By Bert Ely
The FCS did it again — it lowered its corporate income tax bill for 2016 as its pre-tax profits reached a record $5.02 billion. Its combined federal and state income tax liability dropped from $221 million in 2014 to $197 million in 2015 and to $175 million in 2016. Its effective tax rate dropped a full percentage point over the three years — from 4.47% in 2014 to 4.03% in 2015 and 3.48% in 2016. The basic federal corporate income tax rate is 35%. Especially interesting is the fact that CoBank bears an increasing share of the FCS’s tax liability due to the profits it earns on its lending to agribusinesses and rural utilities. Even though CoBank accounts for approximately one-fifth of the FCS’s pre-tax profits, its share of the FCS’s tax liability rose from 74% in 2014 to 87% in 2015 and to 90% in 2016. Consequently, the effective tax rate for the rest of the FCS dropped from 1.59% in 2014 to .69% in 2015 and to .43% in 2016 — just $17 million of tax on pre-tax income of $3.90 billion.
While quite low, the effective tax rate of the 74 FCS associations varied significantly in 2016 — from a positive 8.90% to a negative 5.17%. This table shows the pre-tax income, reported tax liability (or benefit in some cases), and effective tax rate in 2016 for every FCS bank and association. Ten associations had a negative tax liability — called a “tax benefit” — for 2016. Essentially the tax benefit is a loss that can be carried back to recover federal income tax paid in a prior year or carried forward to offset future income tax liability. Twenty associations, mostly small, had a zero tax liability for 2016. Farm Credit Mid-America, the second-largest association, had the largest tax benefit for 2016 of $6.9 million despite earning a pre-tax income of $293 million whereas it reported a tax liability for the prior two years. Perhaps its 2016 tax benefit was due to a $10.5 million patronage dividend it paid for 2016; it did not pay a patronage dividend in the prior two years.
Here is why the FCS pays so little in taxes
FCS institutions are taxed under those provisions of the Internal Revenue Code that apply to co-operatives; they allow, among other things, the tax deductibility of patronage dividends. However, years ago Congress granted additional tax benefits to the FCS. First, three FCS banks are exempt from all federal and state corporate income taxes, as shown in the table linked to the previous article. The fourth bank, CoBank, pays income tax only on the profits it earns on its loans to agribusinesses and rural utilities. Second, FCS associations are exempt from paying federal income tax on profits earned on loans secured by real estate mortgages. FCS associations are subject, though, to federal income tax on the profits earned on non-real estate loans. The effect of all of this favorable tax treatment is substantial — for the 2014-16 period, this favoritism reduced the FCS’s tax bill by $3.78 billion, almost three-fourths of what the FCS’s tax liability would have been had it not enjoyed those tax benefits.
It is extremely difficult to estimate the impact of the FCS’s tax exemptions on its loan pricing, and specifically on the rate it charges on real estate loans, for the following reasons. First, the FCS direct lenders – CoBank plus the FCS associations — operate independently of each other in their lending and loan pricing decisions. Second, some of the associations are more aggressive than other associations in their lending activities and consequently may be quicker to offer a borrower a lower rate just to close a deal, especially if it would be a large loan. Third, loan terms vary greatly as to the term of the loan, fixed versus floating rate, loan size, degree of credit risk, etc. However, dividing the amount of income tax the FCS’s nontaxable entities avoided by a rough estimate of the average amount of real-estate secured loans outstanding in 2016 suggests that the FCS’s tax exemption on its real estate lending profits enabled it to reduce its average mortgage loan rate in the range of one percent in 2016. That reduction, though, could vary greatly, from loan to loan, based on the factors cited above.
Bill introduced to reduce tax on banks’ ag real estate lending
Rep. Lynn Jenkins (R-Kan.) has introduced a bill in the House (H.R. 2205) that would give FDIC-insured banks tax parity with the FCS for loans on ag real estate and rural housing. Called the Enhancing Credit Opportunities in Rural America Act, or ECORA, the bill would achieve this tax parity by amending the Internal Revenue Code to exempt from a bank’s taxable income the interest-rate spread the bank earned on any loan secured by agricultural real estate, provided that the property is “substantially used for the production of one or more agricultural products.” This tax exclusion also would apply to rural homes financed by commercial banks. The home would have to be a single-family residence and the principal residence of its occupant, provided that the residence “is located in a rural area.” Paralleling the FCS’s rural housing loan authority, the residence could not be located in a community with a population exceeding 2,500. When Congress will consider this bill is unknown.
FCA chairman talks again about FCS structural change
Following up on a speech reported in the February 2017 FCW, in which Farm Credit Administration (FCA) chairman Dallas Tonsager talked about the need for a discussion about structural change in the FCS, in a March 7 speech at the annual meeting of AgriBank (one of the four FCS banks), he again “called for a year of dialog about the structure of the [FCS].” Implicit in Mr. Tonsager’s remarks is his apparent belief that changes in the two-tier structure of the FCS — the four FCS banks funding and overseeing today’s 73 direct-lending associations — needs to be simplified and strengthened. However, he identified only three groups of stakeholders that should participate in this dialog — ag producers (presumably the FCS’s borrower/stockholders), FCS bondholders, and Congress. He clearly ignored two other groups of concerned stakeholders — commercial banks and other taxpaying competitors of the FCS and the general public, especially folks living in rural areas who are ineligible to borrow from the FCS but are impacted by the FCS’s lending and investing decisions in rural America.
In his talk, Tonsager did identify some important public-policy issues that merit discussion, such as when the territory served by an FCS association “becomes very large, how can the institution ensure that its staff is knowledgeable about all of the types of agriculture that are practiced in the territory?” He also asked “What are the criteria that help determine the ideal number of banks and associations? Is there a minimum or maximum size for an association or bank to be able to adequately serve its customers? How do you expect the relationship between the [FCS] banks and associations to evolve?” He urged his listeners “to keep your discussions and initiatives transparent . . . it’s important to keep the [FCS’s] owner-borrowers informed every stop of the way.” That is a fine admonition, but it is extremely parochial, for discussions as to how the FCS should evolve and possibly be restructured must reach far beyond the FCS to encompass all rural interests, including those who compete against the FCS. Conceivably, the FCA could begin to push for FCS structural change in the next Farm Bill.