It was a pretty good week for corn and soybean futures in Chicago. However, given the last six months of trade that’s not a huge accomplishment.
Presented below you’ll see two thoughts on where the markets might be headed. “Bad Weather Rising” lays out Scott Irwin’s longer term contrarian view. He’s of the opinion the markets over the next five years will reflect a higher mid-point. Irwin’s colleague at the University of Illinois, Todd Hubbs, takes the shorter term ‘marketing view’. His price outlook is less attractive. Again, one view is long-term and the other is short-term. Both have implications for farm and marketing decisions.
Further down in this letter you’ll find an article reposted from farmdocDaily. In it Iowa State’s Keri Jacobs details how the new tax law will impact grain marketing. You’ve likely heard a great deal about the 20% tax break farmers will receive if the first sale of their grain goes through a cooperative. Jacobs offers insight into how this works and the potential impact it will have on agricultural infrastructure.
There’s something a bit fun in today’s letter, too. The first corn harvest of 2018 in the United States has already taken place! Well, it’s actually the 2017 corn crop. Last Thursday I slammed my brakes on just outside of Jacksonville, Illinois to stop and watch Jon Brickey harvest five acres with an 1160 Case combine (he thinks 1969 vintage). I took a few photos and a made a little video.
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Bad Weather Rising
An agricultural economist at the University of Illinois is looking for a long-term recovery in the commodity markets. Commodity prices have been low since 2014, but the price of farmland has remained fairly strong. This is an indication thinks University of Illinois’ Scott Irwin that those buying farmland believe his contrarian view that prices will recover say to $4.00 for corn, $10.75 for soybeans, and $4.75 for all wheat. That’s at least one way to reconcile the firmness of land values. These long-run investors, whether they be farmers or outside investors, are looking for higher averages to restore profitability.
Irwin says there are two reasons for commodity prices to increase. One of them is slow. It’s the return of better economic conditions across the planet. The other he says is fast and violent, “I think it will be a series, in a fairly short period of time, of really poor weather that will be the big event that pulls us out.”
The ag economist is looking for the return of a more normal frequency of bad weather in the United States. Noting that the last twenty-plus years have been the best series in terms of corn belt weather since 1895.
- Merrill Crowley, Midwest Market Solutions
- Curt Kimmel, Bates Commodities
- Wayne Nelson, L&M Commodities
access past Commodity Week programs in the archive
Can Corn Prices Get Above the Current Range
Todd Hubbs, Agricultural Economist - University of Illinois
read the farmdocDaily article
March corn futures continue to trade between $3.48 and $3.60. This has been the case since the release of the November USDA supply and demand tables. It continues today despite the bearish information contained in USDA’s end of year reports released January 12. Todd Hubbs says corn prices continue to stay in relatively narrow range, and that pattern may remain for the next several weeks.
Listen to Todd Hubbs discussion of his farmdocDaily article with Univesity of Illinois Farm Broadcaster Todd Gleason
The University of Illinois grain markets specialist says the present outlook projects ample corn supplies in 2018. This will likely keep corn prices in the current range until information on spring planting is released. USDA’s Prospective Plantings report is due March 29th. Hubbs says a typical price pattern suggests a price rally in late spring or early summer associated with a weather issue. Summer weather and the impact it has on corn production will eventually determine the 2018 corn price.
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The New Tax Laws & Marketing Grain to Cooperatives
A Discussion of the Sec 199A Deduction and its Potential Impacts on Producers and Grain Marketing Firms reprinted from farmdocDaily.
by Keri L. Jacobs
Department of Economics
Iowa State University
The newly passed Tax Cuts and Jobs Act of 2017 introduced substantive changes to individual and entity-level tax rates and deductions, many of them welcomed by individuals and corporations. One section of the Internal Revenue Code (IRC) in particular–IRC § 199A Deduction for Qualified Business Income of Pass-Through Entities (Sec 199A hereafter)–is getting a lot of attention, raising questions and eyebrows for its potential impacts on grain marketing decisions. In essence, language in this section of code gives producers marketing grain a significant incentive to sell to a cooperative rather than a non-cooperative firm.
The purpose of this article is to highlight the primary features of the Sec 199A deduction causing concern and discuss potential implications for producers and grain marketing firms. Note that at one month into the new tax year, there are ongoing efforts directed at modifying the language in the code to correct the unintended effects on producers and grain marketing firms.
What Does Sec 199A Do?
Sec 199A is a deduction that applies to income earned from the business activities of pass-through entities, like S corporations, sole proprietorships, partnerships, and so forth. These are businesses whose income is not taxed at the entity level, but passed-through to its owners. The intent in crafting Sec 199A was two-pronged: 1) to ensure that these pass-through, non-corporate entities had a deduction similar to the reduction in the corporate tax rate, which dropped from a maximum of 35% to a flat rate of 21%, and 2) to retain, for cooperative organizations, a prior deduction that was removed: Domestic Productions Activity Deduction (DPAD), or Sec 199. This is not a typo: Sec 199A replaces Sec 199 of the 2001 Bush tax cuts. Note that the DPAD was a jobs-creation deduction and available to manufacturing firms across many sectors, including agricultural cooperatives marketing farmers’ domestic production of grain.
The Sec 199A deduction for pass-through entities is based on qualified business income (QBI). There are restrictions on what qualifies as a business activity for this deduction (many services, for example, do not), and both the definition of qualified business income and calculation of the actual deduction are complicated. But in simple terms, the deduction is 20% of the qualified business income, subset to a wage limitation. Though complicated, this portion of the code is not contentious.
Sec 199A has a second feature, and this is the part that leaves open a number of questions about unintended consequences. In addition to the deduction related to qualified business income, it provides a 20% deduction on ‘qualified cooperative dividends.’ Typically we think of qualified cooperative dividends as the annual allocation of profits from a cooperative to its members–these are better called qualified cooperative patronage allocations. In this new law, those are indeed included in the payments eligible for 20% deduction and also not hugely controversial. However, another payment by cooperatives to its members is also included in the definition of ‘qualified cooperative dividends’: per unit retains (more correctly called per unit retains paid in money, or PURPIM). Per unit retains, in the simplest terms, are the payments from cooperatives to members for their grain or other agricultural production. Note the deduction applies only to the marketing or pooling functions (grain and other agricultural products) and does not include purchases by members for agronomy, seed, fuel, etc.
Per unit retains were defined as ‘qualified cooperative dividends.’ As a result, a producer selling grain can receive a 20% deduction of gross grain sales (before farm expenses) from taxable income less capital gains if s/he is a member selling to a cooperative. If instead the sale is to a non-cooperative marketing firm or processor (e.g., ADM, Cargill, or any number of independent grain marketing firms), the deduction is 20% of the net income. At the surface, this creates a significant effective basis gap between otherwise equal basis bids for grain or other agricultural commodities. A simple example, abstracting from the complexities of QBI and marginal tax calculations shows the potential.
A farmer has $500k in gross grain sales (140,000 bushels) and $100,000 in net farm income, all from selling grain. If she markets through a cooperative, she anticipates a patronage allocation of $0.025 cents per bushel, or $3,500.
- Choice A: She markets the crop to an independent grain firm or processor and, through Sec 199A, she deducts up to 20% of her QBI: 20% x $100,000 = $20,000 potential deduction.
- Choice B: If she markets the crop to her cooperative, she deducts up to 20% of gross sales (20% x $500,000 = $100,000) because they qualify as per unit retains, plus 20% of any qualified patronage allocation (20% x $3,500 = $700). The potential deduction is $100,700.
It is clear to see why producers are eager for clarification on this law and why independent grain firms and processors want it changed. Facing equivalent cash bids in the market, the signal is pretty clear that it is advantageous to market to a cooperative.
What if it stays as written?
The above example is meant for illustration, and there are a number of factors that might mitigate the true differential created by the law, and these are producer-specific. Still, contemplating its preservation, a cascade of questions emerge regarding grain and agricultural product movements, local capacity, optimal organizational structures for farmers, and the fate of independents. Below are my thoughts summarized in the two broader questions I receive, vetted with trusted colleagues and grain marketing experts. The perspective I provide here applies to agricultural producers and grain marketing in the Midwest, but certainly there are related or larger impacts for other types of ag cooperatives throughout the country.
- Do cooperatives have the storage and transport capacity to handle agricultural products if all producers sell to a cooperative? What happens if not? What will be the local price impacts?
Grain storage facilities aside, a number of mitigating origination options are already used. In regions where processors and ethanol plants exist, producers use ‘direct-ship’ contracts to haul grain directly to a processor even though it is sold to the cooperative. Without recent data regarding the proportion of grain moving this way, it is hard to say whether we will see a significant change in those patterns, and even if so, grain movements and prices will find an equilibrium. Independent grain firms and processors likely will seek to establish marketing arrangements with cooperatives as a way to secure footing locally in the grain business.
Local price impacts are another unknown. On the one hand, some independents and corporations received a nearly 40% reduction in taxes (from 35% to 21%) via Sec 199A that cooperatives, which pass through member-based income to patron-members did not. The argument has been made that they can use those tax savings to be price competitive in the eyes of producers making the marketing decision. On the other hand, local capacity constraints at cooperatives may depress local basis, particularly during harvest, which partially mitigates the tax-differential created by Sec 199A.
Cooperatives typically do not turn away grain from members, which is why we observe large grain piles on the ground during harvest. Producers individually will need to weigh the potential tax deduction benefit with other costs associated with marketing grain: hauling distance, local basis differential, differentials in wait times at grain dumps, and so on. If net farm income is expected to be low, the per-bushel estimated tax difference created by Sec 199A dissipates.
- Will producers form their own cooperatives or independents reorganize as a cooperative?
Effects on grain cooperatives
Producers will be impacted not only by the farm-level deduction of Sec 199A but, as members of cooperatives, stand to notice positive changes related to their cooperative’s patronage allocations and equity redemption. The tax savings to cooperatives on non-member business and the supply-side of their business are just like those for other corporations, and the new tax rate is 21% instead of a maximum of 35%. However, if the Sec 199A deduction for producers marketing through a cooperative holds, all producers selling grain to a cooperative will choose membership, effectively eliminating any non-member marketing business. That aside, tax savings on cooperative profits related to input supply or other non-marketing functions could be used to accelerate the cooperative’s equity redemption which gets income into the members’ hands more quickly. Alternatively, the tax savings could be used to improve facilities and service offerings to benefit members.
For those wanting more details, the fact sheet “Impact of Tax Reform on Agricultural Cooperatives” (Briggeman and Kenkel, 2018) dives into the expected changes in cooperative patronage allocation and member-level returns from the law using simulation.
The questions that fall out of the reality of the Sec 199A code as written are important ones, as their answers weigh on the potential for significant changes in the structure of the agricultural supply chain for crops, in grain movements, and in farm-level incomes.
In a statement on January 12, 2018, the U.S. Department of Agriculture’s Under Secretary for Marketing and Regulatory Programs Greg Ibach wrote, “The aim of the Tax Cuts and Jobs Act was to spur economic growth across the entire American economy, including the agricultural sector. While the goal was to preserve benefits in Section 199A for cooperatives and their patrons, the unintended consequences of the current language disadvantage the independent operators in the same industry. The federal tax code should not pick winners and losers in the marketplace. We applaud Congress for acknowledging and moving to correct the disparity, and our expectation is that a solution is forthcoming. USDA stands ready to assist in any way necessary.”
The agricultural industry–cooperatives, too–anticipated that the existing DPAD deduction would not stand in the tax reform negotiations, but thought a similar provision would replace it. Few, if any, anticipated that a cooperative deduction would be expanded to the producer-level, or believe it will stand as written. Organizations such as the National Grain and Feed Association (NGFA) and the National Council of Farmer Cooperatives (NCFC) are working jointly on a revision with Congress. Tax professionals, agricultural businesses, and producers are waiting for clarification on whether the law will stay as-is or be changed, and will then await guidance from the IRS on interpretation.
1969 Case 1160 Shucking Corn in January
Jacksonville, IL - Jon Brickey of Murrayville, Illinois decided to take advantage of the 50-degree weather January 25, 2018, to shuck corn with his vintage 1969 (circa) Case 1160 combine. University of Illinois Extension Farm Broadcaster Todd Gleason happened to be passing by and stopped to visit.
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Todd E. Gleason, WILLAg.org
University of Illinois Extension
(217) 333–9797 or email@example.com