Income Averaging for Farmers and Fisherman

Income Averaging for Farmers and Fisherman

Because of the many unpredictable factors involved that are largely beyond human control, an individual engaged in a farming business or fishing business with a profit motive (not merely for recreation or pleasure) may elect to average farm income over three years using Schedule J of Form 1040. The tax imposed in any tax year will equal the sum of the tax computed on taxable income reduced by an amount equal to one-third of the elected farm income. The individual taxpayer utilizing this provision may elect any amount not exceeding his or her taxable income for that period.

This can be done in order to avoid a higher tax bracket in the taxable year which income is earned if your income from farming or fishing is high and your taxable income for one or more of the three prior years was low. In order to qualify for this election, you are not required to have been in the business of farming or fishing during any of the prior years and you may elect to average that income even if your filing status was not the same in the relevant years.

Further, the IRS defines a farming business as the trade or business of cultivating land or raising or harvesting any agricultural or horticultural commodity. That definition does not include any business or trade involving commodities grown or raised by someone else. The IRS similarly defines a fishing business as the trade or business of fishing in which the fish harvested are intended to enter commerce or enter commerce through sale, barter, or trade. That definition does not include any fishing activity in any way related to a scientific research vessel.

Example So, if farmer Karl produces $10,000 dollars in taxable income in 2004, $10,000 dollars in taxable income in 2005, $20,000 dollars in taxable income in 2006, and then experiences a bumper year and realizes $60,000 in income in 2007 – he may elect to average up to $30,000 of that gain over the prior three years. This would result in a substantial saving of money as the allotment of $10,000 to each of the prior years would allow Karl to be taxed according to the 15% bracket on all of his gains in the four year period.