact, at an interest rate of 7% and an RP coverage level of 55%, a producer could guarantee $10,206 and $15,750 more in revenue for a 324-acre and 500-acre farm size, respectively. Currently, a producer could expect to pay an interest rate ranging from 8 – 8.50% and would be advised to elect at least a 55% RP coverage level to ensure operating loan obligations are met.

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Safety Net Tool (BETA)

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Thank You!! Questions?

Dr. Ryan Loy

Email: rloy@uada.edu

Phone: (214) 642-9066

FarmEconAR.com

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