Farm Income Averaging

For tax years beginning after 1997, an individual engaged in the business of farming, as defined in the instructions for Schedule J (Form 1040), Farm Income Averaging, can average his or her elected farm income (EFI) by shifting it to the 3 prior years.

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

Corporations, partnerships, S corporations, estates, and trusts cannot use farm income averaging. A beneficiary does not engage in a farming business through a trust or an estate.

Elected Farm Income (EFI)
EFI is the amount of income from your farming business that you elect to shift to the 3 prior years. You can designate as EFI any type of taxable income attributable to your farming business, up to your taxable farm income. Taxable income from farming includes all income, gains, losses, and deductions attributable to your farming business. 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 will be treated as a reasonable time.

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

1. Subtract the EFI from your total taxable income.
2. Figure the tax on the amount in step (1) using the current year's tax tables, tax          rate schedules, or, if applicable and lower, the maximum capital gain tax rates.
3. For each of the 3 prior years, make the following computations.
   a) Add one-third of the EFI to the taxable income of the prior year.
   b) Figure the tax on the amount in (a) using the tax rate schedule for that prior year or, if applicable and lower, the maximum capital gains tax rates.
   c) Subtract that year's actual tax from the tax in (b).
4. Add the amounts in step (3)(c) to the amount in step (2). The result is the tax for the current year.

Filing status. Your filing status may be different in the election year than in the prior years, or you may be married to different spouses in those years.

Separate return for the election year and joint return for a prior year. If you are filing a separate return for the election year and you filed a joint return for any prior year, then for that prior year add one-third of the EFI to the prior year's taxable income and apply the prior year's tax rate for married filing jointly.

Joint return for the election year and separate return for a prior year. If you are filing a joint return for the election year and you filed a separate return for any prior year (or if you filed a joint return with a different spouse in a prior year), then for that prior year add one-third of your share of the EFI to the prior year's taxable income and apply the prior year's tax rate for the applicable filing status.

Separate return defined. A separate return can be a return filed by an unmarried individual, including a head of household or surviving spouse, or a married individual filing a separate return.

Effect on Other Tax Determinations
You subtract EFI from your taxable income in the election year and add one-third of it to the taxable income of the prior year to obtain the tax rate to use for income averaging. The following are examples of other tax determinations involving EFI.

• Any net operating loss (NOL) carryover and net capital loss carryover are applied to the election year before EFI is subtracted.
• Any NOL carryover that was only partially applied in a prior year is not refigured to offset the EFI added to that prior year.
• The determination of whether, in the aggregate, the sales and other dispositions of business property (section 1231 transactions) produce long-term capital gain or ordinary loss is made before EFI is subtracted.
• Any net capital gains shifted to a prior year that had a capital loss do not offset that loss. The gains are taxed at the prior year's maximum capital gains tax rates (or, if lower, the regular tax rate.)

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. However, if you have certain nonrefundable personal credits (such as the credit for child and dependent care expenses, the child tax credit, the Hope credit, or the lifetime learning credit), that offset regular tax without regard to the tentative minimum tax, your total tax may increase or decrease.

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

Making, Revoking, or Changing an Election
You can make a late election to income average, or amend or revoke a previously made election, only if you make it in conjunction with another adjustment that affects the taxable income of the election year or any of the three prior taxable 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.

If you do not have an adjustment in the election year or any of the three prior taxable years, you can make a late election, or amend or revoke a previously made election, only if you obtain the consent of the IRS.

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