As of the writing of this article, GreenStone’s tax and accounting department is busy meeting with farmers across Michigan and northeast Wisconsin to help each customer manage taxable incomes and to support our farmers in making wise management decisions for current and future farming operations – reducing taxable income levels where it is possible and makes sense by buying equipment, prepaying for inputs, carrying over crops, or using other tax planning strategies available. It has been extremely busy this year with the commodity prices that most of our farmers were fortunate to experience!
When you are reading this article, we are now into 2023 and it is too late to buy inputs or equipment to reduce 2022 taxable income. However, there is another play that can still be run come income tax filing time this year – that is to utilize farm income averaging via the Schedule J Internal Revenue Service Form.
Our tax accountant experts anticipate the use of farm income averaging to increase this year – farm taxable income levels have been relatively strong the last year few years due to commodity prices and significant government aid. Many farmers have utilized accelerated depreciation methodologies such as Section 179 or bonus depreciation in the past few years to manage taxable income levels down.
After a few years of strong results, rising equipment borrowing rates, continued supply chain issues in the equipment market, and questions of potential increases in income tax rates in the future - it may feel like you are running out of rope and can no longer (or no longer want to) continue kicking income tax burdens down the road. Farm income averaging may assist you this year if you will be paying income tax.
What is farm income averaging?
It is a federal statute that allows farmers to spread a portion of their current year farming income equally over the three previous tax years. By averaging an income tax burden over several years, you can reduce the effects of both low and high taxable income years. This can be done using the aforementioned IRS form 1040 Schedule J.
How does it work?
Below is a simplified computation showing the impact of farm income averaging for a married filing jointly 1040 return. The example assumes that the farmer’s taxable income for 2022 is $323,800 and that 2021, 2020 and 2019 were all managed to $0. With this fact pattern if farm income tax averaging were not used, the farmer would have paid the following tax each year:
With the use of farm income averaging during the 2022 tax filing, a farmer could assign between $78,950 and $81,050 to 2019 through 2021 to soak up all of the 10% and 12% tax brackets for those years. When filing the 2022 tax return, you act like the farmer paid the respective tax for each year and add those taxes to the remaining amount taxed in 2022. This is how it would look in the simplified scenario:
As you can see, the effective tax rate drops from 20.2% to 11.5% via the utilization of income averaging. It results in permanent tax savings of $28,119.
What can you do?
The IRS has been friendly to farmers with this statute – it is flat out a great provision for farmers. This is something you should bring it up to your CPA or income tax professional this year to see if it is an option for your individual situation. The rules can be complicated and this article is a simplified example. However, you’ll want to at least ensure it is being considered when you complete this year’s income tax filings.
If you are interested in learning more about anything you read within this article, contact your CPA or a local GreenStone tax accountant. GreenStone offers a full array of tax and accounting services for farmers and other business owners and we are ready to assist you with your income tax filing needs.
To view the article in the online 2023 Winter Partners Magazine, click here.
