Getting the Most Out of the Tobacco Quota Buyout

Farm Business Management Update, June/July 2005

By Dixie Watts Reaves, (dixie@vt.edu), Associate Professor, Agribusiness Management and Marketing, Agricultural and Applied Economics, Virginia Tech

On Saturday, May 28, Virginia Cooperative Extension, North Carolina Cooperative Extension, and the Institute for Advanced Learning and Research jointly offered an educational program for recipients of tobacco buyout funds. The six-hour workshop, supported by the Risk Management Agency and additional sponsors (Edward Jones, First Citizens Bank, Davenport and Company LLC, and First Investors Consulting Group) provided detailed information on the tax implications of the buyout, investment options for buyout recipients, and options for alternative or supplemental enterprises in the post-buyout marketplace. The program was videotaped and can be viewed at http://2gdn.net or utilizing the direct link, http://164.106.50.133/Events/IALR/Tobacco_Buyout.htm .

Justin Hendrix of the Institute welcomed participants and served as the overall moderator for the day. He introduced Virginia Delegate Robert Hurt for opening comments.

Following Delegate Hurt's remarks, Arnold Oltmans, with the Department of Agricultural and Resource Economics, North Carolina State University, provided a discussion of the tax implications of the buyout. He indicated that the grower payments would be treated as ordinary income and the owner payments as capital gains. He urged both growers and owners to begin working with their tax professionals early and to begin collecting the necessary historical records to document their basis in the quota. Owners have the option of deferring their capital gains tax by utilizing a like-kind exchange. The timeframe for utilizing the exchange is limited and strict guidelines must be adhered to. Recipients will also have an option of choosing a lump sum payment after the first year. Financial institutions will offer a discounted lump sum, in return for receiving the future annual payments. Recipients are responsible for paying taxes at the time they receive the lump sum payment. When considering lump sum opportunities, Oltmans suggests asking the financial institution, "What interest rate are you charging me?" If the recipient can invest those funds at a rate higher than that interest rate, or if he/she can pay off a higher interest rate debt, then it is a good deal from an economic perspective. However, taxes will still have to be considered, and the tax effects will depend on the amount of the payment, the basis in the quota, other taxable income the recipient has, and filing status. Every individual's situation will be different; there is no simple answer to the question, "Should I take the lump sum?" Tobacco buyout details can be found at the Department's website: www.tobaccobuyout.cals.ncsu.edu .

Alex White, Department of Agricultural and Applied Economics, Virginia Tech, addressed the question of what to do with the buyout money. He presented six options for the use of the money. First, the recipient must pay taxes. Payment of taxes is not optional; however, tools to help reduce the amount of taxes paid include SEP, SIMPLE, 401(k), Keogh, and IRA's. Second, buyout dollars can be used to build liquidity. As a rule of thumb, an individual should have two to six months of living expenses as a financial safety net. Third, funds could be used to pay down debt and reduce pressure on cash flow. A fourth option is to invest in farm assets. Before doing so, the recipient should be clear about goals, should examine markets and productive capacity, and should compare the return on those farm assets to the return that could be achieved from a non-farm investment. Fifth, recipients should also consider investing in themselves and their families. Core values and goals will help recipients decide on a percentage of the buyout funds that should be invested in family goals. Finally, recipients could invest in non-farm assets. Prior to making choices about the type of investment, one must know the purpose and time frame for the investment (growth or income) and must understand his/her risk tolerance. Investment assets include stocks, bonds, mutual funds, real estate, and other investments. As the potential returns increase, the level of risk generally increases also. According to White, the basics of investing include clearly defining the investment goal, choosing the appropriate asset in terms of time horizon, risk tolerance, and earnings goal, and spreading the investment over different classes of assets.

During lunch, a panel of representatives from financial institutions provided insights into their firms and the types of products and services they offered. Panelists included Ryan Garrett (Edward Jones), Cleighton Hilbert, Jr. (Davenport and Company), Eddie Herndon (First Citizens Bank),and Pamela Bryant (First Investors Consulting Group).

The workshop closed with a panel discussion, moderated by Dixie Watts Reaves, Department of Agricultural and Applied Economics, Virginia Tech, focusing on alternative market development opportunities for producers. John Hall, Department of Animal and Poultry Science, Virginia Tech, offered insights into the potential for increased cattle production in Southside Virginia. Drew Arnn, Department of Forestry, Virginia Tech, discussed options for long-term forest investments on the farm. Joyce Latimer, Department of Horticulture, Virginia Tech, discussed a number of options for uses of greenhouse space for bedding plants and other floriculture products. Andy Hankins, Virginia State University, discussed a number of non-traditional enterprises that producers might consider adding to their farm operations. Denise Mainville, Department of Agricultural and Applied Economics, Virginia Tech, closed the panel with a discussion of risk management options for the producer. Each panelist's presentation can be viewed at http://164.106.50.133/Events/IALR/Tobacco_Buyout.htm .

With the deadline for signing up to receive buyout payments in mid-June, many growers and owners can now turn their attention to how to use the buyout dollars most effectively when they arrive in the next few months. Whether recipients choose ten years of annual payments or a lump sum, the buyout provides an opportunity for wise investing.

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