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The Farm CPA

RSS By: Paul Neiffer, Top Producer

Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.

Average is Important for 2013 Tax Filing

Jan 21, 2014

We had a reader ask the following question:

"I would like to here more about income averaging over years and when should someone think of it or not?"

Farmers enjoy a unique method of computing their income tax liability versus other taxpayers. Due to the possible wild swings in farm income, the Tax Code allows farmers to elect to spread their current year farm income over a four-year period (the current year plus the last three years). By electing this spread, a farmer may be able to substantially reduce their current income tax liability by dropping high income tax brackets in the current year and moving it to the previous three years with lower tax brackets.

For example, assume a farmer earns $300,000 from farming in the current year and without using income averaging, his tax liability would be about $65,000. Now, the farmer elects to spread $210,000 of his current year farm income over the last three years. During those years, he had exactly zero taxable income. His income tax liability now will be completely taxed in the 15% tax bracket resulting in total taxes of about $42,000 thus creating tax savings of $23,000.

Therefore, the ultimate goal of farm income averaging is to spread current year higher tax bracket farm income into the three previous year's lower tax brackets (if they are available; if previous years tax brackets are all higher than current year, then no tax savings will result).

With the imposition of the new 39.6% high income tax bracket for 2013, high income farmers will alway want to use farm income averaging to get rid of their 2013 farm income that is in both the 35% and 39.6% tax bracket. They will always save money by doing this. Let's look at an example:

A married farmer normally has $750,000 of taxable income each year. The normal tax liability for 2013 is about $245,000. The farmer elects to carryback about $350,000 of farm income to the previous three years that is all taxed at 35%. He saves 4.6% on $300,000 or $13,800. In 2014, he has the same amount of income and saves another $13,800 less $1,150 taxed at 4.6% on the 2013 year. In 2015, he has the same amount of income. He saves $13,800 in 2015 less about $6,000 that is taxed at 39.6% in 2013 and 2014. In 2016, he makes the same election, however, now his savings are only about $3,500 since his only savings is that part of the income that will be taxed at 35% in the 2015 tax year. The rest of the income will all be taxed at the highest rate.

Therefore, by electing farm income averaging in all four years, the farmer ends up saving about $37,000 over the four-year period. This means that all farmers in the highest tax bracket for 2013 must use farm income averaging to maximize your income tax savings. After you get your return back from your tax advisor, make sure to check that Schedule J has been prepared and that enough farm income was elected to be carried back.

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