Tax Guide for Farmers – Income Averaging

The Internal Revenue Code includes laws that govern the unique income and expenses associated with farming. One such section of law pertains to income averaging for farmers.

This is the eighth and final publication in a series of articles on income for farmers. The previous entries covered Recordkeeping and Accounting, Income from the Sale of Farm Products, Rent Income, Agricultural Program Payments, Income from Cooperatives, Cancellation of Debt, and Income from Other Sources. If you operate or work on a farm, the materials covered in these articles may be of use.

Income Averaging for Farmers

If you own or operate a farming business, you may be able to use income averaging. Income averaging refers to an option whereby a farmer can average some or all of their farming-related income over the previous three years, using the tax rates from those years.

Why Use Income Averaging?

In cases where your farming income in the current year is high but your taxable farming income from one or more of the three previous years was low, income averaging may allow you to lower your taxes.

Who Can Use Income Averaging?

You can use income averaging to calculate your income tax in any tax year where you owned or operated a farming business as an individual, a partner in a partnership, or a shareholder in an S corporation.

A farming business is defined as the trade or business of cultivating the land or raising or harvesting an agricultural or horticultural product. This includes:

  • Operating a nursery or a business that produces sod
  • Raising or harvesting tress that bear fruit, nuts, or other crops
  • Raising ornamental trees
  • Raising animals or otherwise managing animals
  • Leasing land to a tenant engaging in a farming business, so long as lease payments are based on a percentage of the farm production rather than at a fixed rate and are based on a written agreement entered into before the tenant began operating the farming business on the land

A farming business does not include:

  • Harvesting agricultural or horticultural products as a part of a contract when those products were grown by someone else
  • Buying and reselling plants or animals grown or raised by someone else

Corporations, estates, partnerships, S corporations, and trusts cannot use income averaging.

If your filing status has changed, you may still use income averaging. For example, if your filing status in the three base years single but your filing status is now married filing separately, you may still use income averaging.

Elected Farm Income (EFI)

EFI is the amount of your farming income that you choose to have taxed at base tax year rates. Any income from your farming business can be designated as EFI, so long as your EFI does not exceed your taxable income.

Income from your farming business is defined as the total of any farm income or gains minus any farm expenses or losses permitted as taxable deductions. Farming income designated fro EFI can also include gains or losses from the sale of farm property other than land, if the property was used regularly over a substantial period for farming.

Farming income designated for EFI cannot include gains or losses from the sale of land development rights, grazing rights, or other similar rights.

How to Determine Tax Using Income Averaging

Your individual tax using income averaging should be based on the detailed instructions on Schedule J (Form 1040).

Who can help me with other questions about income averaging and farming income?

If you have additional questions about farming income or need help preparing your tax return, you can get help from a tax attorney. A tax attorney is available who specializes in Internal Revenue Code laws that pertain to farming and farming income.

Complete and submit the form below or call the telephone number at the top of this web site. A tax attorney will get in touch with you to begin answering your questions and giving you the help you need.

The initial consultation with a tax attorney is free of charge and completely confidential. Therefore, you have every reason to get the help you need and deserve today, so take that first step.

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by Mark Johnston

Mark has been a contributor to legal web sites related to bankruptcy, tax, and criminal law since 2011. He has an Accounting degree from Texas A&M University.