Farm Income Averaging May Save Tax

Higher grain prices and increasing milk prices should lead to higher income for farmers and many planning opportunities for accountants. One of the opportunities is the strategic use of farm income averaging.
Farm income averaging has been available since 1998 and allows individuals engaged in farming to elect to average farm income over three years to obtain the benefit of applying lower income tax rates from prior years to current taxable income.

A farming business includes the cultivating of land or raising or harvesting of any agricultural or horticultural commodity. Taxpayers eligible for farm income averaging include an individual operating as a sole proprietor, partner in a partnership, or shareholder in an S corporation, without regard to whether the individual was engaged in a farming business in any prior base year. Corporations, partnerships, S corporations, estates and trusts cannot use income averaging.

The elected farm income, or EFI, is the amount of taxable income attributable to any farming business that is specifically elected by the taxpayer. Any portion of taxable income attributable to farming may be designated as EFI. Farm taxable income includes gain from the sale or disposition or property, other than land, regularly used by a farmer for a substantial period in a farming business. So gains from the sale of equipment and other personal property are eligible and, although gains from the sale of land or development rights do not qualify, structures affixed to the land including barns and bin systems would qualify. Services performed as an employee are disregarded in determining whether an individual is engaged in a farming business.
However, a shareholder of an S corporation engaged in a farming business may treat wages received from the corporation that is attributable to the farming business as EFI.

Use of farm income averaging no longer affects the alternative minimum tax (AMT). Effective for tax years beginning after 2003, the comparison of regular tax to AMT occurs prior to the use of farm income averaging. If regular tax exceeds AMT before the use of farm income averaging, no AMT is incurred for the year. Alternatively, even if you owe AMT before farm income averaging, using it may still reduce your total tax.

Another tip to remember is that you can elect income averaging on a late or amended return. You may also amend to change the amount of elected farm income in a prior election or revoke a previously filed election. It may be advantageous to amend a base year to better position the base years for a current or future year election. This is the perfect time of year to review prior year returns to study this potential opportunity.

This tax tip was submitted by:
Cheryl Wittmann, CPA
Agribusiness Group
Wegner LLP CPAs & Consultants

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