Schedule J (1040) - Income Averaging for Farmers and Fisherman

Kevin Burkett, Extension Associate, Clemson University
Dr. Steve Richards, Extension Associate, Clemson University

Introduction

Farmers and fishers experience significant variations in income from year to year, which causes their taxable income (and taxes owed) to fluctuate.  These fluctuations in income potentially create a higher tax liability overall, due to the progressive nature of the federal income tax code: as income level rises, tax rates also rise (see Table 1). This means that a farmer or fisherman having a good year could end up finding themselves in a higher tax bracket compared to their not-so-good years.

To help these farm businesses smooth out swings in income and reduce overall tax liability, the Internal Revenue Service (IRS) allows individuals engaged in farming or fishing to elect “income averaging” under 26 CFR § 1.1301-1. The definition of farming is found in IRC §263A(e)(4) for this purpose, and is illustrated below. The income which is eligible for averaging includes crop and livestock sales (and fish income) and the sale of personal property used in farming (e.g., machinery and equipment).

Are You a Farmer or a Fisher?

• A farming business is in the trade or business of cultivating land or raising or harvesting any agricultural or horticultural commodity.
• A fishing business is in the trade or business of fishing in which the fish harvested, either in whole or in part, are intended to enter commerce or enter commerce through sale, barter, or trade.
• Aquaculture operations (farm-raised clams, oysters, and fish) are considered farming under the broad definition of “fish” in the IRS definition of farming.

What Are The 2024 Tax Brackets?

The current federal rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The filing status brackets and rates apply equally to each taxpayer regardless of their industry. These percentages have changed over time due to tax law changes and inflation adjustments, but Table 1 below illustrates where they presently stand in 2024.

Table 1. 2024 Individual Income Tax Rates and Taxable Income Brackets

Tax rate	on taxable income from . . .	up to . . .
10%	$0	$23,200
12%	$23,201	$94,300
22%	$94,301	$201,050
24%	$201,051	$383,900
32%	$383,901	$487,450
35%	$487,451	$731,200
37%	$731,201	And up

Using Income Averaging

One of the first steps in tax planning is figuring out which tax bracket a taxpayer typically falls into.  With income averaging, a taxpayer can “move” income from the current year (known as Elected Farm Income, even if you are a fisher) and move it to prior years (base years) under prior years’ tax rates (see Figure 1).  

This effectively allows the taxpayer to “fill up” unused brackets of the prior years. The benefit would be that income taxed at a higher rate for the current year can be taxed at lower rates due to the taxpayer’s lower income level and tax brackets experienced in previous years.

Tax Planning

For the current year, the income averaging benefit is maximized when the rates from averaging are the same as the current year rate. For instance, if the averaging rate is 22% for each of the base years (past three years) and the current year rate is 22%, there is no further tax benefit. Once income averaging has been applied, it does affect future income averaging calculations. In Figure 1, the $30,000 that has been moved from 2024 to the prior three years will be part of any future calculations. Continuing the example, in 2025 if income averaging were to be elected again, the $10,000 (each) that was moved to 2021, 2022, and 2023 would still apply. 2021 would no longer be part of the calculation (only the prior 3 years are used), so 2022, 2023, and 2024 would be the base years.  If 2025 income levels were also in the 22% bracket, it may be another opportunity for the taxpayer to income average as there are still “gaps” in the 2022 and 2023 tax years’ 12% brackets. Sometimes, if a taxpayer or preparer realizes a bigger income year is coming, they may income average with no current year benefit, so when they make the calculation in future years, they have created bigger bracket “gaps” for future years to fill.

Other Considerations

The examples in this article are for educational purposes and illustrate the concept and benefits behind income averaging. Only individuals can utilize this provision, meaning that estates, trusts, and C Corporations are not eligible. For those in a partnership, S Corp, or LLC, their share of farming or fishing income is averaged on their individual 1040 return. If an individual was involved in both a farming and fishing operation, those incomes are combined for the purposes of Schedule J. Certain items of income are includable (sale of business assets for instance) and other items are excludable (sale of land). For these reasons, we encourage you to work with your trusted tax professional to understand the impact of Schedule J for your operation.

IRS Publications

IRS forms and publications can be found by going to www.irs.gov and typing in the name of the publication/form or the publication/form number in the search bar toward the top of the webpage. Publications may be viewed online or downloaded.

For further information visit, www.IRS.gov/ScheduleJ and  IRS Publication 225 – Farmers Tax Guide.

Additional Topics

This fact sheet was written as part of Rural Tax Education, a national effort including Cooperative Extension programs at participating land-grant universities to provide income tax education materials to farmers, ranchers, and other agricultural producers. For a list of universities involved, other fact sheets, and additional information related to agricultural income tax, please see RuralTax.org. 

This information is intended for educational purposes only. You are encouraged to seek the advice of your tax or legal advisor, or other authoritative sources, regarding the application of these general tax principles to your individual circumstances. Pursuant to Treasury Department (IRS) Circular 230 Regulations, any federal tax advice contained here is not intended or written to be used, and may not be used, for the purpose of avoiding tax-related penalties or promoting, marketing or recommending to another party any tax-related matters addressed herein.

USDA is an equal opportunity provider, employer, and lender. Rural Tax Education is part of the National Farm Income Tax Extension Committee.  The land-grant universities involved in Rural Tax Education are affirmative action/equal opportunity institutions.

This material is based upon work supported by the U.S. Department of Agriculture, under agreement number FSA21CPT0012032. Any opinions, findings, conclusions, or recommendations expressed in this publication are those of the author(s) and do not necessarily reflect the views of the U.S. Department of Agriculture. In addition, any reference to specific brands or types of products or services does not constitute or imply an endorsement by the U.S. Department of Agriculture for those products or services.

Published September 2024

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