A program of tax deferred savings accounts is one alternative being considered by Congress to help farmers manage year-to-year swings in income. The Farm and Ranch Risk Management (FARRM) accounts would allow them to deposit funds during years of high net farm income that they could draw on during low income periods.
“Farmers able to build new savings through these FARRM accounts could self-insure some of their income risk, with the additional incentive of tax deferral and possibly tax savings through bracket reduction,” say USDA Economic Research Service senior economists Ron Durst and James Monke, who discussed the option at the annual Agricultural Outlook Conference in Washington.
But the way the program is structured, a large percentage of farmers would not be eligible to participate, and for many of those eligible the amount they could contribute would be quite small.
As proposed by Congress, farmers could get a federal income tax deduction for FARRM deposits of up to 20 percent of eligible farm income. Deposits would be made into interest bearing accounts, and earnings would be distributed and taxable annually. Withdrawals from principal would be at the farmer's discretion and would be taxable in the year withdrawn.
Deposits could remain in an account for up to five years, with new amounts added on a first-in, first-out basis. Any deposits not withdrawn within five years would incur a 10 percent penalty. FARRM funds would also have to be withdrawn if the participant stopped farming. Deposits and withdrawals would have no impact on self-employment taxes.
Only individual taxpayers who report positive eligible farm incomes would be eligible for FARRM accounts, and to benefit from tax deferral, the farmer would also have to owe federal income tax in the year of the deposit.
“Using Internal Revenue Service data, an estimated 916,000 farmers could be eligible to contribute as much as $2.8 billion to FARRM accounts,” Durst and Monke note. “Farm sole proprietors account for over two-thirds of eligible participants and over three-fourths of potential contributions.”
Even though sole proprietors dominate the estimates, significant variation exists within their ranks. Nearly 73 percent either report a farm loss or have no federal income tax liability, and could not participate or benefit from participating in FARRM accounts, they say.
Nearly half the remaining 27 percent of sole proprietors who are eligible would be limited to contributing less than $1,000 in any given year. Only about 1 in 6 could contribute more than $1,000.
“Thus, while the amount of money necessary to provide risk protection for either farm operations or household living expenses is difficult to estimate, with over 80 percent of all farmers limited to contributions of less than $1,000 in any given year, and with participation rates certain to be less than 100 percent of those eligible, most farmers are not likely to accumulate significant reserves,” they say.
Large family farms with sales over $250,000 are the most likely to be eligible, at 69 percent, with an average potential contribution of $10,800.
It is for these large farms — and many primary occupation small farms — that FARRM accounts could offer the ability to build “a sizable and useful self-insurance safety net over a period of several years.”
At the other extreme, limited resource farms (those with sales of less than $100,000 and a household income of less than $10,000 for tax purposes) would be least likely to be eligible. For those eligible, their average potential deposit is only $760 and “for such small amounts, FARRM accounts would be of little value.”
They would also offer little for so-called “retirement” and “lifestyle” farms, “but these may not need additional risk management tools since their primary occupation and source of income are away from the farm.”
While farmers “clearly respond to tax incentives,” Durst and Monke note, without specifying other income criteria for eligibility, a large share of the benefits could go to “relatively few farmers, including some who do not rely on farming for their livelihood.”
Because the current proposal doesn't specify a maximum deposit or accumulated balance, about 0.5 percent of sole proprietors would be eligible to contribute over $20,000 annually. The average off-farm income for this group exceeds $250,000, “increasing the likelihood that their contributions would be high.”
To meet the goals of increasing risk management and achieving program efficiency by providing benefits that exceed costs, FARRM accounts “must create new savings rather than replacing existing risk management practices,” Monke says. “New savings must come from reduced household consumption, or from funds that would have been invested in the business. If deposits come from assets shifted from existing savings, savings intended for another account, or borrowing, FARRM accounts would serve more as a tax management device than risk management. IRS data also suggest that, at least initially, most farmers who are potentially eligible have ample resources to shift funds in to FARRM accounts instead of creating new savings.”
Given the limitations, Durst and Monke say, FARRM accounts may improve short term cash flow for those who can participate, “but are not likely to significantly reduce the demand for emergency relief from the federal government.”