Income Tax Management of Oil and Gas Lease Payments

by: Chris Zoller, Extension Educator, ANR, Tuscarawas County; Peggy Kirk Hall, Director, OSU Agricultural & Resource Law Program & David Marrison, Extension Educator, ANR, Ashtabula County

A renewed interest in oil and gas leasing in Ohio has the potential to provide landowners with substantial new revenue. Landowners who receive income from oil and gas lease bonus payments and royalty payments must understand the tax implications. Oil and gas income is subject to both federal and state income tax and must be reported appropriately. While a landowner can’t avoid paying taxes on oil and gas revenues, the landowner can use strategies to manage income taxes. This fact sheet reviews how to report oil and gas revenues and summarizes examples of tax management strategies for landowners.

Click here to access the Oil & Gas Tax Fact Sheet

Elimination of Federal Estate Tax Bill Proposed in Congress

By David Marrison, Associate Professor

Could the Federal government be following Ohio’s lead in eliminating the Federal Estate Tax or is this “Election Year” posturing?

The federal estate tax is currently set at 35% on estates over $5.12 million. If nothing is changed on January 1, 2013 the estate tax exemption will drop from $5.12 million to $1 million and the estate tax rate will jump from 35% to 55%. In his 2013 budget proposal, President Obama is supporting a $3.5 million estate tax exemption and 45% estate tax rate.

At the close of March 2012, Senator John Thune, Republican from South Dakota introduced the Death Tax Repeal Permanency Act S. 2242, which would permanently abolish the federal estate tax. This act would repeal the federal estate tax, repeal the federal generation-skipping transfer tax and lock in a $5 million lifetime gift tax exemption and 35% gift tax rate The Senate bill mirrors House Resolution 1259 which was introduced by House Representative Kevin Brady, a Republican from Texas.

Many farm organizations have been advocating the repeal of the Federal Estate Tax due to its effect of these businesses being able to be transferred to the next generation. National Cattlemen’s Beef Association President J.D. Alexander stated in a recent press release, “The death tax is detrimental to the farmers and ranchers who live off the land and run asset-rich, cash poor family-owned small businesses.”

According to a study by Douglas Holtz-Eakin commissioned for the American Family Business Foundation, repealing the death tax could create 1.5 million additional small business jobs and decrease the national unemployment rate by nearly 1% Holtz-Eakin is the former director of the non-partisan Congressional Budget Office.

Remember, this is an election year so there is not much hope that any action will be taken on the Federal Estate Tax until after November.

What Can I Do?
So what can farmers do? As with any legislation, take time to exercise your right to talk to your elected officials. Let them know how the changes to the federal estate tax could affect your farm. More importantly, schedule an appointment with your attorney to make sure your estate plan is up to date. Be proactive not reactive! To contact your elected officials, go to the House of Representatives website at: http://house.gov/ and search for your local congressman using the Zip code search engine and your State Senators at: http://www.senate.gov/ and search by state. You can also access and monitor the progress of Senate Bill 2242 and House Resolution 2242 at these sites as well.

2012 Ohio Field Crop Enterprise Budgets

by: Barry Ward, OSU Extension, Leader, Production Business Management, Department of Agricultural, Environmental, and Development Economics & Dianne Shoemaker, OSU Extension Field Specialist, Dairy Production Economics

Budgeting helps guide you through your decision making process as you attempt to commit resources to the most profitable enterprises on the farm. Crops or Livestock? Corn, Soybeans, Wheat, Hay? We can begin to answer these questions with well thought out budgets that include all revenue and costs. Without some form of budgeting and some method to track your enterprises’ progress you’ll have difficulty determining your most profitable enterprise(s) and if you’ve met your goals for the farm. Budgeting is often described as “penciling it out” before committing resources to a plan. Ohio State University Extension has had a long history of developing “Enterprise Budgets” that can be used as a starting point for producers in their budgeting process.

Newly updated Enterprise Budgets for 2012 have been completed and posted to the Farm Management Website of the Department of Agricultural, Environmental and Development Economics. Updated Enterprise Budgets can be viewed and downloaded from the following website: http://aede.osu.edu/programs/farmmanagement/budgets Enterprise Budget projections updated so far for 2012 include: Corn-Conservation Tillage; Soybeans-No-Till (Roundup Ready); Wheat-Conservation Tillage, (Grain & Straw), Corn Silage, Alfalfa Hay and Alfalfa Haylage.

Our enterprise budgets are compiled on downloadable Excel Spreadsheets that contain macros for ease of use. Users can input their own production and price levels to calculate their own numbers. These Enterprise Budgets have color coded cells that allow users to plug in numbers to easily calculate bottoms lines for different scenarios. Detailed footnotes are included to help explain methodologies used to obtain the budget numbers. Budgets include a date in the upper right hand corner of the front page indicating when the last update occurred.

Federal Estate Tax Exemption Limits Set To Drop in 2013

By David L. Marrison, Associate Professor

At the end of 2010, President Obama signed “The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.” Most will remember that this bill extended many of the Bush era tax cuts. What many do not remember is that this legislation also made some significant changes to our federal estate tax laws. And quite frankly, this is the one area that concerns me the most when I think of the future of many of our farms across Ohio.

The estates of every U.S. citizen are subject to the federal estate tax upon their death. However, a certain potion is exempt from the tax. In 2012, this exemption is $5.12 million. Therefore, in 2012 if the value of the net estate – meaning the gross estate reduced by allowable estate tax credits and deductions – does not exceed $5.12 million, then the estate will pass to the heirs free from federal estate taxes. Any amount above $5.12 million is subject to a 35% tax. The increase to a $5 million exemption was a welcomed relief as individuals developed their estate plans.

The increase to the $5 million exemption is short lived as the increase only applies to 2011-2012. Congress must revisit the estate tax laws before the end of 2012, otherwise we will revert to pre 2001 exemption levels. This means that on January 1, 2013, the federal estate tax exemption will drop all the way down to $1 million and the estate tax rate will jump up to 55% (Ouch). This could affect hundreds of farms, small businesses and recipients of oil & gas lease payments. It is not hard for many of our farms to be valued at over $1 million dollars. Can you afford to pay a 55% estate tax on the value above $1 million? This could be a nail in the coffin for many small farms trying to transition their farm to the next generation.

So what can I do? I think it is imperative that farmers exercise their right to talk to their elected officials. Let them know how the changes on the bonus depreciation measures and the federal estate tax could affect your farm. More importantly, schedule an appointment with your attorney to make sure your estate plan is up to date. Be proactive not reactive!

Contacting Your U.S. House of Representative
Go to the House of Representatives website at: http://house.gov/ and search for your local congressman using the Zip code search engine and your State Senators at: http://house.gov/ and search by state.

Western Ohio Cropland Values and Cash Rents 2011-12

by: Barry Ward, OSU Extension, Leader, Production Business Management, Department of Agricultural, Environmental, and Development Economics

Ohio cropland varies significantly in its production capabilities and cropland values and cash rents vary widely throughout the state. Generally speaking, western Ohio cropland values and cash rents differ substantially from eastern Ohio cropland values and cash rents. This is due to a number of factors including land productivity and potential crop return, the variability of those crop returns, field size, field shape, drainage, population, ease of access, market access, local market price, potential for wildlife damage, and competition for rented cropland in a region. This fact sheet is a summary of data collected for western Ohio cropland values and cash rents.

Click here for the Western Ohio Cropland Values and Cash Rents Fact sheet 2011-12

Ohio cropland values and cash rental rates are projected to increase in 2012. According to the Western Ohio Cropland Values and Cash Rents Survey, bare cropland values are expected to increase from 7.3% to 9.1% in 2012 depending on the region and land class. Cash rents are expected to increase from 5.7% to 11.5% depending on the region and land class.

The “Western Ohio Cropland Values and Cash Rents” study was conducted surveying professionals knowledgeable about Ohio’s cropland markets. Surveyed groups include farm managers, rural appraisers, agricultural lenders, OSU Extension educators, farmers, landowners, and Farm Service Agency personnel.

Top Cropland
Survey results indicate that “top” performing cropland in western Ohio averages 193.8 bushels of corn per acre. Results also show that average value of “top” cropland in 2011 was $6,732 per acre. According to this survey “top” cropland in western Ohio is expected to be valued at $7,293 in 2012. This is a projected increase of 8.3%.

“Top” cropland in western Ohio rented for an average of $229 per acre in 2011 according to survey results. “Top” cropland is expected to rent for $250 in 2012. This equates to a cash rent of $1.29 per bushel of corn produced. Rents in the “top” cropland category are expected to equal 3.4% of land value in 2012.

Average Cropland
Survey results for “average” producing cropland show an average yield to be 160.5 bushels of corn per acre. Results show that the value of “average” cropland in western Ohio was $5,504 per acre in 2011. According to survey data this “average” producing cropland is expected to be valued at $5,916 per acre in 2012. This is a projected increase of 7.5%.

“Average” cropland rented for an average of $179 per acre in 2011 according to survey results. “Average” cropland is expected to rent for $194 per acre in 2012. This equates to a cash rent of $1.21 per bushel of corn produced. Rents in the “average” cropland category are expected to equal 3.3% of land value in 2012.

Poor Cropland
The survey summary shows the average yield for “poor” performing cropland equals 130.7 bushels of corn per acre. Results also show that the average value of “poor” cropland was $4,439 per acre in 2011. According to survey data this “poor” producing cropland is expected to be valued at $4,805 in 2012. This is an increase of 8.2%.

“Poor” cropland rented for an average of $140 per acre in 2011 according to survey results. Cash Rent for “Poor” cropland is expected to average $150 per acre in 2012. This equates to a cash rent of $1.15 per bushel of corn produced in 2012. Rents in the “poor” cropland category are expected to equal 3.1% of land value in 2012.

2012 Farm Bill: Status and Outlook

Carl Zulauf, Professor,
Department of Agricultural, Environmental and Development Economics
The Ohio State University

This article was reprinted with permission from the March/April 2012 issue of U.S. Canola Digest magazine (www.uscanola.com).

Background: A draft farm bill was written for potential submission to the Budget Reduction Super Committee as part of the ongoing debate over the federal budget deficit. The Super Committee process failed to reach consensus and the draft farm bill has never been officially released to the public. The farm bill now reverts to its normal process, but with at least broad outlines of a draft bill negotiated between several members of the House and Senate farm bill leadership. This paper provides a brief summary of widely-reported parts of the existing farm bill draft. The summary focuses on broad themes. The paper then briefly addresses implications of a return to the normal process and selected questions and issues.

Summary of Draft Farm Bill

It is widely-reported that the draft bill reduced spending on the farm safety net by $23 billion over 10 years, relative to baseline spending. The safety net includes farm programs and crop insurance. Savings largely came from eliminating the direct payment program.

A revised revenue shallow loss program was adopted in place of the ACRE program. Farms continue to have the choice of either a shallow loss revenue program or a price support program. The marketing loan program remains.

No cuts were made in farm insurance subsidies. A stand-alone revenue insurance program was created for cotton. A supplemental county revenue insurance program was added.

A revenue margin program was created for dairy. The margin is based on the difference between the price of milk and cost of feed.

Spending on conservation programs were cut, with a primary source of savings being a reduction in the maximum number of acres allowed in the Conservation Reserve Program. Some conservation programs were consolidated. The Environmental Quality Incentives Program and Conservation Security Program remain.

Spending on nutrition programs was reduced slightly. No major changes were made in the broad structure of nutrition programs although changes in some rules and regulations were proposed.

While not part of the farm bill, the ethanol and biodiesel blender credit and the ethanol import tariffs expired on December 31, 2011.

Returning to a Normal Farm Bill Process

The normal farm bill process is for the House and Senate Agriculture Committees to separately debate and draft, by majority vote, a bill. The bill is then debated and amended on the floor of each respective legislative chamber. Usually a conference committee convenes to compromise differences between the two bills.
In contrast to the normal process, the farm bill drafted for the Super Committee was written by a few Senators and Representatives. This does not mean the views of others were not considered, but it is reasonable to speculate that it is unlikely the full Agriculture Committees, as well as the House and Senate floors, agree with a farm bill drafted by only a few members.

A key factor framing future debate will be the size of the budget cut that the Agriculture Committees will have to address as their part of the cuts triggered by the Super Committee’s failure to report a substitute set of budget cuts. The larger these cuts, especially relative to the cuts assumed in drafting the Super Committee farm bill, the more likely will substantive changes be needed in the draft bill.

It also matters how the budget cut instructions, if any, are phrased. Specifically, will the Agriculture Committees be given a budget cut but then allowed to choose which programs to cut and in what years to make the cuts? Or, will the Agriculture Committees be given cuts for specific programs for specific years.

It is difficult to overstate the importance of the size, wording, and timing of the budget cuts.

Questions and Issues

Congress could decide to postpone enacting a farm bill in 2012. Supporters of this view note the difficulty this Congress has had in reaching compromises and the upcoming general elections. However, history suggests skepticism regarding postponement. While some farm bills since 1980 have been late, none have been postponed.

A key question framing debate over the farm safety net is how best to provide supplemental risk management protection over and above existing crop insurance coverage. Crop insurance subsidies are largely taken as given in the current farm bill debate. Discussion is focused on spending for other safety net programs. Insurance subsidies could become an issue if budget cuts exceed the cuts used in drafting the Super Committee farm bill.

Underlying this issue are questions about how much and what type of risk should individual farmers bear. These questions are not receiving as much attention, but are keys to deciding the eventual farm safety net. In particular, there are competing views between fixed, statutorily set target prices and a market oriented risk management policy designed to protect producers’ revenue.

Another key question is, how to handle so-called multiple year risks in a fair and fiscally responsible manner. Crop insurance addresses yield and revenue risks that occur between planting and harvest. It does not address multiple-year declines in revenue due to unexpected changes in markets or policy. Examples of multiple-year declines are the so-called grain demand collapse of the early 1980s and Asian financial crisis of the late 1990s.

Two issues are likely to have a stronger presence in the normal farm bill process. They are, tighter limits on payments to farms and whether conservation compliance should be required for all farm safety net programs, including crop insurance. Both are major concerns for many non-farm groups. Respectively, they are viewed as ways to make programs fairer for smaller farms, and as ways to sustain environmental gains as spending on conservation programs are cut. These are issues that make many farmers uncomfortable. However, they are part of the broader debates that occur when the farm bill is viewed as a social contract between the farm and non-farm sectors to improve all segments of the U.S.

Spring Safety on the Farm

By: Chris Bruynis, Assistant Professor & Extension Educator

The agricultural industry is one of the most dangerous occupations in the United States due to a broad range of risks associated with the occupation. Risks include road travel of slow, large equipment; many moving parts and wheels; a broad range of pesticides and fertilizers that have safety requirements associated with their use; and long hours associated with spring field operations.

Research from the National Safety Council indicates that 700 farmers and ranchers die in work-related accidents annually. Additionally, agricultural industry statistics also indicate that another 120,000 agricultural workers suffer disabling injuries from work related accidents. With proper safety measures in place and followed, many of the deaths and accidents could be prevented.

Dee Jepsen, OSU Specialist reminds us what is required and recommended for agricultural equipment while traveling on public roads:

  • At all times, an Slow Moving Vehicle (SMV) emblem is required
  • Headlights and taillights are required 30 minutes after sunrise and 30 minutes before sunset
  • Headlights and taillights are required during day hours if inclement weather conditions exist, including fog and rain
  • Additional extremity lighting is required on dual-wheeled tractors
  • Amber flashers and turn signals are recommended at all times
  • Ideally towed implements should have their own reflectors, lights, and an SMV emblem. However law requires these items be present when the implement blocks the lighting/marking configuration on the tractor.
  • Use escort vehicle when possible

Additional information on lighting and marking of agricultural equipment can be found http://ohioline.osu.edu/aex-fact/pdf/AEX_598_08.pdf

Other safety measures that should be observed around the farm include:

  • Provide safety training for all family members and employees (including volunteers)
  • Make sure all safety shields are in place and working properly
  • Make sure the family member is mature (old) enough to handle the task assigned
  • Follow all safety precautions on farm chemicals such a re-entry intervals and personal protective equipment
  • Make sure you have sufficient labor resources to get the work done. Tired, sleepy employees or family members are at increased risk for an accident.

A little common sense and some preventive measures go a long way in keeping everyone safe and making 2012 a productive, prosperous year.

Risk and Reward of Planting Early: Crop Insurance Implications

By: Chris Bruynis, Assistant Professor & Extension Educator

Unseasonably, warm, dry weather has prompted farmers to think about planting. If one looks at Mother Nature and the development of the tree leaves along with the current soil temperature, it is time to plant. But if one looks at the calendar and reads the provisions of their crop insurance policy it is not. So what is at risk?  According to Gary Schnitkey, Professor at the University of Illinois, COMBO products – which include Yield Protection (YP), Revenue Protection with harvest price exclusion (RPwExcl), and Revenue Protection (RP) plans – have “earliest planting dates”.  

In Ohio, the earliest planting date for corn is April 6th, and April 21st for soybeans.  To verify your county or check out a different crop go to http://webapp.rma.usda.gov/apps/actuarialinformationbrowser/2012/ReportDisplayCrop.aspx.

According to the USDA Risk Management Agency crops planted before the earliest planting date are not eligible for replant payments if those acres need to be replanted.  These acres will still receive full coverage for yield or revenue losses if good management practices are followed. As with planting after the earliest planting date, good farming practices must be followed on acres planted before the earliest planting date.  For acres planted before the earliest planting date, this may be a particular issue if the early planted acres result in a poor stand.  If good farming practices dictate those acres should be replanted, those acres need to be replanted even though those acres will not receive replant payments.

What are the potential replant payments for 2012?  The maximum indemnity is the chosen price election multiplied by the 20 percent of the yield guarantee, up to 8 bu for corn, 3 bu for soybeans. This year, based on crop insurance prices of $5.68/bu for corn and $12.55/bu for soybeans, these allowances imply a maximum replant payment of $45.44/ac for corn and $37.65/ac for soybeans.

What are the potential rewards? Most farmers I talk with tend to believe that earlier planted corn yields better.  Research by Purdue Extension indicates there is not a strong relationship between planting date and yield http://www.agry.purdue.edu/ext/corn/news/articles.07/PlantingDatePerspectives-0411.html. Others might argue better weed control or spreading out the time to get crops planted with the size and scale of equipment owned.  Whatever the reason, many farmers like to start early (if nothing else but for bragging rights at the local coffee shop).  So it begs the question “Is it too early to plant?”  I will tell you in about 45 days.

Marcellus Shale Payments Subject to Ohio CAT

By David Marrison, OSU Extension Extension Educator & Associate Professor

Landowners across Ohio may be surprised to learn the bonus lease and royalty dollars received for their Marcellus Shale Leases will be subject to the Ohio commercial activity tax (CAT) if payments of over $150,000 are received. The CAT was enacted in House Bill 66, which was passed by the 126th General Assembly. The CAT is an annual tax imposed on the privilege of doing business in Ohio, measured by taxable gross receipts from most business activities.

Most receipts generated in the ordinary course of business are included in a taxpayer’s CAT base. This tax applies to all types of businesses: e.g., retailers, service providers (such as lawyers, accountants, and doctors), manufacturers, and other types of businesses. The CAT applies to all entities regardless of form, (e.g., sole proprietorships, partnerships, LLCs, and all types of corporations). The tax does have limited exclusions for certain types of businesses, such as financial institutions, dealers in intangibles, insurance companies and some public utilities if those businesses pay specific other Ohio taxes. This tax has been in existence since 2005.

A person with taxable gross receipts of more than $150,000 per calendar year is subject to this tax, which requires such person to register with the Department of Taxation as a taxpayer. The term “gross receipts” is broadly defined to include most business types of receipts from the sale of property or in the performance of a service. Please note that certain receipts are not taxable receipts, such as interest income. The following are some other examples of receipts that are excluded from a taxpayer’s CAT base: dividends, capital gains, wages reported on a W-2, interest (other than from credit sales), or gifts.

Internal Revenue Code section 1231 provides guidance on why the oil & gas receipts are included in a taxpayer’s CAT base. Specifically, the Code states that timber, coal, and iron ore are considered property used in the trade or business, assuming they are contained in the ground. Once the mineral is removed from the ground, however, it is no longer an asset used in the trade or business, and therefore receipts from the sale of this mineral are included in a taxpayer’s CAT base.

So what are the tax rates for the CAT? The rate for the first $1 million in taxable gross receipts (from $150,000 to $1,000,000) is a flat $150. The rate for receipts above $1 million is 0.26%. The $150 annual minimum tax is due no later than May 10th of each year with the annual tax return for calendar year taxpayers or with the first quarter return for calendar quarter taxpayers. A calendar year taxpayer that will have over $1 million in taxable gross receipts for a calendar year is required to switch to a quarterly taxpayer in the subsequent year and, if it elects to, can switch to a quarterly taxpayer at any time during the current calendar year.

CAT Example:
John B. Landowner owns 400 acres in northeastern Ohio and is a teacher at the local high school. He leases his land for $3,000 per acre, which totals a bonus payment of $1,200,000. To calculate his CAT obligation, Mr. Landowner would pay $150 for the first million dollars and then apply the .26% tax rate for the remainder ($200,000),which equals $520. He has no other commercial business activity so his total CAT obligation would be $150 + $520 =$670.

Electronic registration for the CAT is available online through the Ohio Business Gateway. Paper registration forms can be downloaded at http://tax.ohio.gov/forms/index.stm. More information about the CAT can be obtained from the Ohio Department of Taxation at http://tax.ohio.gov, by email link at http://tax.ohio.gov/channels/global/contact_us.stm, by telephone: 1-888-722-8829, or by mail at: P.O. Box 16158 Columbus, Ohio 43216-6158

References:
Ohio CAT Website. http://tax.ohio.gov/divisions/commercial_activities/index.stm

Ohio CAT Frequently Asked Questions. http://tax.ohio.gov/faqs/CAT/cat.stm

Informational Handout: Commercial Activity Tax: I.R.C. Section 1221 and 1231 Assets Excluded from “Gross Receipts” http://tax.ohio.gov/divisions/communications/information_releases/CAT/documents/CAT200508.pdf