Pub 1 2012 Issue 1

18 Leading advocate for the banking industry in Kansas. T WO COBANK DIVISIONS PAY MOST of the FCS’s tax bill. As I have reported many times, the FCS enjoys an extremely low ef- fective tax rate. Last m onth I reported that the overall FCS tax rate dropped from 7.2% for the fourth quarter of 2010 to 5.7% for the third quarter of 2011. What I did not report was that the FCS’s tax bill dropped $6 million from the fourth quarter of 2010 to the third quarter of 2011 even though FCS’s pre- tax profits rose $140 million between the two quarters. In effect, the FCS had a negative tax rate of 4.3% on that increase in profits. The primary reason the FCS tax rate is so low is due to the fact that profits on FCS real estate lending are exempt from all income taxes. To further minimize their tax liability in recent years, all but three FCS associations have structured themselves as an ag- ricultural credit association, or ACA, with two wholly owned subsidiaries – a Federal Land Credit Association (FLCA) and a production credit as - sociation (PCA). The FLCA, which does the ACA’s real-estate lending, is exempt from all federal, state, and local taxes while the PCA, which does the ACA’s non-real-estate lending, is subject to federal income taxes but in many states is exempt from state and local taxes. Patronage dividends paid by the PCA are tax-deductible, further reducing the ACA’s overall tax liability. The five farm credit banks are exempt from corporate income taxes, with one Bert Ely’s FARM CREDIT WATCH © 2012 Bert Ely important exception – CoBank has to pay income taxes on the profits it earns on its agribusiness lending (largely to agricultural cooperatives) and its lending to utility cooperatives. For the first nine months of 2011, these two CoBank lending divisions produced 20.4% of FCS’s total pre-tax income yet accounted for 73.9% of the FCS’s income-tax liability. Viewed from an- other perspective, those two CoBank divisions paid an effective tax rate of 22.4% on their pre-tax earnings versus a 2.03% tax rate for the rest of the FCS. The third-quarter 2011 numbers did not differ greatly – the two CoBank divisions produced 18.3% of FCS’s total pre-tax earnings yet accounted for 69.3% of FCS’s total income-tax liability – the CoBank divisions had an effective tax rate of 21.6% versus 2.14% for the rest of the FCS. The gap between these tax rates and the basic federal corporate tax rate of 35% gives one a good sense of the magnitude of the tax advantage the FCS has over its taxpaying competitors. Tax rates vary among the ACAs There were significant differences among the 81 ACAs in their effective tax rate during the first nine months of 2011. Fifteen ACAs, with total pre-tax income of $296 million, had effective tax rates above 5%, ranging froma high of 10.43% to 5.19%, for an average rate of 7.97%. Seven ACAs with total pre-tax income of $521 million had tax rates ranging from4.91% to 2.85%, for an av- erage rate of 4.29%. The largest group of ACAs – 34 – with $1.071 billion of pre-tax income had tax rates ranging from 1.97% down to .01%, for an av- erage rate of .76%. Another 19 ACAs with $133 million of pre-tax income reported no income tax liability. Bring up the rear were six ACAs with pre-tax income of $1.3 million and negative tax expense due to negative income or apparent tax refunds. The effective tax rate for the five most profitable ACAs during the first nine months of 2011 varied significantly. The second-largest, but most profitable ACA, Shedding Light on the Farm Credit System, America’s Least Known GSE. System Update