How Income Averaging benefits Farmers | Smith, Kunz & Associates

Income Averaging For Farmers

December 17, 2014

Have a great year? Lower your taxes by electing income averaging.

Farming income can fluctuate widely. Wide ranging reports list 2011 as one of the best years in the last decade for many farmers. However, boom for one farmer may be due to the bust of another. Much of this year's increase in commodity prices has been attributed to droughts and flooding in other parts of the country and world. Due to the extremely uncertain variables that affect farming, it is common to have very little income in a poor year, with a large amount of income the next year.

Tax law permits farmers to elect income averaging which shifts some of your current year farm income to the prior three years. If you had a profitable year in 2011, you may be able to lower your tax liability for the successful year by spreading the income to lower income years. In this way you will pay lower tax rates on the income earned.

Who Can Elect Income Averaging

There are a number of rules you should understand in order to decide whether to make this election. You may make the election if you are a sole proprietor in a farming business, a partner in a partnership engaged in farming, or a shareholder of an S corporation engaged in farming. An estate or a trust may not make this election.

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. Farm income can include gain from the sale or disposition of property, other than land, which you regularly use for a substantial period in your farming business.

What to Be Aware of before Electing

Although income averaging allows you to spread 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. In effect, the election smoothes your average tax bill over multiple years. Since the election, once made, may only be revoked with the permission of the IRS, it is important that all the relevant factors be considered.

Please call our office at 208-356-8500 if you would like to further discuss income averaging or agriculture accounting.