In the farm industry, you quickly learn that farming incomes can fluctuate a great deal from year to year. Yields are affected by many elements outside of your control, such as drought, insect infestations, fire, flood, and the general weather conditions of the year. Some years you will yield significant profits and be subject to higher tax rates. Other years you will be subject to minimum tax liability as your yields provided little profits or even loss. The best way to plan ahead for this income fluctuation and sustain your farm operation is to utilize farm income averaging. Here is everything you need to know about farm income averaging and how to best utilize this tax management tool.
What is Farm Income Averaging?
Farm income averaging or FIA is a tax management tool that is available to farmers and ranchers in the United States. This tax management tool can be elected after the end of the tax year. Essentially, this tool allows a certain amount of your farm income to be spread over a three-year period. For example, this is available to prevent farmers from being pushed into a higher tax bracket if they sold a large portion of property or yielded abnormally large profits from a single crop season. Overall, this tax management tool allows you to average your farming income equally over a three-year tax period to prevent being taxed at a higher rate. Averaging your farm income reduces the tax burdens associated with both bountiful and lean yielding years. The IRS form associated with farm income averaging is 1040 Schedule J. This form can be found on the official IRS website.
To file a 1040 Schedule J, it is not necessary for the individual to have been involved in farming in previous years. The only stipulation is that the individual must be involved in the farming industry in the year that they file. Individuals engaged in any farming business, including sole proprietors, partners, or shareholders in an S corporation, can utilize this tax management tool. Individuals involved in the farming industry through estates and trusts are not eligible to utilize the farm income averaging tool.
What is Classified as Farm Income for FIA Purposes?
The IRS considers a farming business an operation involved in the trade of cultivating land or the trade of raising or harvesting any agricultural commodities. The IRS excludes the buying and reselling of plants or animals raised by someone else under this classification.
The farm income for farm averaging purposes is considered by the IRS to be the overall income, deduction, gain, and loss attributable to an individual's farming business. The rental income on a share of production from a tenant's farming operation is classified as farming income by the IRS. They also consider the gain on the sale or other disposition of non-land property used in an individual's general farming operation to be considered farm income. However, cash rent farming operations and compensation received by an employee are not considered farm income by the IRS.
Key Points to Consider When Utilizing Farm Income Averaging
Election of Schedule J is made available for taxpayers with farm income after the end of the year.
Farm income averaging spreads high amounts of farm income over the previous three years.
Utilizing Schedule J does not change income reporting for the three base years. Instead, it utilizes the portion of the lower tax brackets that were left unused in prior years to determine the current year's taxes.
Individuals don't have to have farm income in the previous years, just in the year of election.
Cash rent farmers are excluded from farm income averaging.
Election of Schedule J may be revoked with permission from the IRS.
Connect With Us
At Lutz, we specialize in providing accounting services. We provide the best tax, accounting, assurance, business consulting, and valuation services to every one of our clients. We are the largest locally owned firm of its kind in Nebraska. Being a Nebraska based firm, we have a strong understanding of the farm industry. We can help you get the most out of your farming operation and answer any questions you may have.
Farm income averaging can be a powerful tax management tool for many farm operations. It allows you to better prepare for the ups and downs that are certain to occur when working in the farm industry. Fluctuating income is the only real certainty when it comes to farming. However, the 1040 Schedule J is not beneficial in all scenarios and is not a substitute for crucial year-end planning by farmers. Contact us today with any questions you may have about taxes, accounting, or business consulting surrounding your farm operation. Your success is our success. We are here to help you get the most out of your farming operation.
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