Farm Income Averaging
As most in the agricultural industry know, income from farming and ranching can vary significantly from year to year. Yields and prices are affected by many factors outside the farmer’s or rancher’s control, so they are provided with a unique tax planning tool – farm income averaging.
Farm income averaging is a planning tool that allows farmers and ranchers to average some or all of their current year’s farm income equally over the previous three years.
This is beneficial in high-income years when the farmer runs the risk of being pushed into a higher tax bracket, as it allows current year income that would be taxed at a higher rate to be averaged out over the prior three years’ lower tax brackets.
What is Farm Income for Income Averaging?
The IRS defines farming as the trade or business of cultivating the land or raising or harvesting any agricultural or horticultural commodity. The following are all examples of possible places farm income could be reported to you:
- Schedule F for farm income
- Schedule K-1 for income passed through farm partnerships or farm S-Corporations
- W-2s for wages received by S-Corporation shareholders from Farm S-Corporations
- From 4797 for Gain on the Sale of Farm Assets (equipment, breeding stock, etc.) used in a farm business
- Form 4835 for Crop share rent income
What is NOT Farm Income for Income Averaging?
A few types of income may appear to meet the definition of farm income but do not qualify for income averaging. These include:
- Gain on the sale of land used in farming operations
- Cash rent for farmland
- Contract harvesting of an agricultural or horticultural commodity grown or raised by someone else
- Merely buying or reselling plants or animals grown or raised by someone else
- The election to average farm income is made with the filling of the tax return after the end of the year.
- The use of farm income averaging does not change the income reported in the prior years, instead utilizes any portion of lower tax brackets unused in the previous years.
- You do not have to have farm income in the prior years to utilize income averaging of current year farm income.
- The election to average farm income does not impact self-employment taxes in the current or prior years.
Farm income averaging is a valuable tool that helps farmers and ranchers better prepare for the ups and downs of the industry. However, farm income averaging is only sometimes beneficial and is one of many areas to consider in year-end planning for farmers. Please contact your Adams Brown advisor if you have questions regarding farm income averaging.