We know that dairy income is likely to be down substantially this year for most dairy farmers. The only "taxable" income to report is the sale of culled cows while farm operation is likely to show a substantial loss. In loss years, dairy farmers who are proactive, typically could create an optimum amount of net losses and carry those losses back five years to get a large income tax refund which could be added to their working capital.
However, the new tax law has substantially limited that ability. Farmers are now only able to create a maximum net operating loss of no more than $250,000 ($500,000 for married couples) and you can only carry that loss back two years. And in most cases you can not even carry back that large of a loss since you have to reduce it by any other income reported on the return. Any excess losses are required to be carried forward and those excess losses cannot offset self-employment income which creates a double whammy for our farmers.
What should a dairy farmer do in this situation? Most farmers have pushed forward a fair amount of deferred taxes and dairy farmers are likely the same. This is due to taking advantage of prepaid farm expenses at year-end for feed and other input costs or using deferred payment contracts. Since the dairy is likely to show a large loss this year, farmers should consider not prepaying as much expense or not deferring milk sales into 2019. The taxable income goal for a married farmer should be about $100,000 of net income which would soak up any child tax credits and the 10% and 12% income tax bracket (if Section 199A is available this is actually an 8%-9.6% tax bracket).
Also, if they break even on their farm operation and show about $100,000 of Section 1231 gains from culled cows, then they would likely owe no federal income tax.
Lastly, for those dairy farmers who are part of a cooperative, they need to be planning on creating enough taxable income to soak up the DPAD that flows through from the cooperative. This DPAD is typically in the 3-5% of gross sales range (some lower and some higher). Unlike the regular 20% Section 199A deduction that does not include Section 1231 income, this DPAD is allowed to fully offset taxable income including the sale of culled cows. Therefore, a diary farmer who sells to a cooperative really should strive to show taxable income of at least the estimated amount of DPAD that will flow through from the cooperative. If they do not do this, then that deduction is lost forever. There is no carryover of any DPAD. It is use it or lose it.
Here is an example:
Ben Johnson has a dairy that will lose money this year; however, he has the ability to not defer income into 2019 to bring income up. He expects the DPAD from his cooperative to be $250,000 and he has culled cow sales of $400,000. Instead of the actual farm loss of $500,000, he elects to bring his net farm loss down to $50,000. This results in about $350,000 of gross taxable income from farming and he is allowed to offset the $250,000 DPAD from the cooperative against this income (there is no regular Section 199A deduction since you can't take this against Section 1231 income and he has negative ordinary taxable income). After subtracting his standard deduction of $24,000 all of the remaining Section 1231 capital gain income will be taxed at zero on his federal return plus getting his refundable portion of his child tax credit of $1,400 for each child under age 17. The only tax he might owe is state income taxes.
If Ben did not do this planning, he would show a loss of $100,000 on his return that could be used to offset other income (if any). The $250,000 DPAD would permanently disappear and the extra $450,000 of losses shown would not be available to offset self-employment income in the future. Simply electing to report a loss is not always the smart thing to do and under the new tax law that is even more apparent.