The Importance of Farm Income Averaging and Schedule J
by Mike Kortus, CPA
In farming, so many things fluctuate from year to year, sometimes even day to day. Yields and commodity prices can be affected by many things outside of a farmer’s control such as weather, markets, and supply. This volatility could cause farmers to pay tax at high rates during a good year and use up losses against low rates during poor years. However, we can help manage these income swings and help farms sustain cash flow in their operations with farm income averaging. Let’s look at an overview of farm income averaging and the best way to utilize it to minimize your tax.
What is Farm Income Averaging?
Farm income averaging is a tax management tool that is available to farmers and ranchers. It allows farmers to spread out a year’s taxable income evenly over the prior three years and take advantage of lower unused tax rates.
For example, if a farmer had three years of losses or very low income, followed by a year of very high profit margins on their commodity, they could use up 0-15% rates in prior years rather than paying tax at 32-37% rates in the current year. It is a unique advantage available only to farms and helps plan for uncertainty that may be faced.
Schedule J on Form 1040 is used to figure farm income averaging. Qualified farm income includes net income from growing or raising commodities, as well as sale of farm equipment and crop-share rental income. Cash rental income and farmland sales do not qualify for farm income averaging. Farm businesses using Partnerships, S-Corporations or LLCs can all utilize this tool.
Proactive tax planning is critical to properly take advantage of farm income averaging. Because most farming business can file taxes on a cash basis, year-end planning for income and expenses can be even more advantageous than many other businesses. Understanding farm income averaging can help agribusinesses make strategic decisions that permanently save tax over the years and help manage the tax impact to their business.
How Can We Help You?
Through our tax planning practices and our expertise in the agriculture industry, we can help with your farm accounting needs. Whether it’s current year tax planning, amending prior year tax returns to include the benefits of Schedule J or proactively planning for the tax implications of future ownership transitions, we are excited for the opportunity to serve businesses in the agriculture industry.
Call us at (360) 734-4280 or fill out the form below and we'll contact you to discuss your specific situation.
Mike Kortus, CPA
Mike Kortus joined Larson Gross in 2015 and specializes in agriculture and food processing tax preparation and planning.