Income Averaging for Farmers and Fishermen 2012
Checklist
Schedule J allows farmers and fishermen to average farming or fishing income over three years to reduce federal income tax liability from volatile income patterns. This form applies to individuals filing Form 1040 or Form 1040NR who have taxable income from a trade or business of farming or fishing.
The Internal Revenue Service does not require farming or fishing to be your principal income source. You do not need to have operated a farming or fishing business during the base years to qualify for income averaging.
Understanding Schedule J Eligibility Requirements
You qualify to use Schedule J if you have income from a trade or business of farming or fishing during the current tax year. The IRS defines a farming business as cultivating land or raising or harvesting any agricultural or horticultural commodity, including operating nurseries, raising livestock, managing dairy operations, and operating plantations or ranches.
A fishing business includes catching, taking, or harvesting fish, as well as operations at sea that support fishing activities. Nonresident aliens filing Form 1040NR can use Schedule J if they meet the farming or fishing income requirements.
For entity-level reporting, the form is unavailable to C corporations, estates, or trusts that are submitting their own tax forms. Individual taxpayers who receive farming or fishing income through pass-through entities may use income averaging on their personal income tax return.
Eligible entity structures include
- Individuals operating as sole proprietors may qualify when they report farming income
directly on Form 1040.
- Partners in partnerships are eligible when they receive distributive shares of farming or
fishing income reported to them by the partnership.
- Shareholders in S corporations may use income averaging when farming or fishing
income is allocated to them through Schedule K-1.
- Members of limited liability companies that are taxed as partnerships or S corporations
are eligible when they receive farming or fishing income through those entities.
The entity itself does not file Schedule J. Rather, the individual taxpayer uses the form to average their allocated farming business income on their personal tax return.
How Schedule J Computes Tax Using Base Year Rates
Schedule J divides your current year's elected farm income by three and allocates one-third of that amount to each of the three prior base years. The form then recalculates tax for each base year by adding the one-third portion to that year’s original taxable income and applying that year’s tax rates.
This method averages tax brackets across multiple years rather than averaging the income amounts themselves. You calculate tax separately for the current year’s remaining income and for each of the three base years, then sum all four tax amounts to arrive at your total income tax liability.
To perform the calculation, you must compile taxable income figures from the three previous tax years. You must also confirm whether you used Schedule J in any of those years, because that affects which amounts you use on the current form.
When you used income averaging in a prior year, you reference specific lines from that year’s
Schedule J rather than using taxable income from your original Form 1040. Detailed worksheets are included in the form to calculate base year amounts when your prior year taxable income was zero or less, accounting for net operating losses and capital loss carryovers.
Required Tax Rate Schedules for Base Year Calculations
Schedule J requires you to apply the appropriate tax rate schedule for each base year when computing tax on the allocated farm income. Single filers and those who checked the filing status box 1 or 2 on Form 1040NR must use Schedule X for the corresponding base year.
Schedule Y-2 must be utilized for base year tax calculations by married taxpayers who are filing separately or those who have selected filing status box 3, 4, or 5 on Form 1040NR. Married taxpayers filing jointly or qualifying widow(er) filers who checked the filing status box 6 on Form
1040NR must use Schedule Y-1.
Head of household filers must use Schedule Z when calculating tax on base year amounts. The
IRS forms instructions specify which tax rate schedule applies to your filing status for each year.
If you claimed the foreign earned income exclusion on Form 2555 or Form 2555-EZ in a base year, you must complete additional worksheets. Start with the Foreign Earned Income Tax
Worksheet, then use the Schedule D Tax Worksheet to figure the tax on the specified amount for that base year.
Elected Farm Income Components and Limitations
Your elected farm income includes all income, gains, losses, and deductions attributable to your farming business or fishing operation. Schedule F reports farm income and expenses, while
Schedule C may report fishing self-employment income.
You must include gain or loss from selling property regularly used in your farming business for a substantial period. Property sales must occur within a reasonable time after ceasing operations, which the Internal Revenue Service considers to be within one year of cessation.
Elected farm income excludes the following items
- Income, gain, or loss resulting from the sale of land is excluded from elected farm
income for Schedule J purposes.
- Income earned from selling development rights, grazing rights, or similar property rights
does not qualify as elected farm income.
- Any portion of income that exceeds your total taxable income for the current tax year
cannot be included as elected farm income.
You do not need to include all of your farming or fishing income as elected farm income.
Choosing to average only a portion of your farming business income may produce a more favorable tax result, depending on how different amounts affect your tax brackets for the current and prior three tax years.
Documentation Requirements and Filing Procedures
You must gather farm and fishing income documentation for the current year and the two prior years before completing Schedule J. Collect Schedule F forms showing farm income and loss,
Schedule C forms if fishing self-employment applies, and K-1 forms from farming partnerships or S corporations.
Gather Forms 1099-MISC and 1099-NEC reporting farm-related income, along with all supporting ledgers, receipts, and expense records covering the three-year period. You may need copies of your original or amended IRS forms for the base years to obtain taxable income figures.
You can request prior-year tax returns using Form 4506, which generally requires a fee for each return. The Internal Revenue Service waives the fee if your main home, principal place of business, or tax records are located in a federally declared disaster area.
Form 4506-T provides free transcripts of your tax return or account information. Keep a copy of your current year income tax return to use for income averaging in future years, as you will need it when calculating base year amounts for the next three filing periods.
Tax Comparison and Filing Decision
Schedule J produces a single tax calculation based on the income averaging method. The form includes a caution statement advising that your income tax may be less if you calculate it using the standard tax table, tax computation worksheet, qualified dividends and capital gain tax worksheet, or Schedule D tax worksheet.
You should compare the Schedule J result with the tax calculated using standard methods before deciding whether to attach Schedule J to your return. The IRS does not require you to submit both calculations or compute tax twice.
Attach Schedule J to Form 1040 or Form 1040NR only if income averaging produces a lower tax liability than standard computation methods. Complete all required amounts on Schedule J, attach it to your return following the form instructions, and sign and date all IRS forms and schedules.
File your return according to the Internal Revenue Service filing location requirements for your geographic area. Schedule J does not affect your self-employment tax calculation, which you must compute separately using Schedule SE based on your actual current year farming or fishing income.
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