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Publication 225

Income Averaging for Farmers(p17)

If you're engaged in a farming business, you may be able to average all or some of your farm income by using income tax rates from the 3 prior years (base years) to calculate the tax on that income. This may give you a lower tax if your current year income is high and your taxable income which includes income from farming from one or more of the 3 prior years was low. See the Instructions for Schedule J (Form 1040), for the definition of the term "farming business."

Who can use income averaging?(p17)

You can use income averaging to figure your tax for any year in which you were engaged in a farming business as an individual, a partner in a partnership, or a shareholder in an S corporation. Services performed as an employee are disregarded in determining whether an individual is engaged in a farming business. However, if you're a shareholder of an S corporation engaged in a farming business, you may treat compensation received from the corporation that's attributable to the farming business as farm income. You don't need to have been engaged in a farming business in any base year.
Corporations, partnerships, S corporations, estates, and trusts can't use income averaging.

Elected Farm Income (EFI)(p17)

EFI is the amount of income from your farming business that you elect to have taxed at base year rates. You can designate as EFI any type of income attributable to your farming business. However, your EFI can't be more than your taxable income, and any EFI from a net capital gain attributable to your farming business can't be more than your total net capital gain.
Income from your farming business is the sum of any farm income or gain minus any farm expenses or losses allowed as deductions in figuring your taxable income. However, it doesn't include gain or loss from the sale or other disposition of land, or from the sale of development rights, grazing rights, and other similar rights.

Gains or losses from the sale or other disposition of farm property.(p17)

Gains or losses from the sale or other disposition of farm property other than land can be designated as EFI if you (or your partnership or S corporation) used the property regularly for a substantial period in a farming business. Whether the property has been regularly used for a substantial period depends on all the facts and circumstances.
Liquidation of a farming business.(p17)
If you (or your partnership or S corporation) liquidate your farming business, gains or losses on property sold within a reasonable time after operations stop can be designated as EFI. A period of 1 year after stopping operations is a reasonable time. After that, what is a reasonable time depends on the facts and circumstances.

EFI and base year rates.(p17)

If your EFI includes both ordinary income and capital gains, you must use tax rates from each base year to compute tax on an equal portion of each type of income. For example, you can't tax all of the capital gains at the rate for capital gains from a single base year.

How To Figure the Tax(p17)

If you average your farm income, you will figure your tax on Schedule J (Form 1040).

Negative taxable income for base year.(p17)

If your taxable income for any base year was zero because your deductions were more than your income, you may have negative taxable income for that year to combine with your EFI on Schedule J.

Filing status.(p17)

You aren't prohibited from using income averaging solely because your filing status isn't the same as your filing status in the base years. For example, if you're married and file jointly, but filed as single in all of the base years, you may still average farm income.

Effect on Other Tax Determinations(p18)

You subtract your EFI from your taxable income and add one-third of it to the taxable income of each of the base years to determine the tax rate to use for income averaging. The allocation of your EFI to the base years doesn't affect other tax determinations. For example, you make the following determinations before subtracting your EFI (or adding it to income in the base years).

Tax for Certain Children Who Have Unearned Income(p18)

If your child was under age 19 (or 24 if a full-time student) at the end of the tax year and had unearned income of more than $2,000, part of that income may be taxed at your tax rate instead of your child's tax rate. For more information, see the Instructions for Form 8615.
If you use income averaging, figure your child's tax on unearned income using your rate after allocating EFI. You can't use any of your child's unearned income as your EFI, even if it's attributable to a farming business. For information on figuring the tax on your child's unearned income, see Pub. 929.

Alternative Minimum Tax (AMT)(p18)

You can elect to use income averaging to compute your regular tax liability. However, income averaging isn't used to determine your regular tax or tentative minimum tax when figuring your AMT. Using income averaging may reduce your total tax even if you owe AMT.

Credit for prior year minimum tax.(p18)

You may be able to claim a tax credit if you owed AMT in a prior year. See the Instructions for Form 8801.

Schedule J(p18)

You can use income averaging by filing Schedule J (Form 1040) with your timely filed (including extensions) return for the year. You can also use income averaging on a late return, or use, change, or cancel it on an amended return, if the time for filing a claim for refund hasn't expired for that election year. You generally must file the claim for refund within 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later.