Income Averaging for Farmers and Fishermen 2017
Checklist
Schedule J permits individuals engaged in farming or fishing to average current-year income over a four-year period, which includes the election year and three prior base years. This election can reduce your overall income tax liability when current-year income from farming or fishing activities significantly exceeds income from previous years.
Eligibility Requirements for Schedule J
You qualify to use Schedule J if you are an individual engaged in a farming business or fishing business during the tax year. Partners in partnerships conducting farming or fishing operations may use Schedule J on their individual returns, and shareholders of S corporations engaged in farming or fishing businesses may also elect income averaging.
Nonresident aliens engaged in farming or fishing businesses can use Schedule J when filing
Form 1040NR. The 2017 form explicitly permits nonresident aliens to make this election if they
meet the business engagement requirement.
To be eligible for this election, you are not required to generate more than half of your gross income from farming or fishing activities. An individual is not required to have been engaged in a farming or fishing business during any of the three base years to make an income averaging election for the current year.
Entity Restrictions
Corporations and partnerships cannot file Schedule J directly as the form applies only to individual taxpayers. Entities taxed as C corporations, estates, and trusts cannot use this income averaging provision under any circumstances.
Calculating Elected Farm Income
Your elected farm income represents the portion of your taxable farming or fishing income that you choose to average over the four years. You enter this amount on Schedule J, Part I, line 2a, using net farm or fishing income from Schedule F, line 34, or Schedule C, line 31.
Income Sources Eligible for Averaging
- Net profit or loss reported on Schedule F or Schedule C that is attributable to farming or
fishing operations may be included as income eligible for averaging.
- Wages and other compensation received by an S corporation shareholder from a
farming or fishing business qualify as income sources that may be averaged.
- Compensation earned as a crew member on a fishing vessel is eligible for averaging
when the payment is based on a share of the catch.
- Net capital gains arising from the sale of property that was regularly used in a farming or
fishing business may be treated as income eligible for averaging.
- Self-employment tax deductions that are directly attributable to farming or fishing
business activities may also be included in the income averaging calculation.
Your elected farm income cannot exceed your total taxable income for the year. Elected farm income does not include income from the sale or disposition of land, development rights, or grazing rights.
You may elect to include all or only part of your eligible farm or fishing income in the averaging calculation. Different amounts of elected farm income can produce different tax results depending on how the income allocation affects your tax brackets across the base years.
Understanding the Four-Year Averaging Method
Schedule J uses a four-year averaging method that allocates your current-year elected farm income across three prior base years. You divide your elected farm income by three, and this one-third amount increases the taxable income for each of the three base years.
The calculation then determines what your tax liability would have been in each base year if you had received this additional one-third income during those years. Based on the tax rates and brackets that were in effect during each particular base year, you finalize the calculation.
For 2017 returns, the base years are 2014, 2015, and 2016. You must obtain your original or amended tax returns for these years to extract the required taxable income amounts and properly complete the Schedule J worksheets.
Computing Your Final Tax Liability
The final tax liability equals the sum of two components calculated through the Schedule J worksheets. First, you calculate the tax on your current-year taxable income after subtracting the elected farm income, which represents your non-averaged income for 2017.
Second, you calculate the additional tax that would result from adding one-third of the elected farm income to each of the three base years. These amounts combine to produce your total tax liability under the income averaging election, which may result in significant tax savings compared to standard calculation methods.
Required Documentation and Base Year Information
You must gather complete copies of your Form 1040 returns for the three base years preceding your election year. Attach Schedule F or Schedule C for the current year showing net farm or fishing income to demonstrate the source of your elected farm income.
If you receive farm or fishing income through a partnership or S corporation, attach Schedule
K-1 forms and provide a detailed statement explaining how the pass-through income appears in your Schedule J calculations. This supporting documentation helps the IRS verify the accuracy of your income averaging election.
Base Year Information Requirements
1. You must obtain the taxable income amount for each base year from line 43 of Form
1040 or line 41 of Form 1040NR, depending on the return filed for that year.
2. Any Schedule J elections made during the base years must be identified and considered if they affect the current income averaging calculations.
3. Net operating loss carryovers or carrybacks that affected taxable income in any base year must be taken into account when determining adjusted base year amounts.
4. Capital loss carryovers that reduced taxable income in a base year must be included to ensure proper adjustment of base year taxable income figures.
For base years with zero or negative taxable income, complete the applicable Taxable Income
Worksheet provided in the Schedule J instructions. These worksheets adjust for net capital loss
deductions, net operating losses, and exemption deductions that affect the averaging calculation.
You must preserve all base year records for at least three years after filing your election year return. Proper recordkeeping ensures you can respond to IRS inquiries and support your income averaging calculations if questioned.
Filing Requirements and Tax Implications
Attach Schedule J directly to Form 1040 or Form 1040NR when filing your return. Do not file
Schedule J as a standalone document, as it must accompany your primary tax return to constitute a valid election.
Secure all schedules and supporting statements for your return in the order specified by the IRS assembly instructions for 2017. Sign and date Form 1040 in the designated spaces, ensuring the date matches your actual filing date.
This election applies only to your regular income tax calculation under Section 1 of the Internal
Revenue Code. The averaging election does not affect your alternative minimum tax calculation on Form 6251, which you must compute separately using standard methods.
You must still complete Schedule SE to calculate self-employment tax on your net farm or fishing income, as income averaging does not reduce self-employment tax obligations. Social
Security and Medicare taxes remain calculated on your actual current-year earnings regardless of any income averaging election.
Mail your complete return package to the appropriate IRS address listed in the 2017 Form 1040 instructions. Retain copies of all forms, schedules, worksheets, and supporting documentation for your records to comply with federal recordkeeping requirements.
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