Farm Income Averaging

If you are engaged in a farming business, you may be able to average all or some of your current year's farm income by shifting it to the 3 prior years (base years). The term "farming business" is defined in the instructions for Schedule J (Form 1040).

Who can use farm income averaging? You can elect to use farm income averaging if, in the year of the election, you are engaged in a farming business as an individual, a partner in a partnership, or a shareholder in an S corporation. You do not need to have been engaged in a farming business in any base year.

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

Elected Farm Income (EFI)

EFI is the amount of income from your farming business that you elect to shift to the base years. You can designate as EFI any type of income attributable to your farming business. However, your EFI cannot exceed your taxable income, and any EFI from a net capital gain attributable to your farming business cannot exceed your total net capital gain.

Income from your farming business is the sum of any farm income or gain minus any farm deductions or losses allowed as deductions in computing your taxable income. However, it does not include gain from the sale or other disposition of land.

Gains from the sale or other disposition of farm property. Gains from the sale or other disposition of farm property, other than land, can be designated as EFI if you (or your partnership or S corporation) use the property regularly for a substantial period in a farming business. Whether the property has been regularly used for a substantial period depends on all the facts and circumstances.

Liquidation of a farming business. If you (or your partnership or S corporation) liquidate your farming business, gains on property sold within a reasonable time after operations stop can be designated as EFI. A period of one year after stopping operations will be treated as a reasonable time. After that, what is a reasonable time depends on the facts and circumstances.

Shifting EFI to base years. If your EFI includes both ordinary income and capital gains, you must add an equal portion of each type of income to each base year. You cannot add all of the capital gains to a single base year.

How To Figure the Tax

If you elect to average your farm income, you will figure the current year's tax on Schedule J (Form 1040).

Negative taxable income for base year. If your taxable income for any base year was zero because your deductions exceeded your income, you may have negative taxable income for that year to combine with your EFI on Schedule J.

Schedule J for 1998 or 1999. Although the Schedule J for 1998 and 1999 did not allow you to use negative taxable income for a base year, you can now file amended returns on Form 1040X to do so. If you did not use Schedule J for 1998 or 1999 and this change would make using it beneficial, you can amend your returns to elect its use. If you used Schedule J for 1998 or 1999 and your taxable income for any base year was zero, you can amend your return to refigure your tax (or to revoke your election). For more information, see the Schedule J instructions.

Filing status. You are not prohibited from making a farm income averaging election solely because your filing status is not the same in an election year and the base years. For example, if you are married filing jointly in the election year, but filed as single in all of the base years, you may still elect to average farm income.

Effect on Other Tax Determinations

You subtract your EFI from your taxable income in the election year and add one-third of it to the taxable income of each of the base years to determine the tax rate to use for income averaging. The allocation of your EFI from the election year to the base years does not affect other tax determinations. For example, you make the following determinations before subtracting your EFI in the election year or adding it in the base years.

• The amount of your self-employment tax.
• Whether, in the aggregate, sales and other dispositions of business property (section 1231 transactions) produce long-term capital gain or ordinary loss.
• The amount of any net operating loss carryover or net capital loss carryover applied and the amount of any carryover to another year.
• The limit on itemized deductions based on your adjusted gross income.
• The amount of any net capital loss or net operating loss in a base year.

Tax on Investment Income of Child Under 14

If your child's investment income is more than $1,400, part of that income may be taxed at your tax rate instead of your child's tax rate.

If you elect to use farm income averaging, figure your child's tax on investment income using your rate after shifting EFI. You cannot use any of your child's investment income as your EFI, even if it is attributable to a farming business. For information on figuring the tax on your child's investment income, see Publication 929, Tax Rules for Children and Dependents.

Alternative Minimum Tax

You cannot use income averaging to determine your alternative minimum tax (AMT). When figuring your AMT, the regular tax you subtract from your "tentative minimum tax" is the tax you computed using farm income averaging. This may cause you to owe AMT or increase your AMT but, generally, it will not increase your total tax.

Credit for base year minimum tax liability. You can use income averaging to figure your regular tax liability for the purpose of determining the credit for a base year minimum tax liability.

Making, Revoking, or Changing an Election

You make a farm income averaging election by filing Schedule J (Form 1040) with your timely filed (including extensions) return for the election year. You can make a late election, or amend or revoke a previously made election, only if you do so either in conjunction with another adjustment that affects the taxable income of the election year or any of the base years or to take advantage of the change discussed under Negative taxable income for base year, earlier. An adjustment may be caused by a variety of things. The following are examples of situations that may result in an adjustment.

• An NOL carryback.
• A disaster loss election.
• A change made as the result of an audit.
• Any other change that results in your filing an amended return.

If you do not have an adjustment in the election year or any of the base years, you can make a late election, or amend or revoke a previously made election, only if you obtain the approval of the IRS. You can request approval by submitting a request for a private letter ruling to the IRS National Office. See Revenue Procedure 2001-1 in Internal Revenue Bulletin No. 2001-1.

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