Schedule J Income Averaging Guide for Farmers 2014

2014 Instructions for Schedule J | Income Average for

Farmers and Fishermen Checklist

Schedule J allows eligible farmers and fishermen to reduce their tax liability by allocating current-year farm or fishing income across a three-year base period. This method can lower your overall tax burden when your 2014 income is significantly higher than your income in prior years.

Eligibility Requirements

You qualify to use Schedule J if you earned taxable income from a farming or fishing business during 2014. A farming business includes cultivating land, raising or harvesting horticultural commodities, raising or managing livestock, and leasing farmland to tenants under share-based agreements.

Fishing businesses are engaged in the capture, retention, or harvesting of fish with the intention of redistributing them to the market through trade, barter, or sale. The Internal Revenue Service does not require you to have engaged in these activities during the base years of 2011, 2012, or

2013.

Nonresident aliens who file Form 1040-NR and have farm or fishing income may use Schedule

J to calculate their tax liability. Estates and trusts cannot use this form because they file using a different reporting structure under Form 1041.

Individuals filing as sole proprietors, partners in partnerships, or shareholders in an S corporation may all elect income averaging if they meet the income source requirements. Your filing status may differ between the base years and 2014 without affecting your eligibility to use

Schedule J.

How Income Averaging Works

Income averaging does not create a simple arithmetic mean of your income over four years.

The calculation method divides your elected farm income by 3.0 and allocates the result to each of the three base years.

You add this allocated amount to each base year’s taxable income separately and calculate hypothetical taxes for 2011, 2012, and 2013 using the tax rates that applied in those years.

Combining the tax on your remaining 2014 income with the sum of these hypothetical taxes determines your total tax liability under the income averaging method.

Comparing this result to your standard 2014 tax calculation reveals whether income averaging provides a tax benefit. You should use the method that produces the lower tax liability on your final tax return.

What Qualifies as Elected Farm Income

Elected farm income includes all income, gains, losses, and deductions attributable to your farming or fishing operations. This includes net profit or loss from Schedule F, farming income reported on Schedule E, and income from Schedule K-1 if you participate in a farming or fishing partnership or S corporation.

You may also include gains or losses from the sale of property regularly used in your farming or fishing business for a substantial period. Elected farm income does not include income from the sale of land, development rights, or grazing rights.

It is not necessary to include all of your farm or fishing income on line 2a of Schedule J. The tax result may be more favorable if you restrict the amount you select, depending on the impact of the allocation on your marginal tax rate each year.

Filing Process

1. Step 1: Gather 2014 Income Documentation

   Collect Schedule F if you operate a farm, Schedule K-1 if you receive farm or fishing income through a partnership or S corporation, and any other records showing business income from farming or fishing activities.

2. Step 2: Obtain Base Year Tax Returns

   Retrieve copies of your tax returns for 2011, 2012, and 2013 showing the taxable income you reported in each year. Farm or fishing income is not required in these prior taxable years.

3. Step 3: Complete Schedule J Lines 1 Through 4

   Enter your total 2014 taxable income from Form 1040, line 43, on Schedule J, line 1. On line 2a, enter your elected farm income. Complete lines 2b and 2c if your elected farm income includes

   capital gains or unrecaptured section 1250 gain. Subtract line 2a from line 1 and enter the result on line 3. Calculate the tax on line 3 using 2014 tax rates and enter it on line 4.

4. Step 4: Calculate Base Year Hypothetical Taxes

   For each base year, retrieve your taxable income and enter it on lines 5, 9, and 13. Divide your elected farm income by 3.0 and enter the result on lines 6, 10, and 14.

   Add the allocated amount to each base year’s taxable income. Calculate the hypothetical tax for each base year using the tax rates that were in effect during 2011, 2012, and 2013. Enter these amounts on lines 8, 12, and 16.

5. Step 5: Determine Your Final Tax Liability

   Add the taxes from lines 4, 8, 12, and 16 to calculate your total tax under income averaging.

   Compare this amount to the tax you would owe using standard 2014 tax calculation methods.

   Use the lower amount as your final tax liability.

   Capital Gains Treatment

   If your elected farm income includes capital gains, you must complete lines 2b and 2c on

   Schedule J. Line 2b captures the net capital gain portion of your elected farm income, which is the excess of net long-term capital gain over net short-term capital loss.

   Line 2c captures any unrecaptured section 1250 gain attributable to your farming or fishing business. These amounts receive special tax treatment under the Internal Revenue Code and must be calculated separately to ensure accurate application of the lower capital gains tax rate.

   When calculating hypothetical taxes for the base years, you must allocate one-third of the amounts on lines 2b and 2c to each year. This allocation ensures that capital gains receive preferential tax treatment in each base year calculation.

   Documentation and Filing Requirements

   Attach Schedule J to the back of your Form 1040 or Form 1040-NR in the order specified by the assembly instructions. Include all supporting schedules, such as Schedule F or Schedule K-1, that document the source of your farm or fishing income.

   Ensure that your Social Security number appears on all forms before submission. Sign and date your tax return before mailing it to the address provided in the IRS forms instructions for your state and filing status.

   Keep copies of your 2014 return and Schedule J for use in future years if you elect income averaging again. Retain all records related to your farming business or fishing business for at least three years after the filing deadline.

   Important Limitations

   Schedule J does not affect your alternative minimum tax calculation or reduce the tax imposed under section 1 of the Internal Revenue Code when calculating alternative minimum tax on