Preface: “Farming looks mighty easy when your plow is a pencil and you’re a thousand miles from the cornfield.” – Dwight D. Eisenhower.
2022 Industry Planning: Income Averaging for Farmers and Fishermen
Expectations with many of the farmers and fishermen in the United States, is that income has fluctuated widely during the past several years. Due to the extremely uncertain variables that affect farming revenues, including weather, drought, and other uncontrollable factors, it is common to have very little income in a poor year, with a large amount of income the subsequent year. By electing income averaging and spreading your farming income from a profitable year over a three-year period, you may be able to lower your tax liability for the successful year by avoiding the higher tax brackets. For example, if you have a high profit year after low-income years you would benefit as your farm income which otherwise would be taxed at the 25 percent rate or higher would be shifted to the 15 percent bracket for the prior years, thus saving taxes.
There are a number of rules you should understand in order to decide whether to make this election. You may make the tax election if you are a sole proprietor in a farming or fishing business, a partner in a partnership engaged in farming or fishing, or a shareholder of an S corporation engaged in farming or fishing. An estate or a trust may also not be selective with this election.
Under the election, the tax imposed in any tax year will equal the sum of the tax computed on your taxable income, reduced by the amount of farm income elected for averaging, plus the increase in tax that would result if taxable income for each of the three prior tax years were increased by an amount equal to one-third of your elected farm income. Your elected farm income is the amount of taxable income attributable to any farming business and which you specify under the election. Elected farming income can include gains from the sale or disposition of property or equipment, other than land, which you were regularly operating for a substantial period in your farming business.
For purposes of the income averaging election, a farming business includes operating a nursery or sod farm, raising or harvesting of trees bearing fruit, nuts or other crops or ornamental trees, or raising animals. Note that a farming business does not include the harvesting of crops grown by another person or the buying and reselling of plants or animals that are grown or raised by another person.
Although income averaging allows you to range the latitude of your farm income from a high-income year over the three prior years, it does not always result in a lower tax for the election year. In some cases, when the tax for a base year is calculated on the taxable income for that year plus one-third of the elected farm income, a higher tax rate may apply. Additionally, once the election is made, it can only be revoked only with the permission of the IRS, therefore it is important that all the relevant tax factors be considered.
Please contact our office if you would like to further discuss how income averaging might work for you as a farmer or fisherman.