The proposed extension to farm legislation that expired in September would be for "some months" but for less than a year, the source said.

If an extension is passed the United States would avoid reverting to 1949 "permanent law" and a potential spike in the retail price of milk to as much as $8 a gallon in 2013.

The Senate passed its new five-year farm bill in June, and the House Agriculture Committee followed with a version in July.

But the House bill, with large cuts in food stamp funding for lower-income Americans, has never been brought to a vote by the full House. The Senate and House remain far apart on the issues of food stamps and crop subsidies.

Many estimate that U.S. retail milk prices could rise sharply in 2013 - to some $6 to $8 per gallon from the current level of about $3.53 - if the government reverts to 1949 statutes that would require USDA to buy and store dairy products at inflated prices.

Pressure has been rising from the Agriculture Department and dairy groups for Congress to take act by year-end - if not on the entire farm bill, then at least on an extension or a specific "patch" to address the dairy program.

The price of milk will not double on January 1 if Congress does not act, but would likely rise gradually as supplies are removed from normal merchandising channels and instead land in USDA storage facilities.

"USDA continues to review a variety of options for administering programs, show permanent law become legally effective on January 1," a spokesman said.

Government buying could quickly produce a glut of milk, butter, cheese and powdered milk that would get stored in warehouses, given to food banks and exported as food aid, said Jay Gordon, a dairy farmer and executive director of the Washington State Dairy Federation, a trade organization.

"We're not going to sit around watching the Super Bowl and eating chunks of butter," said Gordon, who has about 150 cows on his farm in Washington state. "But the government has to keep buying" to keep the price up.

Major milk retailers have been watching the Congressional maneuvers closely, without outlining specific strategies.

"When it comes to milk, competitive price changes do occur all of the time, where allowed. Milk costs are adjusted both up and down monthly. At this point we do not anticipate any changes in the cost of milk as a result of the bill," said Mike Siemienas, spokesman for Supervalu Inc., a major U.S. grocery store operator with chains such as Albertsons and Jewel-Osco.

The International Dairy Foods Association, which represents companies that provide about 85 percent of the bottled milk, ice cream and cheese to U.S. consumers, is hopeful that Congress will succeed in passing a farm bill extension.

But the group this week urged USDA Secretary Tom Vilsack to avoid or delay the impact of a return to 1949 law, should an extension or patch not be successful. Vilsack, for his part, has repeatedly urged Congress to act responsibly.

"The worst outcome would be for us to continue to see Congress do nothing, and for permanent law to come into effect," Vilsack said last week.

Some lawmakers have been counting on time being on their side, regardless of the status of legislation.

"Implementation of permanent law will take a considerable amount of time, and to that end, I call on (the USDA Secretary) to carefully consider all relevant factors and to take public comment through a rule making process before proceeding," Frank Lucas, chairman of the House Agriculture Committee, told the Tulsa World newspaper this week.

A formal rule making process - which is also advocated by IDFA, absent a farm bill extension - could typically be expected to take up to several months.

The process "will enable stakeholders, not just dairy producers and processors but also food manufacturers, food retailers and others, to voice their concerns prior to the implementation of any new rule," IDFA President Connie Tipton said in a letter to Vilsack dated December 27.

(Additional reporting by Doug Palmer in Washington, Jessica Wohl in Chicago and Al Scott in Seattle, writing by Ros Krasny; Editing by Bob Burgdorfer and David Gregorio)