Farming income can fluctuate dramatically from year to year. Weather, market prices, and production costs can all impact profitability, leaving some years with significant gains and others with losses. Farm income averaging is a valuable tax management tool that helps smooth those highs and lows, allowing producers to plan more effectively and maintain long-term stability. 

What is farm income averaging? 

In our work with producers, we frequently see wide swings in taxable income caused by weather-related crop losses, livestock market shifts, or delayed insurance payouts, all scenarios where FIA can make a measurable difference. Farm income averaging (FIA) allows eligible farmers and ranchers to spread a portion of their current year’s revenue over the previous three tax years. This helps prevent them from being pushed into a higher tax bracket during a profitable year. The election is made on IRS Form 1040, Schedule J, after year-end. 

This provision is available to individuals, partners, and S corporation shareholders who are engaged in a farming business. However, cash rent landlords and passive investors do not qualify. Farmers don’t need to have had farm income in prior years, they simply need to be in the farming business within the year the election is made. Farm income averaging does not impact self-employment tax; it only affects federal income tax. 

What counts as farm income?  

Farm income is defined as income, deductions, gains, and losses directly attributable to the trade or business of farming. This includes cultivating land, raising livestock, or harvesting agricultural commodities. 

Income from custom farming, crop insurance proceeds, conservation program payments, and certain carbon credit or renewable energy contracts may also qualify if they are directly related to the farming operation. However, income from cash rent or employment wages is not considered farm income for averaging purposes. Crop share income based on the tenant’s production can also be included in Farm Income Averaging. 

Not all agricultural-related income qualifies. For example, the sale of land previously used in farming cannot be included for Farm Income Averaging. 

Key Considerations

While the fundamentals of FIA remain the same, there are a few updates and planning considerations to keep in mind: 

• Potential Tax Rate Changes: The individual tax rate reductions under the Tax Cuts and Jobs Act (TCJA) are scheduled to expire after 2025. Farmers may benefit from accelerating income into 2025 or deferring deductions depending on projected rate changes in 2026. 
• Expanded Income Sources: As more producers participate in sustainability programs, carbon credit sales and renewable energy income may qualify as farm income if directly tied to the operation. The IRS has issued evolving guidance in this area, making professional interpretation valuable when classifying newer income streams. 
• Pass-Through Entity Planning: Partnerships and S corporations cannot elect FIA directly. It must be made by the individual taxpayer. Be sure to track and report each owner’s share of farm income accurately. Misreporting partner allocations is one of the most common reasons Schedule J elections are flagged for additional IRS review. 
• Recordkeeping and Compliance: The IRS has increased its review of Schedule J elections to ensure only qualified farm income is included. Maintain documentation supporting your activities, income sources, and any allocation decisions. 
• Interaction With Other Deductions: FIA can affect the qualified business income (QBI) deduction, self-employment tax, and other provisions. A coordinated tax strategy can help maximize overall benefits. 

Is farm income averaging right for you? 

Farm income averaging can be an effective way to manage income volatility and reduce tax exposure, but it’s not beneficial in every situation. The decision depends on your income mix, business structure, and long-term goals. 

Lutz has advised agricultural producers across the Midwest for decades, helping them navigate income swings caused by drought, market fluctuations, crop insurance timing, and operational changes. Our accounting services are tailored to the ag industry and can help you analyze your options, project tax outcomes, and make informed decisions that support the health of your operation year after year. Contact us to learn more.