IRS Issues Final Regulations for Income Averaging

The IRS has issued final regulations relating to the income averaging method of computing income tax that is available for farmers.

The final regulations address the issue of equitable treatment for shareholders of S corporations who receive farm income. In addition, the regulations also address the issue of rental income from a farming business.

Specifically, the new regulations, set out in T.D. 8972, state provide the following:

  • Shareholders of S corporations who receive income attributable to the S Corporation farming business may treat that income as farm income for purposes of income averaging. It does not matter if the income is paid in the form of wages or distributed as the shareholder's share of the S corporation income.

  • Landlords who receive income as a result of a tenant's farming operation on the landlord's land may treat the income as farm income for purposes of income averaging only if a written agreement is set out designating the landlord's share of the farming income and that agreement is issued prior to the tenant beginning "significant activities" on the land. If no such written agreement existed prior to the tenant beginning significant activities, the rental income received by the landlord is not eligible for income averaging, even if the landlord materially participates in the farming operation.

  • For purposes of income averaging, a base year income amount may be negative. The negative amount of taxable income, however, may not include net operating losses or other carryovers or carrybacks.

The final regulations are effective January 8, 2002, and apply to tax years beginning after December 31, 2001. Taxpayers with tax years beginning prior to December 31, 2001 may also rely on the regulations.

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