Idaho Cattle Feeders Association, Inc. Tennessee Livestock Association Utah Cattlemen's Association American Brahman Breeders Associa- American Galloway Breeders Association American Hereford Association American Polled Hereford Association American Shorthorn Association International Maine Anjou Association I. PROPOSALS OF THE AMERICAN NATIONAL CATTLEMEN'S ASSOCIATION In the hearings before the Committee on Ways & Means in 1969, the ANCA appearing jointly with representatives of the National Livestock Tax Committee ("NLTC"), was asked by the Committee to work with its staff to develop positive proposals to help eliminate so-called abuses by a relatively small number of tax profiteers in agriculture but at the same time not substantially harm the legitimate industry. Such proposals offered by the ANCA in conjunction with the NLTC and other livestock groups to accomplish this goal, were included and adopted in a 1969 tax reform act as follows: 1. The depreciation recapture rules of Internal Revenue Code ("IRC”) Section 1245 were applied to depreciable livestock used for draft, breeding, dairy or racing purposes; 2. The holding period of cattle and horses was extended from 12 to 24 months to qualify for capital gains treatment under IRC Section 1231: 3. The tax free exchange provisions were clarified to provide that male livestock cannot be traded tax free for female livestock; 4. The law was changed to require taxpayers to prove the purpose for which livestock is held in addition to proving the length of time livestock is held to qualify for capital gains; and 1 5. A sliding scale recapture of land improvement expenses was established when farm or ranch land is sold within ten years after its acquisition. These positive proposals which became part of the 1969 Tax Reform Act have had the desired effect and should remain in effect. IRC Section 1251 establishing an Excess Deductions Account for farm losses under certain circumstances, also a part of the 1969 Tax Reform Act, is unfair and unworkable and should be eliminated. And economic realities dictate that the hobby loss presumption in the IRC Section 183 be extended to two out of seven years for cattle as it presently stands for horses. II. COMMENTS ON THE ECONOMICS OF THE CATTLE INDUSTRY A. Livestock Farming Low Profit, High Risk Industry Traditionally, livestock raising has been a low profit industry. (See Exhibit 1.) Indeed, exceptions to this rule generally are difficult to predict and result 1 1 Returns on investment on cattle ranches on the Edwards plateau of Texas vary from 4.2 to 2.75 percent based on current land values. Boykin, C. C. and Forrest, N. K., "Economic and Operational Characteristics of Livestock Ranches: Edwards. Plateau and Central Texas." Texas Agriculture Experiment Station, MP978, January 1971, p. 23. from seasonal fluctuations in production costs, and prices received or farm land appreciation due to factors unrelated to the profitability of livestock raising. From the point of view of percent return on investment, cattle raising does not even compare favorably with other agricultural enterprises. (See Exhibit 1.) And agriculture does not compare favorably with all industry and especially not with the return on investment from manufacturing. (See Exhibits 2 and 3). Even with the current dramatic increases in the pirce of live cattle, parity stands at 93% up from 88% a year ago." (See Exhibits 4 and 5). The risks to which the livestock industry are subject are legion, including an ever changing and growing glossary of diseases, weather, prices and government regulations. The accompanying graph (See Exhibit 6) demonstrates the great fluctuations in prices that can change dramatically within a month's time. Prolonged drought, unusually cold or unseasonable weather, unexpected blizzards, can all raise havoc with the profit picture of the livestock operation. The present situation is instructive of these risks. Today, cattle are selling at an all time high. USDA figures indicate that prices received for meat products are up 7% above mid-December. At the same time, however, the price of feed is up 7% from mid-December and 30% above a year ago as compared to a 24% increase for livestock prices. Because of the severe weather in large areas of the country including the High Plains, the Midwest and the West, death loss has been estimated in some areas as high as three to four times higher this winter than last winter. And, like everyone else, the farmer, too, was subject to the 7% increase in the cost of living from mid-January, 1972. Those cattle that did not die, did poorly and normally expected gains were either not obtained or reduced with the accompanying substantial increase in cost. Were prices today at year ago levels, the losses in the livestock industry would be immense. B. Livestock Industry is Capital Intensive The amount of capital that necessarily must be subjected to such risks to produce the meat demanded by the American housewife is staggering. (Per capita consumption of beef has increased at the average rate of nearly three pounds per year over the past decade. As a consequence of increased consumer acceptance combined with a growing population, per capita beef consumption is projected to reach 130 pounds by 1980 compared to 85 pounds in 1960). In 1972 the total investment in farms assets as 335.2 billion dollars. Of this amount, 27.5 billion was invested in livestock, almost triple the amount invested in 1950. It has been estimated that approximately 55% of the agricultural sector relates to livestock." In the feeding sector alone, in excess of 5.1 billion dollars in capital was necessary to feed the 13.9 million head of cattle on feed in January, 1973.o The cattle industry does not now enjoy nor has it ever been the beneficiary of agricultural subsidies. To the contrary, prices paid by the cattle industry have undoubtedly been increased by farm subsidies in other sectors of the agricultural economy. C. Change in the tax law could deplete capital in the livestock industry It has been estimated that in the cattle feeding industry in the six major cattle feeding states, 2-22 billion dollars in capital becomes available to the cattle feeding industry alone from outside investors. Similar figures are not available for the production's side of the industry. It is suggested that perhaps one-half of the $2-22 billion is invested within the framework of the present tax laws that allow the prepayment of feed before it is fed. If this amount of capital from this segment of the industry were withdrawn, it has been concluded that: "1. Prices of feeder cattle would immediately decline. Prices of breeding animals would tend to decline accordingly. 5 Prepared statements submitted by witnesses, Panel Discussion of Tax Reform before the Committee on Ways and Means, House of Representatives, Ninety-third Congress, First Session, February 20, 1973, p. 109. This increased consumption has not taken much more of the housewife's disposable income. In 1951 an hour's wages brought 1.7 pounds of beef; in 1971 an hour's wages bought 3.3 of even better beef. Industry Information Council of ANCA and American National CowBelles, Inc., "Beef Industry Facts." Department of Commerce, Statistical Abstracts of the United States, 1972, Table No. 985, p. 595. 7 Prepared Statements, supra note 5 at 93. 8 Id. at 118-119. • Id. at 121. "2. Feeder cattle would tend to be fed to lighter weights, which would tend to reduce total beef supplies. "3. Cattle breeders during the first six months would tend to cull breeding herds more closely and hold over fewer heifers for replacements. This action would reduce feeder cattle supplies for three to five years in the future. "4. Consumer prices of processed meats would decline in the short run relative to fed beef. Fed beef prices would remain strong in the short run then rise materially as fed beef supplies declined six to ten months in the future. "5. The new outside investor would experience tax disincentives for investing in cattle feeding. This is bound to produce serious dislocations in the funding of an essential industry. This suggests that care should be exercised in adopting any basic changes in the tax rules affecting the industry." "10 III. ANCA OPPOSES ANY CHANGE IN THE PRESENT METHODS OF ACCOUNTING AFFORDED FARMERS AND RANCHERS Congress has recognized and sanctioned the use of the cash basis accounting method traditionally employed by the livestock industry since inception of the federal income taxes in 1913." This system with a few exceptions, has worked well and should be retained. The problems of exploitation by a few tax profiteers can be remedied by relatively simple measures without disturbing the entire system. A. Accrual Methods of Accounting by Livestock Operators is Virtually Impossible to Achieve Due to the nature of and the conditions surrounding livestock operations, ANCA is of the opinion that simplified record-keeping and accounting methods such as the cash basis, are absolutely essential. In excess of 97% of farmers and ranchers use the cash basis system of accounting.12 Chief among the reasons for using this system is its simplicity. Although the number of farms and ranches is declining and operations are increasing their sophistication in business and accounting methods, the vast majorty of United States' livestock operations are conducted by single operators and their families. His average age is about 52 and on the average he completed 9.4 grades in school.13 A typical livestock operator will earn practically as much income from nonfarm sources as from farm sources. The average income of farmers from all sources per capita was $2,546 per year in 1970.15 In discussing today's livestock industry we tend to visualize only the very large operations when in fact, for example, in Texas today the average sized cow herd is 17.16 The profile of the typical rancher suggests someone who lives on a small farm or ranch from which he commutes to town where he is generally employed as a wage earner. Although the average assets marshalled by one of these operators may seem substantial, (See Exhibit 3) he cannot yet be called in the true sense, a businessman of the variety who hires and fires, accounts and plans, even in the sense of a small town merchant. His records are kept in a checkbook, a notebook supplied by the local farm implement dealer, and on the grainery door. To ask him and even his more sophisticated cousin to keep the kind of accounts that even the experts cannot agree on, is asking too much. B. Strict Accrual Accounting Does Not Fit Farmers and Ranchers and Therefore Should Not be Forced Upon Them A strict accrual system would be a virtual impossibility even for the most sophisticated accountant in the livestock industry. Since gain on the sale of breeding animals held for their requisite holding period is taxed at capital gains rates, it would be most essential for the farmer or his accountant to differentiate between and properly segregate the costs of raising his breeding stock from the cost of raising animals held for sale. In many instances the farmer or rancher is unable to determine for a significant period of time whether to place an animal with his sales herd or to retain it as a member of the breeding herd. Attempting 10 Id. at 128. 11 Id. at 100. 12 Internal Revenue Service, "Statistics of Income-1968 Business Income Tax Returns," U.S. Government Printing Office, Washington, D.C., 1972, p. 21. 13 U.S.D.A., Agriculture Report No. 175, E.R.S. 1970, pp. 33-35. 14 T.S.D.A., Agriculture Statistics, 1971, Table 690. 15 Ibid. 16 Prepared Statements, supra note 5 at 107. to allocate costs in these circumstances would test the ingenuity of even the most complex accounting equipment. Similar but greater problems develop where, as is commonly the case, the farming or ranching operation includes the raising of livestock as well as the growing and harvesting of crops and other agricultural activities. For example, in some areas of the Southwest, full utilization of the land requires that an operator raise sheep, goats, cattle, horses and crops. To properly allocate the cost of the overall agricultural business to the multifaceted operations involved would be a nightmare and exercise in futility. In the final analysis, it would be an impossibility. C. Accurate Inventories are Extremely Difficult Unlike other businesses where the production and sale of merchandise is a significant factor and a strict method of accounting is required for income tax purposes, ranching and farming is not the kind of business where accurate inventories can be made at periodic intervals and meaningful cost-accounting methods employed. Although many operations are small, covering only a few acres and head of cattle, the corresponding lack of sophistication of these operators would make this system difficult to administer. On the other hand, many ranches cover thousands of acres and livestock cannot be conveniently located and inventoried on December 31st or any other specific date for accounting purposes. D. Strict Accrual Accounting Can Be Very Expensive Even if the accrual method of accounting were feasible and could be complied with, this would substantially increase the operational costs of the farmer and rancher which are now already at record levels. With such additional costs to cope with and viewing the already existing thin overall profit margins of livestock operations, it is conceivable that the added burden of increasing the complexity of their record-keeping and attendant costs would cause many farmers and ranchers to cease operation. E. Expert Accounting Assistance Is Not Always Available Furthermore, in the large number of rural areas there are no accountants or an insufficient number of accountants, to perform the complex bookkeeping chore that would result from imposition of the accrual method of accounting on farmers and ranchers. Statistics show that in areas where farms and ranches are most abundant, accountants are least abundant. Even if the services of a qualified cost accountant could be obtained, additional time and expense which would be spent in trying to justify to the Internal Revenue Service or to a court the method of cost allocation used, which would be obviously subject to very close scrutiny, could be most substantial. F. Consequences When Cash Accounting Results in a Deferral of Income Except in some cases of apparent abuse where the deferral aspects of cash accounting are distorted by the quick "in-and-outer" who may make large deductible purchases of deed in the fall for one turn of cattle feeding and then sell out in early spring, it is hard to conceive that this aspect of cash accounting will outweigh the many advantages of this system in the particular circumstances of the industry in which it is used. Cash accounting permits some fine tuning of agricultural income but in a business where income is sledom assured and never at regular, level monthly installments, the system should not be upset. Also, one man's deferral is usually another man's income. When a farmer prepays some feed, that payment becomes income to the seller. And improper use of the deferral can result indeed in greater taxation by causing income to be doubled up, thereby increasing not only the amount of tax due in one year, but the tax rate on the increased amount of income and by converting earned income to nonearned income which is subject to higher tax rates. The deferral aspect of cash accounting does permit, indeed encourages, expansion of the livestock enterprise. If a farmer reduces his operation, the so-called deferrals catch up to him. At a time when increased production is obviously desirable, it is submitted that disincentives for expansion should not be created. G. Use of the Cash Basis in Cattle Feeding Cattle feeding affords opportunities for some abuse of the cash basis of accounting. The abuse is by those who take advantage of the system without making any real lasting contribution to the industry-i.e., a person in the cattle business on December 31st and out as soon as his cattle can be sold the following spring. The problem is one of an immediate deferral of taxes which will be recaptured the following tax season, perhaps at higher rates, unless of course, another tax shelter is found. If this investor leaves his money at risk in the cattle business for a substantial period of time, we see no reason why he should not be allowed to keep cash basis records. His contribution to the cattle industry in terms of equity capital and increased incentive to production for both crops and livestock is more valuable than the disadvantage of a temporary deferral. If this type of investor were to be eliminated from the cattle scene, it has been estimated that the result in the intermediate and long range would be a disincenive for production and then eventual increase in meat prices. ANCA believes the already strict requirements for permitting the deduction of prepaid feed could be adjusted to eliminate the problem of the in-and-outer. This, it is believed, could be dome administratively without the need for legislation. IV. THE CAPITAL GAINS TREATMENT OF BREEDING ANIMALS SHOULD BE RETAINED 17 At a time when orderly expansion of the beef cow herd is in order. it would not be in the best interest of the consuming public to deny capital gains incentive to farmers and ranchers to build their herds. Because of low profitability, the historical economic incentive for ranchers to build their herds has not been great. The average investment required per cow unit will vary between 750 and 1500 dollars. (See Exhibits 7-9.) And although returns from the sale of calves has increased recently, so have the costs of production. The latest USDA figures show an increase of 21% in the price of feeder cattle above a year ago, however, the cost of feed has increased 30% above a year ago levels.18 This is not to mention the steady rise in other prices to which the rancher has been subjected for years without a corresponding increase in his prices received. A. The 1969 Reform Act eliminated abuses of the capital gains treatment of livestock The 1969 Tax Reform Act extended the holding period for livestock from 12 to 24 months, placed a burden of proof on the taxpayer as to the purpose for which livestock is being held as well as the length of time which it is held, and clarified the law to prevent the tax free exchange of bull or steer calves for heifers or cows. That act also subjected depreciable breeding cattle to the recapture of depreciation. These 1969 Act provisions have essentially eliminated whatever tax profiteering was going on at that time. In addition to the above provisions, cattlement are subjected, like everyone else, to the minimum tax on tax preferences including capital gains and the increase in capital gain rates. ANCA argues that it would not be in the interest of the livestock industry of the United States or of the consuming public to further restrict capital gains treatment of breeding livestock. B. Capitalization of cost of raising breeding livestock next to impossible As stated above, the accounting problems of allocating the cost of production of breeding livestock as differentiated from the cost of producing livestock held for sale, especially when several enterprises including crops and livestock are involved, would be great. To decide, for example, what part of the cost of fixing fence should be capitalized as benefitting the breeding cow herd or the horse band and what part should be expensed as an item relating to the calves that will be sold, or the steers that have been purchased for fattening on grass, would pose more problems than it would be worth. V. PRESENT METHODS OF DEPRECIATION INCLUDING THE ADR SYSTEM SHOULD BE RETAINED AS WELL AS THE INVESTMENT TAX CREDIT AS IT APPLIES TO LIVESTOCK The arguments for retaining accelerated methods of depreciation are similar in the area of livestock raising as in other businesses. The incentive that accelerated depreciation provides a business to expand and grow is equally applicable to the livestock industry and is necessary at the present time because of the consuming public's interest in such growth. In 1969 the Tax Reform Act changed the law to require recapture of depreciation on breeding livestock at the time the livestock is sold. This ended whatever |