The hemp industry is new and exciting for farmers across the county. People are looking at this crop as a golden ticket and, in some cases, as a way to save a family farm. While many new opportunities exist in the hemp industry, farmers with only one growing season under their belts will tell you that hemp production comes with challenges that many prospective farmers may not expect.

I could write a book on all the problems hemp farmers may encounter at some point during their journey, but there are a few huge issues with hemp production that every prospective grower should know about. These issues begin with seeds and clones and grow into poor-quality plants that cause headaches throughout the growing season.

Farmers expect the seeds or plants they purchase to be of a certain quality. Our current standards for seed quality in other crops set the bar high with adequate germination, years of breeding for specific traits and seed labels that match what is in the bag. Because we had such a large gap in hemp production, we do not have the same standards for hemp that we do for other row crops, such as corn or soybeans. While I expect the quality of hemp seeds and clones to improve with time, prospective hemp farmers need to understand the advantages and disadvantages to planting seeds or clones.

Farmers who are planting hemp for grain or fiber will always purchase seeds to plant, but those who want to grow hemp for cannabidiol (CBD) or other cannabinoids and terpenes have to decide whether they want to use seeds or clones.

Growing From Seed

Planting seeds is a favorable option for growers who not only seek to cut costs, but also want the convenience of ordering seeds and planting when conditions are favorable. This allows growers to purchase and store seeds in a cold room ahead of the growing season. Farmers who have seed-planting equipment will want to purchase seeds to use their existing equipment.

One of the most apparent disadvantages we have learned at Purdue University is the low germination rate of hemp seed. The Office of Indiana State Chemist (which is located at Purdue and administers agricultural laws involving animal feeds, fertilizers, pesticides and seeds to ensure truth-in-labeling, food safety, user safety and environmental protection), has performed germination tests on hemp seeds for the last three years, with average germination rates for grain and fiber hemp seeds just under 70%. While we do not have data on average germination rates for feminized seed, we have heard from several Indiana growers that they saw germination rates as low as 50% in controlled indoor facilities. One explanation for low germination could be improper seed storage. Hemp is an oilseed crop and is prone to degradation at high temperatures.

Other issues concerning hemp seeds also exist. Many growers are purchasing feminized seeds—hemp seeds that are mostly females. An issue with feminized seeds is regarding the percentage of males to females. Companies producing feminized seed typically claim 90% or higher feminization; however, this has turned out not to be the case in some instances. This issue came to a head when a Kentucky hemp business filled a $44 million lawsuit against an Oregon hemp seed company in October because the majority of the seeds it received were male, according to The Oregonian.

This is not a stand-alone incident. Data from Cornell University found that the feminized seeds it tested were far from the 98-99% feminization growers find on the seed labels and closer to 50% female. While a 50% female population is typical in a bag of fiber or grain hemp seed, it is a huge problem for growers purchasing feminized seed, where they are typically paying $1/seed.

Genetic instability in hemp seed exists because there was such a large gap in production of hemp grown for grain and fiber, not to mention that CBD production is also relatively new. Many growers are observing a lot of phenotypic diversity within the same cultivar from the same company. These genetic inconsistencies have caused variation in maturity time, the amount of CBD that can be extracted at harvest (percentage-wise), observed disease susceptibility and overall plant size. As breeders work with the same genetics, a refinement of quality and consistency should occur in the hemp industry.

Because new breeders are entering the industry, they may be unfamiliar with standard practices when it comes to selling seed with proper labeling and certificates of analysis (CoA). Growers should receive a lab-based CoA with their seed or clone orders. I have seen seed labels that state the cultivar, germination rate, feminization rate and that the seeds will not produce more than 0.3% tetrahydrocannabinol (THC). This is not a lab-based CoA and should be a sign that the seeds will likely not perform in a way that matches the label. State agencies are going to start hammering down on proper CoAs and seed labels, so hopefully we see better labeling and accurate CoAs with future seed orders.

© Brian Powell

Growing From Clones

Clones or rooted cuttings are a favorable option for growers who want to ensure an all-female population, but they come at a higher cost per plant. Many Indiana growers have paid up to $5 per clone. Farmers need to keep clones alive while waiting for the optimal planting date. What’s more, there have been incidences where growers receive clones that are not all female and were likely cut from male plants. In addition to receiving male plants, many Indiana growers received cuttings that were infested with aphids or mites or had poor root formation.

Phytosanitary practices need to be followed to ensure growers are receiving high-quality hemp that is healthy at the time of transplanting. My advice is that growers always thoroughly inspect clones prior to accepting them and make sure they have a contract protecting them from spending money and accepting infested plants.

Aside from all these issues growers may encounter, with more production predicted in the coming years (the U.S. hemp-derived CBD market is expected to reach $23.7 billion by 2023, up from the current value of $5 billion, according to analytics and research firm Brightfield Group), there could be shortages of seeds and clones, leading to higher costs to produce hemp. However, we may see a higher quantity and quality of seeds and clones as the industry continues to develop.

Most of us will not experience another crop that has grabbed everyone’s attention like hemp. Hemp has the potential to change agriculture by drawing people back to the farm.

While all of this excitement exists, hemp growers should develop a thorough plan to prepare for the issues outlined above as well as changes in a developing market. The hemp industry is growing incredibly fast, but growers should remember that it took decades of breeding and research to get where we are with row crops. I would recommend prospective growers reach out to more experienced hemp farmers to try to identify sources of high-quality seeds and clones. I think we can glean a lot of great information from Canadian farmers, and I often refer growers to Canadian production guides as a way to start learning about production.

With adequate planning and realistic expectations, prospective hemp growers will be better prepared for the 2020 growing season.

Marguerite Bolt is the hemp extension specialist at Purdue University’s Department of Agronomy. She received her M.S. in entomology from Purdue University, and her B.S. in entomology from Michigan State University. Bolt’s research has focused on hemp-insect interactions and plant chemistry.

To say 2019 has been a monumental year for industrial hemp doesn’t fully capture the sweeping changes the industry has seen. Thanks to the 2018 Farm Bill, hemp was removed from the Controlled Substances Act, making it a federally legal crop. With that change, existing and emerging hemp businesses moved into new tax territory, free from the federal tax burdens associated with cannabis.

1. Put Section 280E behind you

Prior to 2019, hemp growers were subject to Section 280E of the Internal Revenue Code, which limited business deductions to costs of goods sold. Van Asten emphasizes those restrictions applied to hemp businesses’ 2018 returns, but these businesses are free of 280E for the 2019 tax year.

While businesses growing cannabis crops that exceed 0.3% tetrahydrocannabinol (THC) are still subject to Section 280E, “now, a hemp company is able to deduct all of their normal operating expenses like any traditional business can,” Van Asten says. He also points out that hemp businesses no longer have to contend with the numerous cannabis-specific state and municipal excise taxes.

2. Know your state regulations

Even though hemp is federally legal, cultivation requires a license issued under a U.S. Department of Agriculture (USDA) plan or in a state with a USDA-approved industrial hemp production plan. Not all states have approved programs, though. Van Asten stresses staying informed and in-line with your state regulations to ensure you’re entitled to licensed hemp cultivation tax benefits.

“Know your regulatory environment. Obtain your special licenses,” he says. “Several states have limited pilot or research programs. Others have prohibited hemp production. Several states held off commercial growing until 2020.”

3. Stay current on testing requirements

Van Asten underscores the importance of THC testing. Hemp, as defined in the 2018 Farm Bill (formally called the Agriculture Improvement Act of 2018), can’t exceed THC concentrations of 0.3%, and state regulatory programs have provisions for destroying crops that exceed those limits.

“If your crop tests out above 0.3%, you’re technically no longer growing hemp. You now have a Schedule I drug growing in your field,” Van Asten says. Staying compliant avoids potential conflicts—tax-related and otherwise.

4. Explore separate business entities

With hemp’s new standing as a legal crop, Van Asten says choice of business entity, such as sole proprietorship or limited liability corporation, now holds different implications for hemp growers, and they must decide which is best for their operations.

“It’s more a strategic decision, like a traditional business,” he explains. “But farmers who grow hemp along with other crops may want to set up a separate business entity for the hemp portion of their farm.”

Van Asten says this separates the business risks of hemp versus more established crops, but it also segregates the hemp business with outside investment in mind. “An investor may not be interested in a traditional farm, but they might have more interest and willingness to invest in a hemp operation they know is scalable,” Van Asten says.

5. Understand your tax obligations

Hopkins says many hemp farmers operate as sole proprietors. As such, they’re required to make quarterly estimated tax payments. “For self-employed [owners], nobody’s withholding for you, and you need to make those payments yourself or face penalties,” she says.

Fulfilling your income tax withholding obligations as an employer is also important. Hopkins says this can become a little muddy for self-employed farmers who hire family members. Income tax withholding rules differ depending on the relationship.

The IRS states that all children employed by a sole proprietor parent are subject to income tax withholding. However, children under age 18 are not subject to social security (FICA) or Medicare taxes. Similarly, children under age 21 are not subject to Federal Unemployment Tax Act (FUTA) taxes. Different rules apply for spouses and for parents employed in farming activity as well.

If you’re not operating the business as a sole proprietor, family members are likely employees of the business, not of you as the business owner. As such, the exclusions available under sole proprietorships no longer apply. Special rules also apply to contracted crews and foreign ag workers on seasonal visas. “If you’re new to it, find a good payroll provider to help you,” Hopkins advises. A good payroll provider can help you correctly navigate tax withholding requirements for all types of employees.

6. Take advantage of farmer-focused tax credits

Federal tax credits available to traditional agriculture extend to farmers legally growing hemp. One credit Hopkins recommends seizing is the fuel and road use credit. This allows farmers, under certain conditions, to get a refund of excise taxes paid on specific fuels used for farming.

Hopkins explains that diesel fuel for cultivating agricultural or horticultural commodities, including hemp, could qualify for this credit, as could diesel used in the handling and storing of raw materials. “This one you definitely don’t want to miss because you’re [probably] paying excise taxes you’re not subject to,” Hopkins says.

7. Deduct allowable expenses for soil and water conservation

When non-ag businesses improve land to prevent erosion and flooding, expenses typically go unreimbursed. “But if you’re a farmer, you can elect to deduct some of those expenditures,” Hopkins says. “Having this ability can really help a farm reduce their tax burden.”

Hopkins says expenses for grading, constructing and/or protecting waterways, eradicating brush and planting windbreaks all potentially qualify. Improvements must be done under a plan approved by the Natural Resources Conservation Services (NRCS)—either a farmer’s individual plan or an existing county or state program. (For more information, visit the NRCS website.)

8. Claim your qualified business income deduction

As part of the Tax Cuts and Jobs Act of 2017, certain trades and businesses can deduct up to 20% of the net income of a qualified business activity. “This is not related to specific expenditures, and there are a lot of nuances, but farmers are eligible,” Hopkins says. “That’s one you really don’t want to ignore.”

9. Don’t overlook the basics, such as a business plan

Many of Velazquez’s clients were entrepreneurs in other industries, yet they struggle as first-time hemp operators. “It starts with the real basics, the business plan,” she says. “What is your goal? How are you going to accomplish it? What’s your timeline? You need to put those basics to paper.

“Entrepreneurs have great conceptual vision of what they want to do with the business line, but I’ve found that many fail to drive that through a real business plan,” she adds. “The most successful ones I’ve seen have that plan in place and live by it. It’s updated frequently, like a living document.”

10. Get the right people on board

Non-hemp experience doesn’t always translate well for entrepreneurs launching a hemp business. “They may be entrepreneurs, but hemp is new [to them],” Velazquez says. “They need a crash course in how to run this type of new business. If they don’t have the skill set, they need to ensure they have people on the team who do.”

For example, a financially savvy relative with zero farming experience doesn’t automatically make a great chief financial officer. “Inefficiencies in your operation end up in the financials,” she says. “You need the right people in your organization, in the right places, doing the right things.”

11. Plan for ERP software

To be competitive, Velazquez believes hemp business owners should look to enterprise resources planning (ERP) software, which integrates various types of separate business applications into a single management system. “We have a variety of disparate systems doing different things,” she says. “You need one place where you can see all the details for the enterprise as a whole.”

When business applications don’t communicate, business owners may not always see the big picture until it’s too late to make adjustments. For example, if labor and production applications aren’t integrated, the impact of unexpected labor on final production costs may not be apparent until tax time. “When you look at things in a silo, the financials are not as good as they can be,” Velazquez says. “You’re only as good as the information you have.”

12. Investigate federal business tax credits

Velazquez underscores that general business tax credits now apply to legal hemp businesses. “Many hemp clients are just not aware that these exist,” she says.

Some examples include:

• Research and Experimentation Credit. Properly documented research and development (R&D) activities could potentially qualify for this credit. “A lot of hemp operators are doing some very new and cool things. They’re breeding genetics, what we would consider in the tax world to be true research and development,” Velazquez says.
• Opportunity Zone Credit. This credit benefits businesses that invest in economic development and job creation in IRS-specified zones, typically distressed communities. “These are credits that would reduce, dollar for dollar, their tax liability,” she says.
• Domestic Production Activities Deduction. Also known as the Section 199 deduction or the manufacturing deduction, this deduction incentivizes businesses to keep manufacturing activities on U.S. soil. With hemp no longer a Schedule I substance, Velazquez says vertically integrated hemp businesses and hemp processors could qualify.
  

13. Understand cash versus accrual accounting

Under cash-based accounting—the traditional method for farming operations—taxes are paid when cash is received, and expenses are deducted when they are paid. With accrual-based accounting, revenues and expenses are recorded when they’re earned rather than when they’re paid.

Hale says many hemp farmers have contracts with buyers who are fronting money to farmers during the growing process. “Most of those farmers are going to be cash basis farmers, so they’re going to pay income tax on that money when they receive it, regardless of when they deliver the product,” he says.

Prior to the 2018 Farm Bill, accrual accounting sometimes benefited growers limited by Section 280E. While farmers still have the accrual option, Hale doesn’t usually recommend it. “If they’re going to be accrual, they have to start counting inventories and receivables and payables [differently],” he explains. Doing so would mean extra work without equivalent benefit for most farmers.

14. Take advantage of depreciation rules.

Depreciation involves expensing over an extended time period the cost of an asset you’ve purchased. The Tax Cuts and Jobs Act increased farming depreciation allowances significantly. The Internal Revenue Code also allows businesses to deduct the cost of certain assets, up to specific levels, as expenses rather than depreciating them over time.

“This new crop requires some specialized equipment adapted for cultivation and harvest,” Hale says. “Any of that equipment is eligible for the same depreciation rules as any other business. With most ag equipment, farmers can either depreciate it over time, or they can elect to write it off the first year up to some really high amounts.”

15. If new to farming, consider leasing equipment

“Agriculture is a very capital-intensive industry. [Existing] farmers already have equipment,” Hale says. “All they have to do is customize a few pieces for hemp and off they go. If you’re coming into farming from scratch, I would suggest maybe looking at renting equipment until you get comfortable with it.”

He says agricultural lenders are very familiar with leasing equipment. “That might be something to consider instead of trying to buy everything,” Hale says. And, under cash accounting, leasing expenses would get deducted the year they’re paid out.

As the newly legal hemp industry matures and more businesses enter the market, Hale expects a bit of the Wild West ahead for farmers. “It’s exciting, but it’s new,” he says. “Anytime there’s something new, there’s going to pitfalls and land mines and kinks that have to be worked out.”

But whether you’re an experienced hemp farmer or new to the field this year, these tax tips can help you improve your bottom line this tax season—and keep you on track for improved operational efficiencies, along with increased profits, for years to come.

Jolene Hansen is a freelance writer and frequent contributor to GIE Media publications. Reach her at jolene@lovesgarden.com

© iQoncept | AdobeStock

Commercial hemp is a new U.S. agricultural market, but as happens with all agricultural crops, the market will continue to grow, and eventually hemp will become a commodity crop, just as wheat and corn are, for example. But where does the hemp market currently stand as far as value and production volume compared to more mature physical markets? And what can we expect to see in the near and long-term future for this fledgling U.S. crop?

Perspective: Volume and Price

To give some context to the U.S. hemp market’s current size, we can look at the current volume of more mature markets.

The U.S. market for specialty sand (proppants), which is required for the extraction of oil and gas, is approximately 120 million tons per year, based on PanXchange data. In comparison, according to the U.S. Department of Agriculture (USDA), world corn production in the 2017-2018 crop year was 1 billion tons (337 million tons from the U.S.), and world wheat production for the same period was 927 million tons (75 million tons from the U.S.). Production estimates for U.S. hemp still vary widely, but if 437 million pounds were harvested with a 50% crop loss (based on Vote Hemp’s estimation of losses in 2019 due to THC overage, mold, etc.), that would bring the U.S. hemp market production to 218.5 million pounds (109,250 tons) in 2019. Note that corn and wheat trade internationally in 60,000-ton bulk Panamax vessels, so just two global market transactions would total 120,000 tons—more than the entire 2019 U.S. domestic hemp market by volume.

Granted, a substantial price differential exists, as higher valued crops naturally trade in smaller transaction sizes. Using the values of exchange-traded futures (commodities traded on market exchanges that are promised to be delivered in the future), corn and wheat traded at around $136/ton and $178/ton USD, respectively, in the second week of December 2019. If hemp biomass is trading at $8/pound, 1 ton would be valued at $16,000. This should give you good insight as to how much non-CBD, non-specialty industrial hemp will be trading in terms of both price and volume.

Customs of the Trade

Many differences between hemp and other commercial agricultural crops stem from the hemp market’s immaturity.

In the most mature markets, the number of market participants has long since experienced a dramatic consolidation. This is most noteworthy in world markets versus domestic-only markets. Research from Oxfam, for example, shows the ABCDs of agriculture (ADM, Bunge, Cargill and Louis Dreyfus) move more than 75% of world market grains. Mature markets are thus consolidated and insulated with extremely high barriers to entry for new participants. All major players are known to one another.

In hemp, the challenges are very different, including:

• Oversupply. There are scores of farms in the U.S. with 20 to 40 acres and a dearth of large industrial buyers.
• Attempting vertical integration “from seed to sale.” One initial challenge in building a liquid physicals (cash) trading market in hemp is connecting buyer with seller, as the independent farmers described above have less open market demand. It’s noteworthy that the ABCDs, most of which have been around since the 1800s, didn’t significantly expand into vertical integration until early this century in U.S. and world ag markets.
• The lack of credit and performance history among U.S. hemp businesses. Many sellers were duped in 2019 by companies that invested significantly on branding, yet by harvest time, stories poured in about purchasing companies’ financial distresses. Purchase agreements were scrapped due to a lack of working capital and falling prices.

In mature cash markets, one’s word is one’s bond, and it’s why traders say, “You’re only as good as your last trade.” The adage refers to the insulation of these larger markets. Trades are negotiated “on spec,” meaning on a cited specific quality. Quality is tested by the buyer, and any variances are usually negotiated in the final price. Defaults due to quality are exceptionally rare. Payments between trade houses or with producers are usually made at the time of document/title transfer (“cash against documents”) and by letter of credit for ocean-bound destination buyers. Moreover, if you intentionally default on a trade, the industry will learn of it quickly and will see your business as too high of a risk.

In contrast, today’s hemp market is at least three to five years from this consolidation and level of trust among players. In 2020, most buyers will not accept an offer without a certificate of analysis and sample. Sellers will rarely accept a bid without pre-payment, yet that still doesn’t guarantee success in today’s buyer’s market. This is the single biggest obstacle to more liquidity in today’s cash market.

Supply, Demand & Price

In mature markets, a good trader has up-to-the-minute estimates of total market supply and demand. It is essential to assessing current market values and forward prices. In today’s hemp market, too many unknown variables exist to paint a clear picture.

In early 2019, hemp production was estimated by licensed acres, a far cry from actual physical tonnage brought to market. Today, we’re getting a clearer picture of that, but instead of relying on the USDA for forecasts based on decades of data aggregation, the USDA is turning to industry journalists and analysts for help.

The demand side is murkier still; until recently, estimates were only quoted in terms of retail consumer packaged goods’ (CPGs’) value, not supply. These give little to no indication of biomass and refined products demand. It’s the tail wagging the dog and all part of the hype that hemp will be the panacea to farmers’ losses in traditional crops. (See “December 2019 Hemp Market Update: PanXchange Benchmark Pricing.")

Based on that report, we believe demand for hemp refined products will be significantly lower than most had hoped, but we won’t have a clearer picture for six to 12 months.

Evolution to a Mature Market

The hemp market has many challenges yet to overcome in its march toward maturity and liquidity. (See the “Commodity Market Evolution” chart above.) More transparency is needed into true supply and demand, and long-term reliable suppliers and buyers need to emerge. The market is in desperate need of working capital coupled with proper storage.

We are two or three years away from the big trade houses coming into the hemp market to provide working capital and take the risks that provide much needed liquidity. It’s needed and likely inevitable.

In the meantime, these tactics can help you weather the market’s early growing pains:

1. Hope is not a strategy. Do not rely solely on dollar-based estimates of the CBD market. Consider that in Charlotte’s Web end-of-September 2019 financial statements, the only hemp products sold were grown on their own 891 acres, which speaks to vertical integration and how few acres are needed for $95 million in sales.
2. Look for whole-hemp-stalk uses whether you’re a producer or processor. I predict that in the long run, by volume, CBD products and smokable flower will be specialty markets dwarfed by demand for industrial fiber applications, many of which are not yet developed.
3. Think higher volume and lower margins if you are not already carving your niche as a CPG products supplier or buyer.
4. Keep your options open with as much working capital and storage as possible.
5. Establish larger and long-term agreements to add stability to your crop-year planning, but also aim to diversify in the cash market, avoiding reliance on any one trading partner.

Julie Lerner is the founder and CEO of PanXchange, Inc., which provides physical commodity markets with benchmark pricing services and an institutional grade electronic trading platform.