Farmers May Harvest Low Taxes by Averaging Income

The Internal Revenue Service is working to educate farmers and tax professionals about Farm Income Averaging.  The election should be considered when farm income for the current year is high and taxable income from one or more of the three prior years was low.  The provision, from the Taxpayer Relief Act of 1997, was designed to smooth out economic disparities that farmers experience from year to year.

Farm Income Averaging is not automatic.  Qualifying farmers must elect it by filing Schedule J, Farm Income Averaging, with their Form 1040, U.S. Individual Income Tax Return, in order to reap the tax savings.

To qualify a person must engage in the trade or business of cultivating land or raising or harvesting any agricultural or horticultural commodity.  This includes:

·       Operating a nursery or sod farm
·       Raising or harvesting trees bearing fruits, nuts, or other crops
·       Raising ornamental trees (but not evergreen trees more than 6 years old when severed from the roots)
·       Raising, shearing, feeding, caring for, training and managing animals and
·       Leasing land to a tenant if the lease payments are:
·       Based on a share of the tenant's production and
·       Determined under a written agreement before the tenant begins significant activities on the land

It is not necessary to be engaged in a farming business in any of the three base years to qualify for Farm Income Averaging. 

Qualified farmers can average all or part of their current year farm income over the previous three years.  The amount of income chosen for taxation at base year rates is called the Elected Farm Income (EFI).  Any type of income attributable to a farming business can be designated as EFI including operations and capital gains from the sale, liquidation, or other disposition of a farming business. 

Substantial tax dollars can be saved by income averaging.  Those who elect Farm Income Averaging subtract their EFI from their taxable income for the current year and add one-third of it to the taxable income for each of the three base years.

Originally following the enactment of Farm Income Averaging, a negative amount could not be entered as a base year income.  Changes were made to the method in 2000 (which were retroactive to 1998 and 1999) to allow the entry of a negative taxable income for a base year. 

Anyone who may have benefited from Farm Income Averaging for a previous year but who failed to make the election, should still consider filing an amended return.  The deadline for filing a claim for refund is three years from the date the original return was filed or two years from the date the tax was paid, whichever is later. 

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