How to address payment limits is one of the real “hot-button” issues surrounding the next farm bill with some Congressional leaders, public information groups like the Environmental Working Group, the media, the general public and with some producers.

The payment limit issue is bipartisan in Congress, and is likely to garner a lot of discussion during the upcoming farm bill hearings. Most observers feel there will be some provisions in the new farm bill to address payment limits, most likely to tighten some payment limits, and to change or eliminate some of so-called “loopholes” relative to payment limits, such as the “triple-entity rule” and unlimited use of commodity certificates to release grain that is under a Commodity Credit Corp. loan, when posted county prices are lower than CCC loan rates.

U.S. Secretary of Agriculture Mike Johanns announced the Bush administration proposals for the next farm bill in late January. One of the more controversial proposals was to initiate a “hard and fast” $200,000 “adjusted gross income” limit for a farmer to be eligible for farm program payments. The AGI would include “net farm income,” after farm expenses and depreciation are subtracted (Schedule F on federal income tax returns), wages and salaries, investment income and other income.

The current AGI limit for farm program payment eligibility is $2.5 million, so this would represent a major change in U.S. Department of Agriculture policy for farm program eligibility.

Currently, farmers are exempted from the $2.5 million AGI limit, if 75 percent or more of their income is generated from the operation of a farm. Also, the current $2.5 million AGI payment limit includes all farm program commodity payments and conservation payments, such as Conservation Reserve Program, Wetlands Reserve Program, etc.

The proposed $200,000 AGI payment limit would not exempt farmers who earn over 75 percent of their income from the operation of a farm, and CRP and other conservation payments would still follow the existing $2.5 million AGI limit.

It is been estimated that 70,000 to 80,000 farmers who are currently receiving farm program payments would be eliminated under this proposal. Johanns pointed out that this represents only 7 to 8 percent of the farmers in the United States who earn more than $10,000 from the sale of farm goods and products as a farmer.

According to USDA statistics, in 2006, there were slightly more than 172,000 commercial sized operations in the United States with a gross sale of farm products exceeding $250,000 per year. Nearly all of the estimated 70,000 to 80,000 farmers who would be affected by the proposed $200,000 AGI payment limit would be in the group that generates more than $250,000 in gross farm sales, which would mean that approximately 40 to 45 percent of the farmers in this group could potentially not be eligible for future farm program payments.

Many of the family farming businesses raising crops and livestock in Minnesota, Iowa and other Midwestern states have gross farm sales exceeding $250,000 per year.

Following are some considerations to think about regarding the proposed $200,000 AGI “means test” for payment eligibility in the new farm bill.

• The proposed $200,000 AGI payment limit rule totally changes to current focus of the $2.5 million AGI payment rule.

The current $2.5 million AGI rule has been dubbed the “Scotty Pippen Rule” because it is designed to prevent extremely wealthy, non-farmers, such as professional sports players, entertainers and media moguls, from receiving benefits under U.S. farm policy.

Typically, these wealthy non-farmers were receiving large conservation payments (CRP, etc.), rather than farm safety net benefits. Many experts feel that the new proposed $200,000 AGI rule would likely affect thousands of U.S. family farms, who are already subject to payment limitations, and that it could impact younger beginning farmers who rely heavily on cash rented land as part of their operation.

Interestingly, the proposed $200,000 AGI payment limit would not impact CRP payments and other conservation payments, and may actually encourage wealthy land owners to put more productive farm land into those programs, rather than keeping it in crop production. A land owner who is over the proposed $200,000 AGI limit could put a farm in CRP and get payments, but could not rent his land to a son or daughter on a share-rental agreement and get a portion of the farm program payments. Somehow, this does not seem quite right.

• The proposed $200,000 AGI rule could make thousands of farm and ranch families eligible for farm program payments one year, ineligible the next year, then eligible again the next year and then possibly ineligible the next year. The proposed AGI rule would determine farm program eligibility in a crop year based on the previous three-year AGI average from federal tax returns.

It does not appear that there would be a way to prevent farmers from being rotated in and out of farm program payment eligibility from year to year, due to yearly changes in the rolling AGI three-year average. This potential variability in future farm program payment eligibility will make it difficult for farm families to make both short-term farm operational decisions, as well as longer term financial decisions regarding machinery purchases, facility upgrades and land purchases.

The potential loss of the farm program payment “safety-net” may also affect the ability of some farmers to secure both farm operating loans and longer term loans for machinery and land purchases.

• The proposed $200,000 AGI rule could severely limit the ability of some farms to meet the principal debt repayment on term loans for larger investments, such as land and farm machinery. A crop farm operation’s AGI includes income from grain sales and farm program payments; minus expenses for seed, fertilizer, chemicals, fuel, labor, land rent, other crop input costs and farm interest payments.

Principal payments for debt service on intermediate and long-term farm loans are not Schedule F expenses deducted before the AGI is calculated. These debt service principal payments must be made with after-tax dollars, or part of the $200,000 AGI limit. Given the cost of land and farm machinery today, it may be restrictive to many farmers to make required debt service principal payments with this proposed AGI limit.

• The proposed $200,000 AGI rule would base farm program payment eligibility on the AGI for the past three years, which could result in a farmer being ineligible for the farm program payments in a year when the “safety net” is needed the most.

With this proposed rule, it is a possible that a farmer could bump over the $200,000 limit before the beginning of a given crop year, making him ineligible for direct payments, counter-cyclical payments or loan deficiency payments, and then that farmer could have low yields with low prices that result in a zero or negative AGI that same year, with no farm program payments.

On the other hand, in a given year a farmer could have a “bumper crop” with high grain prices, and likely be over the $200,000 AGI limit, but would still be eligible for farm program payments. The proposed $200,000 AGI rule seems to change the “safety net” concept of farm program payments.

• The proposed $200,000 AGI rule could impact land rental contracts between land owners and farmers. Most cash rental agreements on a particular land parcel are negotiated based on average yields on that particular land parcel, and on projected crop income from grain prices and farm program payments, many of which are “safety net” payments that are linked to lower grain prices.

The potential loss of farm program payment eligibility puts much more risk into a land rental agreement from a farmer’s perspective. This could restrict some farmers, especially higher risk or beginning farmers, from being able to competitively bid on rented farm land.

Conversely, some larger farmers who are close to the $200,000 AGI limit may raise cash rent amounts to certain landlords, since cash rental payments are a deductible AGI expense. This could artificially raise land rental rates in some areas, again restricting some farmers from being able to competitively bid for rented farm land.

• The proposed $200,000 AGI rule, in combination with the proposed change in farm program payment eligibility on land purchased through a “Section 1031 Land Exchange,” could create a “Catch 22” for farmers.

In their proposals for the next farm bill, the USDA proposed making all farm land that is purchased utilizing a “Section 1031 Land Exchange” ineligible for future farm program payments. If both provisions were enacted in a new farm bill, following is an example of what could happen: a farmer could sell one farm that was purchased at a low price and now sold at a high price, and use the land sale proceeds to purchase another farm that might be closer to home, better land, etc. Under the USDA proposals, this farm would not be eligible for future farm program payments, if the farmer uses a “Section 1031 Land Exchange.”

However, if the farmer wants to forgo the “1031” in order to keep farm program eligibility, he may still be ineligible for farm program payments, if the capital gains resulting from the land sale pushed him over the $200,000 AGI limit.

This would not affect a lot of farmers, but it could happen. The effect of capital gains on the AGI, and potential loss of farm program payment eligibility, may also prevent some parents from selling land, livestock facilities or farm machinery to their children, while the parents are still farming.

• The proposed $200,000 AGI rule would inequitably treat farm families where one or both spouses have off-farm jobs in order to help provide family income, or to provide health care benefits.

Since the off-farm income would be counted toward the $200,000 AGI, a farm family where one spouse is a professional working off the farm with a higher salary gets treated much differently than a farm family where a spouse is working off the farm at a fairly low salary, even though the two farm families may have similar farming operations.

If money earned from off-farm employment could potentially eliminate a farm operation from future farm program payments, it could force a farm family to choose between having the farm program “safety-net” for risk management in their farm business, or having good health insurance coverage and other benefits for their family. Do we really want to put farm families in this type of difficult situation?

• The proposed $200,000 AGI rule could restrict future farmer investment in renewable energy facilities. Many members of Congress, farm organizations and other groups want to encourage local ownership and investment in renewable energy facilities, such as ethanol and biodiesel plants, wind energy facilities and other projects. In most rural areas much of the investment in local renewable energy projects has come from farm owners and operators from the extra earned income in their farm business.

The $200,000 AGI limit may restrict the amount of investment dollars that farmers have available in the future. Also, any income generated by investments in renewable energy will be counted toward the $200,000 AGI limit, which could slow investments into these projects by farm families, if that investment could result in future farm program payment ineligibility.

At a time when we need much more local investment into renewable energy production, it does not seem logical to have a payment limit rule that may restrict the investment dollars by farm families, and ultimately have a negative impact on rural development in some communities.

Bottom line

As soon as the proposed $200,000 AGI payment restriction rule was announced by Johanns, it was met with mixed responses.

Some public interest groups and members of the media have strongly endorsed the proposal, pointing to the so-called large farm program payment levels received by some farmers in recent years. They also feel that this would help smaller farmers be more competitive; however, that is debatable, as has been pointed out in this column, and in some instances the $200,000 AGI rule could actually hurt smaller beginning farmers.

On the other hand, some question using an income “means test,” such as the proposed $200,000 AGI rule, as a method to determine farm program payment eligibility, and feel that the $200,000 AGI limit proposed by the USDA for the future may be far too restrictive. They feel that we already have the current $2.5 million AGI limit in place to prevent wealthy non-farm entities from getting farm program payments, and that payment limit changes in the new farm bill should be focused on adjustments of the current “three-entity” rule for payment limits, and changes in the use of commodity certificates to release CCC commodity loans beyond payment limit guidelines for LDPs.

With proposals such as the $200,000 AGI rule for future farm program eligibility, we must be careful of the “unintended consequences;” which means that we don’t actually hurt the farm families that we are really trying to help.