Economic & Policy Update

Proposed Gift and Estate Tax Changes

Laura Powers University of Kentucky

You may have been reading in the news lately about proposed changes to various tax laws and their impact on farmers. At this time, we must emphasize the use of the word “potential.” Discussions between lawmakers and the President are ongoing. At this point, however, we would like to provide some background information as to what you may be hearing.

Elimination of Step-up in Basis

One of the potential changes is eliminating the step-up in basis on farming assets, such as equipment, buildings, and land, when those assets transfer ownership through inheritance. Eliminating step-up in basis would have a potentially drastic, and negative, impact on the capital gains tax due at the sale of those assets by the heir. Under current law, for example, when a farmer dies, the heir gets a new “stepped up” basis on assets they inherit, based on current market value of those assets. If the heir later sells the asset, any capital gains tax due by the heir is calculated on the difference between the sales price and their basis determined at acquisition. As an example, under current law, if the decedent had an original basis of $3000 per acre on land and the market value was $10,000 per acre at death, the heir’s basis would be $10,000 per acre. If the heir sold the land for $12,000 an acre, the capital gain tax would be based on a $2000 per acre gain. Eliminating the step-up in basis would result in the heir owing capital gains tax on a $9000 per acre gain ($12,000-3,000). An additional proposal is that there would be an immediate tax liability due at the time the heir acquires the land as a transfer of the increased basis. In other words, the heir would have to pay capital gains tax on the increased value of the asset over the decedent’s time of ownership. Thus, using the previous example, the heir would have an immediate capital gains tax liability based on a $7000 per acre gain ($10,000-3,000). The current proposal includes an exemption for family-owned and operated farms and small businesses. They are looking for an acceptable definition of family. Would “family” only be a son or daughter (the current proposal) of the decedent, or would this also include nieces, nephews or other relations? Testimony provided by the National Farm Income Tax Extension Committee is that farms are often made up of family members from multiple generations and broader relationships. Some own the land while others are involved in the operation of the farm. It is also unclear whether any transfer taxes saved by the election could be recaptured if the land is sold some time after the decedent’s death, as is the case with the current Special Use Valuation. Another question is how this applies to nonland farm assets. Raised cattle and crops and depreciated equipment and breeding stock currently receive step-up in basis. Under the American Families Act proposal, they will have no basis for the decedent’s heir.

Self-Rental

Another talking point regarding tax changes is eliminating the exclusion of Net Investment Income Tax (NIIT) on self-rentals. When the NIIT passed as a part of the Affordable Care Act, it only applied to Investment Income. Many farming operations have either land or equipment in an entity separate from the operating entity.

Basic (per ac) Sell Price (per ac) Gain (per ac) Maximum Tax Rate Tax Paid (per ac)

Tax for 100 Acre Farm

Current Law $10,000 $12,000 $2,000 23.8% $476 $47,600 Proposed Law $3,000 $12,000 $9,000 43.4% $3,906 $390,600 At present, when the operating entity pays the asset-owning entity the rental of those assets, there is no NIIT due on that income, regardless of total income. The Biden Administration plans to eliminate that exclusion. Currently, the NIIT applies for income higher than $200,000 (single) or $250,000 (Married Filing Jointly). Therefore, farms that have self-rental among entities will face an increased tax of 3.8% on that income.

Example

The NIIT also applies to capital gains tax at higher income levels as well. The table below displays a very simplified example of these proposed tax increases, using the earlier example. The Capital Gains Tax computation above is much more complicated than the table implies. The maximum rate of capital gains tax is not computed on all dollars of gain, just on the gain amount over certain thresholds of income. Length of ownership of the asset is also a factor in calculating capital gains tax. The example above is only a demonstration of the proposed tax changes. We are assuming that the overall computation of capital gains tax would remain the same and that the only changes are to the tax rates and determination of basis. For individual tax planning and estimates, seek advice from your tax advisor. Farming is an asset-intensive, yet low-margin business. One of the barriers to entry into farming is the high cost of the assets needed to operate the business. One of the struggles that many farmers face is the availability of cash. Many farmers spend their entire careers paying off the land debt from a 30-year note. It sounds like the next generation will have to do the same. Except they will not be funding an asset, they will have to pay off a tax bill. There have been many government programs lately with the goal of helping young and socially disadvantaged farmers enter farming. Changing the stepped-up basis rules would create significant challenges in attaining these goals. It has also been pointed out that the loss of stepped-up basis, whether applied at death or sale, will increase the cost of land outside the range of farmers who operate at low returns compared to those assets. Thus land may leave agricultural production altogether or become concentrated in the hands of land trusts.

Solar Farming Considerations

An effort to rely on renewable resources instead of nonrenewable has the potential to meet the increased global demand for electricity. Both solar and wind energy have the potential to offset a significant fraction of non-renewable electricity demands, yet it occupies extensive land when deployed at levels large enough to meet global demand. With continuing cost declines, led by federal and state incentives, solar power is playing an increasingly important role in how states meet their energy needs. The following summarizes some of the considerations for individual farmers, communities, and local leaders before any final decisions are made and/or contracts signed: 1. The most suitable land suitable for utility-scale solar farms is flat, clear of trees, structures or other obstacles, free of ponds, streams, and creeks, and bordered by a road that will provide easy access to construction crews.

These conditions are typically found on prime agricultural farmland. This can create tensions between land uses and bid up the price of these higher valued lands. Ideally, solar panels should be used on more marginal lands. 2. It is essential that anyone considering the lease of their land has their contract reviewed by a lawyer familiar with the possible terms. In particular, the contract should clearly specify the disposal of panels and the negotiated terms of returning land for production. In some states, solar companies are required to post a bond to protect the property owner from developer bankruptcy, disposal and clean up. 3. It is easy to be swayed by the short-term benefits of leasing your land for solar panels.

Currently, solar farms are leasing land at prices ranging from $400 to $1,200 an acre.

These lease rents are higher than the current cash rents Kentucky farmers are receiving for cropland and tobacco. In the short run, there are financial benefits, particularly for older farmers who are battling a downturn in the agricultural economy. It is important to make decisions with the long term in mind. How does the present value of the lease payment offered by the developer compare to the expected long-term return if the land was in production? 4. Through the popularity of utility-scale solar farming, it has become clear how important farm succession plans are. If the term of the lease is expected to outlive one’s life expectancy, then creating a succession plan now is critical. 5. Land maintenance might be lower but it is not negligible. Because solar panels capture 20% of the light for about 5 hours of the day, the rest of that solar energy will pass through to the ground. As a result, grasses, broadleaf weeds, and eventually woody shrubs will grow. There are three ways that solar farms can address this potentially unwanted vegetation: herbicides, mowing, ground cover, or a combination of all three. It’s likely that a non-trivial amount of herbicide will need to be used to minimize weeds. In addition, landowners will still need to maintain equipment to remove unwanted vegetation or soil, grade roads or paths, mowing, etc. Some places have used sheep for some maintenance but this probably won’t be sufficient. Kentucky is not yet a significant player in utility-scale solar farming. Currently, Kentucky is ranked 40th as measured by the number of annual new installations. California and the other Southwestern states, and even the state of New York, have been dealing with solar farming for several more years and only recently has there been a surge in interest in Kentucky. The topic is one of significant national, state, and local interest particularly since so many of the affected counties didn’t have any plans in place to address this new competition for land. In an effort to allow time for careful planning, dozens of communities across the country have imposed 6- and 12-month moratoriums on new large-scale solar projects. For example, Porter, NY, Riverhead NY, La Sueur County, MN, San Bernardino County, CA, Marshall County, IN, Duanesburg, NY and Northampton County, NC have all recently voted to impose short-term moratoriums. The local community should proactively adopt policies within its planning and zoning ordinances. The policies should complement the community’s existing comprehensive plan. It is important to not make fragmented decisions and instead identify areas of the community, if any, best suited for utility-scale development. The community should also clearly articulate its values and priorities to ensure all contracts meet the minimum standards. Stakeholder engagement is a key component of large-scale solar development. The majority of the proposed projects will require a zoning change which means the community will have an opportunity to voice their concerns in a public setting. The more community leaders and developers understand local values and policies, the easier it will be to develop a project that is acceptable to the community.

Alison Davis University of Kentucky

U.S. and Global Food Price Inflation

Will Snell University of Kentucky

US Food Price Inflation (1970-2021) Food Price Volatility: US vs Global (1990-2020)

Food price inflation continues to be headline news as the food system adjusts from the lingering effects of COVID-19 amidst tight labor/ag supplies, a resurgence in the U.S. economy, and a host of other factors discussed below. From 2010-2019, food price inflation in the United States was relatively benign, averaging 1.7% annually. Last year, COVID induced major disruptions in our food supply chain ranging from temporary closures of meat processing plants and restaurants to the panic buying of consumers. As a result U.S. food prices overall jumped 3.5% in 2020 -- its second-highest annual level spike over the past 30 years. Since peaking in April 2020, food price inflation eventually trended downward during the latter half of 2020 as the supply chain recovered. However, food prices were up 0.4% in April 2021 – its highest monthly increase since the 1.5% increase in April 2020. For the past 12 months, food prices have increased 2.4%, with a much higher boost for food consumed away from home (+3.8%) versus food consumed at home (+1.2%). Again, this reflects a much higher than the pre-COVID era price hike, but as the chart above indicates today’s food price inflation is still relatively low compared to the decade of the 1970s and 1980s. Retail pork prices have escalated to record levels in recent weeks, plus retail beef prices have been on the rise of late even prior to the seasonal bump generally induced by the summer grilling season. For the past 12 months, pork prices are up 4.9%, compared to 4.2% for beef, but only 0.7% for poultry. For the year, USDA is projecting that food prices will increase only between 2 and 3% for the year, as inflation for most food categories is expected to be at or below their 20-year historical averages. In a recent article, Lusk and McFadden claim that higher unemployment induced by the recessionary fall-out from COVID-19 reduced the “opportunity cost” of time for many food consumers which allowed them more time to shop for lower food cost alternatives. This combined with an increase in the number of more meals consumed at home (which are generally prepared at a lower cost), and bulk buying amidst supply chain concerns may have helped constrain the growth in food prices during COVID-19. Much of the recent run-up in food prices is being caused by several different factors that the industry experienced last year. While crop prices have retreated over the past two weeks, they still remain considerably higher than a year ago due to soaring exports (especially China) and weather concerns evolving from the grain regions in South America. As has been discussed before in this newsletter, increases in commodity prices alone typically do not have a relatively large impact on food prices since the farm value for every one dollar that consumers spend on food averages only 14 cents. The farm value of highly processed Items such as breads and cereals is generally less than 5% of the food dollar, while higher grain prices typically have a much great impact on retail meat prices. But the recent surge in food prices goes much beyond higher commodity prices. Other inputs in the food supply chain such as escalating labor costs in response to tight labor supplies in processing plants and restaurants, increased packaging costs, and higher transportation costs moving food products across the nation as fuel prices rebound. On the demand side, a growing economy with a recovery in dining away from home coupled with expanding commodity/food demand overseas puts additional upward pressure on food prices and overall general inflation. Each 1% increase in the price of food in the United States causes the Consumer Price Index (CPI, a general measure of inflation) to increase by 0.14%.While food prices are increasing, the prices of many other goods in the economy such as lumber, automobiles, copper, iron/ steel and semiconductors are increasing at a much higher level. The U.S. Bureau of Labor Statistics CPI May 2021 report, indicates that overall U.S. inflation is running at a 4.2% clip in 2021, the largest 12-month increase since a 4.9% increase recorded in September 2008. While recognizing that inflation is increasing, officials at the Federal Reserve (i.e., the Fed) at the present time believe the recent run-up in prices is temporary as the market adjusts to some short-term supply chain challenges. Consequently, the Fed at the present time does not indicate an immediate change in monetary policy to boost interest rates as a way to slow down the inflationary pressures on the U.S. economy. However, policy-makers and financial markets are watching closely to