Update on Farm Income Averaging

Published on: 08:52AM Dec 26, 2012

We did a post a few days ago on how farmers may not be affected by the increased tax rates for 2013 if they use farm income averaging.  In that post, we used an example of spreading $1 million of farm income over four years, $250,000 in 2010-2013.  An observant reader reminded us that a farmer could spread even more income, if desired, to the period 2010-2012 to take advantage of the lower rates for those years.

Farm income averaging allows farmer to take an elected amount of income for any year and spread it over the prior three years.  They are limited only to the amount of farm income generated in the current year as long as this income is greater than their taxable income.

Therefore, even if a farmer in 2013 had a substantial amount of income for 2010-2013, they could elect to take their 2013 income and spread it over the prior three years.  As an example, lets assume a farmer had generated $1 million of taxable income for each year from 2010-2013 and all of this income was related to farming.  If they did not use farm income averaging for 2013, their federal tax would be about $358,000.  If the Bush tax cuts were extended into 2013, the net federal income tax would be about $318,000 or a $40,000 increase in taxes.

However, the farmer can elect to take up to $1 million of farm income and carry it back evenly to 2010-2012.  Since the farmer was taxed at a marginal rate of 35% in each of those years, they will elect to carry back about $777 thousand of 2013 farm income (the point when income is taxed at 36%).  This income is then taxed at 35% or about $272,000.  If it had not been carried back, the tax paid in 2013 on this income would be about $301,000 or a savings of almost $30,000.  The farmer cannot eliminate the whole $40,000 increase in taxes, but it is able to save about 75% of the increase.

If the farmer had very low income in 2010-2012, then most likely they could have avoided almost the whole increase in taxes.

Remember, even if the Bush tax cuts expire for 2013, if most of your income is from farming, you will be able to mitigate at least 75% or so of this increase by using farm income averaging.