Dairy Financial Times: Tax planning in spite of it all

By Joel Eigenbrood

As I write this at the end of the third quarter, it’s pretty safe to say it’s been a rough year for the majority of dairy farmers. From falling milk prices during the first half of the year to skyrocketing feed prices experienced in the second half, dairy producers have sustained one blow after another. 

It seems I hear of another dairy bankruptcy or liquidation almost every day. More dairy loans are being classified as distressed by lenders and being moved to the “special assets” or collection groups. While banks want the best customers, it continues to be extremely difficult to find lenders willing to take on new “average” dairy loans. Unlike 2009, most dairies have little equity left to borrow against, and feed dealers and other vendors are much more cautious in extending credit. 

Milk prices have slowly begun to recover, with Class III futures over $20/cwt. for the fourth quarter, and 2013 futures at what could historically be considered high levels. Despite this, profit margins going forward are extremely tight or non-existent for most producers, especially for those who purchase a significant portion of their feed. 

Yet, we continue producing milk under a broken milk pricing system, with basically no hope for a meaningful Farm Bill in the near future. Many producers and industry leaders still seem to have the attitude that once enough producers go out of business, everyone else will be fine. While they may survive this round, I contend if we continue down this road, their time will come to be forced out, as well.

Proactive tax planning

With all of this in mind, why would a dairy farmer possibly need to consider tax planning for the end of this year? There are a number of reasons, but it basically comes down to being proactive. It seems most tax problems can be avoided, minimized – or at least planned for – if they are anticipated. I’d like to lay out a few of the scenarios demonstrating why tax planning is always a good idea. 

Perhaps 2011 was a pretty good year for you (sorely needed and likely not nearly enough to fully recover from 2009) and you prepaid some 2012 expenses or deferred 2011 milk checks until 2012. Under either of these scenarios you have deferred recognition of 2011 income until 2012. 

Your 2012 losses may be enough to offset the deferred income, but you can only be certain with proper planning. You’d hate to wait and find out they weren’t after year end, when it’s too late to take action. At that point you would owe taxes following a loss year when cash flow is already extremely tight. 

Had tax planning been done, you could have foreseen the pending taxable income, and deferred income or prepaid some expenses to minimize it. Complicating the issue, you may not have a feed line being available, because it is fully extended, or your bank refuses to extend further credit. This is another reason why proper planning is critical.

Did you sell animals?

Another possibility: Like many producers, you made the decision to liquidate a portion of your dairy herd, your heifer program or other assets. Tax laws allow you to deduct the costs of raising replacement heifers as they are paid. However, this means that when they are sold, you do not have any cost basis to deduct against the sale of the animals, whether they are sold as heifers or as retired dairy cows. 

The result is that the entire sales proceeds from these animals are taxable income, even if they are sold for less than the cost to raise them. Similarly, in recent years, generous bonus depreciation rules allowed for purchased springers to be 100% deducted when purchased and placed in service. The sale proceeds from these animals would also be 100% taxable gain, and potentially subject to the higher depreciation recapture tax rates. 

Instead of selling animals, some operations have sold real estate or other non-essential assets to recapitalize the business. Such assets may have been purchased many years ago at a much lower price, and the sale could result in significant gains. 

Hopefully, before making the decision to sell any significant amount of assets, you’ve evaluated the potential tax impact of the sale with your accountant. Even if such a sale has already been completed, it’s worthwhile to run a tax projection now, as you may be able to structure other losses to help offset some or all of the gains. An example would be a client who has sold a piece of real estate at a significant gain. We know he is in the process of selling another piece at a loss. If he can close the second sale in 2012, the loss will take a significant bite out of the potential taxes on the first sale.

Even more drastic, you may have made the decision to exit the dairy industry completely. In this case, you only get one shot at structuring the sales of all your assets to minimize taxes owed, leaving you with the most money left in your pocket. One misstep could wipe out anything left after paying off creditors and your tax bill. Your exit could involve income from the forgiveness of debt if you owe more than your assets are worth, in which case you may be able to take advantage of exemptions for the forgiveness of agricultural debt.

Lastly, your operation may be sustaining significant losses in 2012 and you did not defer any income from prior years. It is still a good idea to do some tax planning, as you may wish to defer some 2012 expenses to 2013, when they may yield a greater benefit than simply increasing your 2012 losses. Or, you may know you are going to have some large income items in 2013, which you can accelerate to 2012 and offset with your current year losses. 

The bottom line is that proper tax planning is always a good strategy. Surprises are rarely good when it comes to taxes, and with good planning they can be foreseen and often minimized or avoided. While you never want to make business decisions solely based on tax implications, good economic analysis always includes evaluation of tax consequences so transactions can be structured to yield the most positive tax outcome. 

I’d also stress that it is wise to utilize the services of an accountant or tax preparer with expertise in your industry. This is beneficial both in helping you navigate the financial intricacies of today’s dairy industry, and also the tax laws which apply not only specifically to agriculture, but to dairies in particular. Every operation’s tax situation is different, so it is critical you consult your tax advisor to prevent being blindsided by surprises come tax time. 

FYI

• Joel Eigenbrood, CPA, is a managing partner with Genske, Mulder & Co., LLP, a certified public accounting firm in Costa Mesa, Calif., representing clients who produce 12% of the nation’s milk in 30 states. Contact him via phone: 949-650-9580; or e-mail: joele@genskemulder.com.