Due to a quirk in new federal tax laws, many of the nation's dairy farmers could be milked out of millions of dollars, according to a Cornell University agricultural economist.

As many as 95 percent of the Northeast's dairy farmers might be disqualified from getting a 1996 earned income credit (EIC) if the Internal Revenue Service (IRS) applies the current interpretation of a 1996 tax law amendment. Many dairy farmers had been entitled to these credits in past years.

The concern arises from line 13 on IRS Form 1040. Anyone -- including farmers -- who makes gains from the sale of business assets of $2,200 or more becomes ineligible for an earned income credit. For example, the sale of a dairy cow is now considered the sale of an asset, whereas before the current law, dairy livestock had been exempt.

That could be a substantial blow to small dairy farmers. "The potential disqualification of the credit will cost dairy farmers in the Northeast between $14 to $28 million in 1996 tax refunds," said Stuart F. Smith, Cornell senior extension associate in agricultural economics. He could not say how much money dairy farmers could lose nationwide, but indicated that the state of New York consists of many small dairy farms, which could be particularly hard hit. Smith said that Congress has been apprised of the problem and may be working toward a solution.

An amended 1996 tax law added gains from the sale of capital assets -- such as dairy cows -- to disqualified income. Financial gains from the sales of dairy cattle and other capital gains from the sale of business assets must be included in disqualified income, according to the new IRS rules. Thus, any taxpayer with $2,200 or more of disqualified income cannot receive an Earned Income Credit.

The effect? Considering a typical small farm may have about 50 head of dairy cattle, a farmer will cull (turn over) about 25 percent of the herd annually. Buying a young dairy cow, a farmer will likely have paid close to $1,000. Prices for culled dairy cows now are about $400 each at auction, and the cows tend to be sold to the utility beef market.

For example, if any farmer culls 12 cows annually, and receives $4,800 total for those cows, the farmer is now disqualified from receiving earned income credits.

Smith estimates that 35 percent of the 40,000 Northeast dairy farmers were eligible for an EIC in 1995, which amounted to roughly 14,000 dairy farmers eligible at one time for EICs and tax refunds. Now, all but 5 percent have capital gains more than $2,200 from 1996 as a result of dairy cattle sales, causing their ineligibility for an EIC.

He estimates that the average eligible farm taxpayer would have earned between $1,000 and $2,000 of EIC in 1996, if the IRS had agreed to exclude dairy cattle sales from income disqualified for EIC.

"National farm income tax experts don't believe Congress intended to include gains from the sale of business assets and that a section of the Internal Revenue Service code excludes these gains from income disqualified from EIC," Smith said. "If the IRS refuses to change their position, nearly all dairy farmers will not qualify for EIC."