Income Averaging for Farmers and Fishermen 2013
Checklist
Schedule J allows eligible farmers and fishermen to average farm or fishing income over three base years to reduce tax liability in high-income years. Unlike standard Form 1040 filing,
Schedule J users must recalculate tax liability using averaged income across multiple years, making proper documentation essential for farm activity participants.
Eligibility and Purpose
You may elect income averaging if you operate a farming or fishing business and report net farm or fishing income on Schedule F or Schedule C. The election applies when your 2013 income from farming or fishing is high and your taxable income for one or more of the three prior base years was low.
To be eligible for this election, you are not required to have been engaged in the farming or fishing industry during any of the base years. Income averaging remains available even if your filing status was not the same in the election year and the base years, allowing flexibility in managing your tax burden across different filing scenarios.
Required Documentation and Records
Gather completed Schedule F showing gross farm income, deductions, and net farm profit or loss for the current year and all prior years required for averaging. Collect all Form 1099-MISC forms reporting nonemployee compensation in box 7 for 2013, K-1 forms if you participate in partnership or S corporation farm operations, depreciation schedules, and business expense records supporting Schedule F entries.
You may need copies of your original or amended income tax returns for 2010, 2011, and 2012 to figure your tax on Schedule J. Keep a copy of your 2013 tax return to use for income averaging in 2014, 2015, or 2016, as prior tax return documentation becomes essential for future averaging elections.
Understanding Base Years and the Three-Year Period
Data from four years are necessary for the 2013 Schedule J calculation: the current year (2013),
three base years (2010, 2011, and 2012), and the years preceding it. The form allocates a
portion of your 2013 elected farm income to each base year by dividing your elected income by three and adding one-third to each base year’s taxable income.
This allocation method spreads farming income across multiple tax brackets to minimize your overall tax liability. Each base year receives equal treatment in the calculation, regardless of the actual farming business activity levels during those prior tax year periods.
Calculating Elected Farm Income
Elected farm income represents the amount of your 2013 taxable income from farming or fishing that you elect to include on Schedule J, line 2a. This includes all income, gains, losses, and deductions attributable to your farming business operations, whether from crop sales, livestock transactions, or other agricultural activities. You do not have to include all of your taxable income from farming or fishing on line 2a, as it may benefit you to include less than the entire amount.
Elected farm income includes
- Gain or loss from the sale or other disposition of property that was regularly used in your
farming business for a substantial period of time may be treated as elected farm income.
- All income, gains, losses, and deductions that are directly attributable to your farming or
fishing operations qualify for inclusion as elected farm income.
- When you operate both farming and fishing businesses, the combined income from
those operations may be included as elected farm income.
- Self-employment tax deductions that are attributable to your farming business activities
are also included as elected farm income.
Elected farm income does not include
- Income, gain, or loss from the sale or other disposition of land is excluded from elected
farm income.
- Proceeds from the sale of development rights, grazing rights, or other similar rights are
excluded.
- Any portion of income that exceeds your 2013 taxable income as reported on Form
1040, line 43, cannot be included.
- Capital gains from securities or investments that are unrelated to your farming business
operations are excluded.
The Income Averaging Calculation Method
The Schedule J calculation does not add income from the three years together and divide by three. Instead, you divide only your 2013 elected farm income from line 2a by 3.0 and enter this result on line 6. You then add this one-third amount to each base year’s taxable income separately on the appropriate lines of Schedule J.
You are only adding a portion of current-year elected income to each base year for the averaging calculation; the original income of the base years remains unaltered on your filed tax return.
For each base year, you calculate tax using the applicable year’s income tax rates on the increased taxable income amount, which equals original base year income plus one-third of elected farm income. This approach allows you to benefit from lower tax brackets that may have been available in prior years when your farming income was lower.
Tax Liability and Expected Outcome
Schedule J is designed to reduce your tax liability, not increase it. The 2013 instructions state that this election may give you a lower tax if your 2013 income from farming or fishing is high and your taxable income for one or more of the three prior years was low.
After completing all calculations, you compare the Schedule J result with your regular tax calculation using standard methods. Your tax may be less if you figure it using the tax tables or worksheets instead of Schedule J, so you should attach Schedule J to Form 1040 only if it produces a lower result. Proper application of income averaging can significantly reduce your overall tax burden when farming business revenue fluctuates substantially between tax year periods.
Form 6198 and At-Risk Rules
Form 6198 governs at-risk limitations under Internal Revenue Code Section 465 for certain farm activities. You must file Form 6198 if you are engaged in farming and you have borrowed amounts for which you are not personally liable, or if you participate in a farming syndicate.
Farming syndicates cannot use the cash method of accounting and may be structured as partnerships, limited liability companies, S corporations, or other noncorporate groups if interests in the business have at any time been offered for sale in a registered securities offering.
The Form 6198 requirement exists independently of Schedule J income averaging and applies when you have losses from at-risk activities. This form determines the maximum amount you can deduct after suffering a business loss in the tax year based on the amounts you have truly at risk in the farming operation.
Filing and Assembly Instructions
Complete Schedule J using 2013 tax rate tables or worksheets provided in the Form 1040 instructions to calculate tentative tax amounts for each year. Attach Schedule J behind Form
1040 in the assembly order specified by the 2013 Form 1040 instructions, ensuring Schedule F is also attached to your return.
Sign and date Form 1040 with Schedule J and all required attachments before mailing your tax return to the address specified for your state and filing status. Retain copies of all supporting schedules and prior-year returns for audit documentation for at least three years after April 15,
2014, or the date you file your 2013 tax return, whichever is later.
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