Farm Income Averaging

If you are engaged in a farming business, you may be able to average all or some of your farm income by allocating it to the 3 prior years (base years). This may give you a lower tax if your income from farming is high and your taxable income from one or more of the 3 prior years was low. The term "farming business" is defined in the instructions for Schedule J (Form 1040).

Who can use farm income averaging? You can use farm income averaging to figure your tax for any year in which you were 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 choose to have taxed at base year rates. You can designate as EFI any type of income attributable to your farming business. However, your EFI cannot be more than your taxable income, and any EFI from a net capital gain attributable to your farming business cannot be more than 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 figuring 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 1 year after stopping operations is a reasonable time. After that, what is a reasonable time depends on the facts and circumstances.

EFI and base year rates. If your EFI includes both ordinary income and capital gains, you must allocate an equal portion of each type of income to each base year to figure the tax on EFI. You cannot allocate all of the capital gains to a single base year.

How To Figure the Tax

If you average your farm income, you will figure your 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 were more than 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 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 use it. 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. For more information, see the Schedule J instructions.

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

Effect on Other Tax Determinations

You subtract your EFI from your taxable income 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 to the base years does not affect other tax determinations. For example, you make the following determinations before subtracting your EFI (or adding it to income 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 $1,500, part of that income may be taxed at your tax rate instead of your child's tax rate.

If you use farm income averaging, figure your child's tax on investment income using your rate after allocating 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 prior year minimum tax. You may be able to claim a tax credit if you owed AMT in a prior year. See chapter 14.

Schedule J

You can use farm income averaging by filing Schedule J (Form 1040) with your timely filed (including extensions) return for the year. You can use farm income averaging on a late return, or use, change, or cancel it on an amended return, only if you do so either in conjunction with another adjustment that affects the taxable income of that year or any of the base years. 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.

You can also use farm income averaging on a late return or use, change, or cancel it on an amended return if you get 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 2002-1 in Internal Revenue Bulletin No. 2002-1.

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