AlB-Lancaater Farming, Saturday, March 29, 1997
Leaving Dairy Business? Consider The
Tax Effects Before Selling The Cows
UNIVERSITY PARK (Centre
Co.) It’s a Pennsylvania farm
family’s nightmare. After 20 years
in the dairy business, unfortunate
circumstances and economic forc
es have left a family of four
$125,000 in debt The family de
cides to quit dairying, sell the
cows and equipment to pay off the
debt, and combine an off-farm job
with crops and beef cattle.
They sell 100 raised cows and
for $97,500 and
dairy equipment for $27,500 in
May, and both husband and wife
take jobs in town. Both salaries to
tal $35,000 for the period of June
through December. The salary
money is used for family living
and to catch up on education ex
penses for two teen-age children,
so none is available for debt pay
ment
The ax falls when they have
their tax return prepared the next
April. “When the tax return is
complete, the family finds they
have a total income tax bill of al
most $34,000, plus nearly $l,OOO
self-employment tax from the sale
of calves and other items,” says
Dr. Larry Jenkins, associate pro
fessor of agricultural economics at
Penn State.
“Withholdings on wage income
cover about $2,700 of the tax, but
there is an outstanding balance of
about $31,000 due on April IS.
The family has to take out a new
loan just to pay the tax.”
What happened? “The money
from the sale of their dairy cattle is
all taxable,” explains Jenkins.
“The cattle were all raised, so
there is no basis to offset sale
price. The remaining basis in the
equipment is $lO,OOO, but there
are recaptures on the gain from the
equipment sale because the family
took depreciation deductions over
the past three yeras. The $17,500
gain on the equipment is taxed as
ordinary income.”
The family nightmare is that the
earning assets the cows and the
dairy equipment have been
sold, but now a new debt that is
nearly a fourth of the original one
appears because of the taxes re
lated to the sale of assets to pay
the original debt
Jenkins says that a few options
can alleviate the tax burden of a
farm liquidation, but most people
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Intercourse, PA 17534
(717)768-7100
Office also in:
New Holland
fail to take advantage of them be
cause they sell assets first and talk
to their accountant later. “That
process should be reversed,” he
says. “Talk to the accountant first,
and sell assets later based on the
accountant’s analysis of the tax re
sult and ways to reduce the tax
bite.”
Many people think that there is
no income tax to pay when a farm
er sells assets and uses the pro
ceeds to pay off a large debt. “In
perfectly logical thinking (hat in
dividual has no money because it
was used to pay debt,” Jenkins
says. “Unfortunately, the Internal
Revenue Service doesn’t agree.
That agency views a sale as a sale,
unless the money is donated to
charity. To the IRS, if there is a
sale and resulting gain, tax is due
even if the income was all used for
debt payment.”
What are some ways to reduce
the tax burden that can result from
quitting dairying? “If possible,
spread the liquidation over two tax
years to keep the income in a low
er bracket,” Jenkins says. “For in
stance, if mature animals can be
sold one year and replacements
the next year, it will prevent the
surge in taxable income that re
sults from selling everything in
one year. In some cases, livestock
and equipment can be sold in dif
ferent years to achieve a similar
result”
If the lender agrees, an install
ment sale might be used to spread
income over several years. “This
will keep more of the income in a
lower tax bracket, and it should
produce some interest income on
the unpaid balance that can be
used to offset interest payments on
loan obligations,” Jenkins says.
If two or more families are in
volved in the farm operation, be
sure asset sales are properly di
vided so that income is reported
on the conect tax return. “This can
divide the total sale proceeds so
that each family pays tax in the
lowest tax bracket possible.” Jen
kins says.
Sales that will be subject to self
employment tax should be care
fully reviewed so they don’t over
burden a single taxpayer. “Self-
James R. Clark
employment tax on sales reported
on schedule ‘F’ often prove to be a
bigger burden than income tax,”
Jenkins notes.
If the farming operation will be
continued with a change in enter
prises, consider exchanging some
assets for property that will be
needed in the new farming opera
tion. “Foi example, a family quit
ting dairy farming but planning on
a beef operation might consider an
exchange of dairy breeding ani
mals for beef breeding animals,”
Jenkins says. “This ‘like-land’ ex
change is accomplished tax-free
that is, no gain is recognized
and no tax is due, as long as there
is no transfer of cash and the prop
erty given up has the same value
as the property received.”
The rules on “like-kind” ex
changes are complex, so be sure to
check with a competent tax ac
countant about the specific ex
change being considered. “Some
exchanges do not qualify,” Jen
kins notes. “For instance, you can
not exchange dairy cows for beef
or dairy steers, because they are
not considered ‘like-kind’ proper
ty.”
Dairy operators who have ex
perienced a net operating loss dur
ing recent years may be able to use
the operating loss to offset part of
the gain from liquidating the dairy
herd and equipment. “A net oper
ating loss occurs when operating
expenses for a year exceed operat
ing revenue,” Jenkins says. “Typi
cally, the loss is carried back for
up to three years and used to get a
refund of income tax previously
paid in one or more of the prior
three years.”
In some cases, income tax was
not paid in the three-year carry
back period, and that makes it pos
sible to carry-forward the operat
ing loss for up to IS years into the
future. “When the carry-forward
option is chosen, it is necessary to
include a statement with the tax
return for the year of the operating
loss indicating that the loss is be
ing carried forward rather than
carried back,” Jenkins says.
USDA Announces
EQIP Funding
HARRISBURG (Dauphin Co.)
The U.S. Department of Agri
culture has allocated $3.4 million
to Pennsylvania to implement the
Environmental Quality Incentives
Program (EQIP), according to
William Baumgartner, state
executive director of the Farm
Service Agency (FSA).
This new program was author
ized by the 1996 Farm Bill and
replaces the Agricultural Conser
vation Program (ACP) that has
been so successful for the last 60
years. In 1996, Pennsylvania
received $1.6 million in ACP
funds and $2.2 million for an
Interim EQIP.
EQIP is a voluntary program
providing cost-share assistance to
agricultural producers who install
needed conservation practices on
their land. Conservation practices
are available to assist farmers with
soil erosion control, water quality
improvement, wildlife habitat
enhancement and forestry. The
Natural Resources Conservation
Service (NRCS) and County Con
servation Districts in Pennsylva
nia will provide technical and edu-
The process of preparing the
loss carry-forward statement and
including it with the tax return is
the responsibility of the tax ac
countant who prepares the tax re
turn for the year of the operating
loss. “However, if an operating
loss occurs, the farm manager
should be sure to remind their tax
accountant to either carry-back or
carry-forward the loss so it can be
got mi
rational assistance to fanners who
perform conservation practices
according to a farm {dan.
USD A in Pennsylvania is
required to submit a plan to the
National Office in Washington,
D.C. outlining how EQIP funds
will be utilitized in the state. Cost
share funds will be made available
to designated conservation priori
ty areas in Pennsylvania and for
identified resource concerns out
side of priority areas. When the
state plan is approved by USDA,
EQIP funds will be allocated to
county FSA committees for cost
sharing with farmers.
Farmers may participate in
EQIP by signing a long-term con
tract for five to 10 years to carry
out needed conservation practices.
Most conservation practices that
were available under ACP will
continue to be available under
EQIP.
A sign-up period will be
announced in the near future.
However, applications may be
accepted at any time. Contact your
local FSA office for more infor
mation about EQIP and how to
apply for this new program.
used to secure an income-tax
benefit,” Jenkins says.
If you’re seriously considering
quitting dairy fanning and begin
ning a beef cattle operation, Jen
kins urges you to check die re
cords for historical farm profits
earned by Pennsylvania beef cattle
operations. “Do that before you
invest in a group of beef cows, un
less you have a really good job in
town,” he warns.
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