In agriculture, it’s common knowledge that farm income can fluctuate drastically yearly. Factors such as weather conditions, crop diseases, and market prices are unpredictable and largely beyond farmers’ control. This sometimes-volatile nature of the agricultural industry needs unique financial planning strategies, including farm income averaging.

Farm income averaging is a specialized tax planning tool designed specifically for farmers. It allows them to spread some or all their current year’s farm income equally over the preceding three years. This strategy proves particularly advantageous during high-income years when there’s a risk of escalating into a higher tax bracket. Using income averaging, current-year income, which would otherwise be taxed at a higher rate, is averaged out over the lower tax brackets of the previous three years.

Understanding Farm Income

Farm income, as defined by the IRS, is the business of cultivating land or raising or harvesting any agricultural or horticultural commodity. Here are a few common examples of where farm income may be reported:

• – Schedule F: This is typically used for reporting farm income.
• – Schedule K-1: This is used for income passed through farm partnerships or farm S-Corporations.
• – W-2s: These are for wages received by S-Corporation shareholders from Farm S-Corporations.
• – Form 4797: This is used for reporting Gain on the Sale of Farm Assets such as equipment, breeding stock, etc., used in a farm business.
• – Form 4835: This is used for reporting Crop share rent income.

What Doesn’t Qualify as Farm Income for Income Averaging?

While many types of income fit the farm income definition, not all qualify for income averaging. These include gain on the sale of land used in farming operations, cash rent for farmland, contract harvesting of an agricultural or horticultural commodity grown or raised by someone else, and the mere buying or reselling of plants or animals grown or raised by someone else.

Other Factors to Consider

The choice to average farm income is made when filing the tax return after the year’s end. Farm income averaging doesn’t alter the income reported in prior years but utilizes any portion of lower tax brackets unused in those years. Importantly, you don’t have to report farm income in the previous years to use income averaging for current-year farm income. It should also be noted that the election to average farm income doesn’t affect self-employment taxes in the current or prior years.

Reach Out to Genske, Mulder & Company, LLP Experts

Farm income averaging is a valuable financial planning tool that enables farmers to better cope with the industry’s volatility. However, its benefits are only sometimes applicable and should be considered part of a more comprehensive array of year-end planning strategies for farmers. Should you have any questions regarding farm income averaging or need advice on leveraging it, don’t hesitate to contact us today.