Dairy Channel: Beware of income taxes this year

No, I’m not crazy. This year is the type of financial and milk price situation that often leads farm managers to the unexpected conclusion that they owe taxes. How can this happen when everybody knows we’re not making any money?

Let’s look at a situation which occurs all too frequently.

Combination. First is that combination of low milk prices and poor crop yields. Everybody knows it’s tough to make ends meet when milk prices are low.

Costs continue to accrue, because you must incur the expenses if the business is going to continue to produce a product.

Dairy managers can’t just stop producing milk during times when costs exceed returns, then start producing again when the profit picture turns around. To complicate matters, you can’t predict how low prices will go, or for how long.

Most businesses experience times when returns are negative. The problem comes when costs exceed returns too often or for too long.

This year is doubly difficult because good farm managers have planned for and done everything necessary to produce part or all of their forage and grain needs for the herd, except for the most important input, water.

The drought disaster is depressing enough when we look at terrible yields. But, what do you feed the cows? Now you must go out and buy the forages and grain to make up the yield shortfall.

And guess what happens when crops yields are poor. Crop prices rise. So, instead of producing corn worth $2 per bushel, you spend the money on crop inputs and then have to turn around and buy the crop for $2.50.

Ballooning open accounts. What happens when a combination of low milk prices and higher-than-normal costs occur at the same time?

Quite often, the result of this scenario is that open accounts such as the feed bill, the fertilizer bill, the vet bill, the repair bill, seed bill and parts bill go unpaid or not completely paid.

The balances on these accounts increase over time, because there simply is not enough money to go around. The finance charges (usually at 18 percent annual rate or higher) increase along with the account balances, adding to the cash deficit.

So if there is not enough money to pay these bills, we couldn’t be making any money, right? Right, but you may still owe income tax.

Priorities. When faced with unpleasant choices, responsible people turn to their priorities.

Given the choice of feeding the children or paying the feed bill, most people will ‘let the feed bill ride’ and buy groceries for the family. This is not a major problem if the profits return and the manager can catch up.

But, even if profits return early next year, you may still be in jeopardy for unexpected taxes.

Personal expenses are not deductible. There may be no money left in the checking account to pay it, but you may owe taxes because you failed to pay bills, paying personal expenses instead.

Dozens of times farm managers have told me they had to borrow money to pay income taxes when they had huge increases in open accounts during the business year. Often, farm families owe tax on the entire amount they spent on family living during the year.

The tax return shows a profit when in reality what you did was pay family living and put off business expenses.

Don’t get caught. Calculate an estimate of your business profits for the year now, before year-end. This is especially important if you have seen open account balances increase dramatically this year.

Do this before year-end, while you still have time to make adjustments if necessary.

If you find that profits will result in tax owed, take steps to adjust. Instead of borrowing money to pay taxes, borrow the money now and use it to pay deductible business expenses, such as purchasing corn at harvest instead of waiting for the prices to rise even more.

Borrow the money from the bank or Farm Credit Services at low interest rates and pay off those high interest open accounts. These account payments are deductible and the result is to save money on interest and avoid income taxes at the same time.

These suggestions assume that you are a cash basis tax payer and that profits will return so that you will be able to pay off the loan and continue the business at a profit.

If you are not sure this can happen, you need to think through the situation carefully and decide whether or not to continue the business.

Many farm families continue to accrue losses for longer than they should, eating up equity in the process.

Help available. There is help available for farm managers who need to make these difficult decisions. Your tax advisor or preparer, your attorney, family members and business partners should be consulted.

Your banker or lender and your extension agent can help you with these calculations. Please do not hesitate to get help if you need it.

The Northeast District Extension Dairy Excel Team has helped many families to assess the future of their dairy farm businesses. We remain ready to help you in the same way.