Roller Coaster Income and Taxes: Some Options to Consider Dr. E. Bruce Godfrey and Dr. Tyler Bowles
USU Economics Department

Most dairymen recognize that the last three years have constituted a period of unprecedented change. Milk prices in late 1998 and early 1999 were at all time high levels. This was followed just a year later by prices that were lower than at any point in more than a decade. Thankfully, milk prices in 2001 have improved significantly from those in 2000, but recent declines suggest that milk prices in 2002 will be lower than those obtained in 2001. These wide swings in the price of milk have a major influence on the net returns that dairymen obtain from their efforts and the income taxes they have to pay. This article outlines some of the alternatives that dairymen should consider to reduce taxes they have to pay over time during these roller coaster years.

The first thing that most dairymen should consider is the income averaging provision in the tax code. This provision allows high income years (e.g., 1999) to be "averaged" with low income years (e.g., 2000). This is particularly helpful when the high income years are sufficient to place the owner(s) in a higher tax bracket. Operators should work closely with their tax practitioner in evaluating the benefits of income averaging.

A second option that should be especially considered at the present time is pre-paying some expenses. USDA data indicate that the corn crop in 2001 is expected to be at or near record high levels. As a result, the price of concentrates is expected to be very low. In addition, corn and soybean prices are generally at their lowest at the time of harvest. The harvest of corn and soybeans in the Midwest is slightly behind schedule as a result of heavy rains and high moisture. As a result, corn and soybean prices currently are likely at the lowest point that they will be in the coming year. Operators should seriously consider buying feed now that they will not be using until 2002. Payments for these feeds that are made in 2001 can be credited against income in 2001 when income is relatively high, as opposed to waiting until 2002 when income will likely be lower as a result of decreased milk prices. The purchase of concentrates is not the only input that can be prepaid. While concentrate prices are expected to be low this coming year, the same can not be said for hay. The drought has made hay supplies very short. As a result, hay prices are high, and will likely increase until at least next summer when the new crop is available. Other inputs that might be purchased now and not used until 2002 are supplies, semen and other items that will normally be used in 2002. There is a limitation on the amount of prepaid expenses that can be used to offset income earned in 2001, so care should be used to make sure this provision is not violated.

Many dairymen commonly put off doing repairs to buildings and/or equipment until it is absolutely necessary. However, doing repairs, or at least purchasing the items needed to make the repairs, in years when incomes are relatively high is another business decision that should be considered.

The purchase of new equipment is an alternative that some dairymen consider as the first thing that they might do to reduce taxes. However, the first question that should be asked when evaluating the purchase of any input should be "how will this purchase affect my bottom line in the long run." Making purchase decisions based on how it will affect taxable income in the current year is very short sighted. The purchase of equipment must pay for itself in the long run before it is a sound business decision. Buying equipment that will not have a positive impact on after tax income in the long run is a sure way to reduce income and has been the reason why some businesses have failed.