Averaging of Farm Income

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-121063-97]

RIN 1545-AX01

Averaging of Farm Income

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations for averaging farm

income under section 1301 of the Internal Revenue Code. The regulations

reflect the enactment of the provision by the Taxpayer Relief Act of

1997, as amended by the Omnibus Consolidated and Emergency Supplemental

Appropriations Act, 1999. The regulations provide guidance to

individuals engaged in a farming business who may elect to reduce their

regular tax liability by treating all or a portion of the current

year's farming income as if it had been earned in equal proportions

over the prior three years. This document also provides notice of a

public hearing on these proposed regulations.

DATES: Written or electronic comments and requests to speak (with

outlines of oral comments) at a public hearing

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scheduled for February 15, 2000, must be received by January 14, 2000.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-121063-97), room

5226, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. Submissions may be hand delivered Monday through

Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-

121063-97), Courier's Desk, Internal Revenue Service, 1111 Constitution

Avenue, NW., Washington, DC. Alternatively, taxpayers may submit

comments electronically via the Internet by selecting the ``Tax Regs''

option on the IRS Home Page, or by submitting comments directly to the

IRS Internet site at http://www.irs.gov/tax__regs/regslist.html. The

public hearing will be held in room 2615, Internal Revenue Building,

1111 Constitution Avenue, NW., Washington DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,

John M. Moran, at (202) 622-4940; concerning submissions of comments,

the hearing, and/or to be placed on the building access list to attend

the hearing, Guy Traynor, at (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed

rulemaking has been submitted to the Office of Management and Budget

for review in accordance with the Paperwork Reduction Act of 1995 (44

U.S.C. 3507(d)). Comments on the collection of information should be

sent to the Office of Management and Budget, Attn: Desk Officer for the

Department of the Treasury, Office of Information and Regulatory

Affairs, Washington, DC 20503, with copies to the Internal Revenue

Service, Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC

20224. Comments on the collection of information should be received by

December 7, 1999. Comments are specifically requested concerning:

Whether the proposed collection of information is necessary for the

proper performance of the functions of the IRS, including whether the

information will have practical utility;

The accuracy of the estimated burden associated with the proposed

collection of information (see below);

How the quality, utility, and clarity of the information to be

collected may be enhanced;

How the burden of complying with the proposed collection of

information may be minimized, including through the application of

automated collection techniques or other forms of information

technology; and

Estimates of capital or start-up costs and costs of operation,

maintenance, and purchase of services to provide information.

The collection of information in this proposed regulation is in

Sec. 1.1301-1(c). This collection of information is required by the IRS

to verify compliance with section 1301. This information will be used

to determine whether the amount of tax has been calculated correctly.

The collection of information is required to obtain a benefit. The

respondents are certain individuals engaged in the trade or business of

farming.

Taxpayers provide the information on Schedule J, Farm Income

Averaging, which is attached to Form 1040, U.S. Individual Income Tax

Return, for the taxable year in which income averaging is elected. The

burden for this requirement is reflected in the burden estimate for

Schedule J. The estimated burden for the 1998 Schedule J is 1.31 hours

per respondent.

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless it displays a valid

control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be

retained as long as their contents may become material in the

administration of any internal revenue law. Generally, tax returns and

tax return information are confidential, as required by 26 U.S.C. 6103.

Background

This document contains proposed amendments to the Income Tax

Regulations (26 CFR part 1) for averaging farm income under section

1301 of the Internal Revenue Code (Code). Section 1301 was enacted by

section 933 of the Taxpayer Relief Act of 1997, Public Law 105-34 (111

Stat. 788) (the TRA of 1997), effective for taxable years beginning

after December 31, 1997, and ending before January 1, 2001. Section

2011 of the Tax and Trade Relief Extension Act of 1998, which is part

of the Omnibus Consolidated and Emergency Supplemental Appropriations

Act, 1999, Public Law 105-277, 112 Stat. 2681, amended section 933 of

the TRA of 1997 by deleting the January 1, 2001 ending date.

Section 1301(c) authorizes the Secretary to prescribe regulations

as may be appropriate to carry out the purposes of this section,

including regulations regarding (1) the order and manner in which items

of income, gain, deduction, or loss, or limitations on tax, shall be

taken into account in computing the tax imposed by chapter 1 (Normal

Taxes and Surtaxes) of subtitle A (Income Taxes) of the Code on the

income of any taxpayer to whom this section applies for any taxable

year, and (2) the treatment of any short taxable year.

Explanation of Provisions

I. In General

Under section 1301, an individual may elect to compute the section

1 tax for the current taxable year by designating all or a portion of

the individual's farm income (subject to certain limitations) as

elected farm income, and subtracting it from taxable income. One-third

of the elected farm income is allocated to each of the three prior

years' taxable income and the increase in the section 1 tax that

results from these additions is calculated. The prior years are

referred to as base years. The tax for the current year is the sum of

(1) The section 1 tax for the current year without the elected farm

income and (2) The increase in the section 1 tax for the three base

years that is attributable to elected farm income.

II. Engaged in a Farming Business

The proposed regulations provide that the term farming business has

the same meaning as provided in section 263A(e)(4) and the regulations

thereunder. The proposed regulations also provide that an individual

engaged in a farming business includes a sole proprietor of a farming

business, a partner of a partnership engaged in a farming business, and

a shareholder of an S corporation engaged in a farming business.

III. Making, Changing, or Revoking an Election

The proposed regulations provide that a farm income averaging

election is made by filing Schedule J, Farm Income Averaging, with an

individual's timely filed Federal income tax return (including

extensions). In general, the proposed regulations provide that if an

individual has an adjustment for an election year or base year, the

individual may also make a late farm income averaging election or

change or revoke a previous election. An adjustment is any change in

taxable income or tax liability that is permitted to be made by filing

an amended Federal income tax return, or a change in taxable income or

tax liability resulting from an IRS examination. If

[[Page 54838]]

there is no adjustment for an election year or a base year, a late

election, change, or revocation may be made only with the consent of

the Commissioner. The IRS and the Treasury Department anticipate that

the Commissioner's consent will be obtained by requesting a letter

ruling from the national office.

IV. Calculation of Section 1 Tax

Farm income averaging allocates one-third of elected farm income

from an election year to each of the base years only for the purpose of

calculating the section 1 tax attributable to the elected farm income

allocated to each base year. The proposed regulations provide that the

section 1 tax for the election year is determined by allocating elected

farm income to the base years only after all other adjustments and

determinations have been made. For example, any net operating loss

carryover is applied to an election year before allocating elected farm

income to the base years.

The regulations provide that the allocation of elected farm income

to the base years does not affect any determination (other than the

calculation of the section 1 tax attributable to the elected farm

income) with respect to the election year or the base years. Thus, for

example, in applying the section 68 overall limitation on itemized

deductions to the election year, adjusted gross income for the election

year includes any elected farm income allocated to the base years.

Similarly, the section 68 limitation for a base year is not recomputed

to take into account any allocation of elected farm income to such base

year.

The proposed regulations provide that calculation of the section 1

tax on elected farm income allocated to a base year is made without any

additional adjustments or determinations with respect to that year. For

example, if a base year had a partially used capital loss, the

remaining capital loss may not be applied to reduce the elected farm

income allocated to such year. Similarly, if a base year had a

partially used credit, the remaining credit may not apply to reduce the

section 1 tax attributable to the elected farm income allocated to such

year.

V. Elected Farm Income

The proposed regulations provide that farm income includes all

income, deductions, gains, and losses attributable to an individual's

farming business. An individual may designate what type, and how much

of each type, of farm income is to be treated as elected farm income.

The elected farm income may not exceed an individual's taxable income.

In addition, elected farm income from net capital gain attributable to

a farming business may not exceed total net capital gain. One-third of

each type of elected farm income is then allocated to each base year.

Proposed Effective Date

The regulations, as proposed, apply to any taxable period ending on

or after the date of publication of a Treasury decision adopting these

rules as final regulations in the Federal Register. However, the rules

in these proposed regulations may be relied on by individuals for

taxable periods ending before the publication of the Treasury decision.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in Executive Order

12866. Therefore, a regulatory assessment is not required. It has also

been determined that section 553(b) of the Administrative Procedure Act

(5 U.S.C. chapter 5) does not apply to these regulations. It is hereby

certified that the collection of information in these regulations will

not have a significant economic impact on a substantial number of small

entities. This certification is based upon the fact that the collection

of information imposed by this regulation is not significant as

reflected in the estimated burden of information collection for

Schedule J, which is 1.31 hours per respondent. Therefore, a Regulatory

Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C.

chapter 6) is not required. Pursuant to section 7805(f) of the Code,

this notice of proposed rulemaking will be submitted to the Chief

Counsel for Advocacy of the Small Business Administration for comment

on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any electronic or written comments (a

signed original and eight (8) copies) that are submitted timely to the

IRS. The IRS and Treasury Department request comments on the clarity of

the proposed rules and how they can be made easier to understand. In

addition, comments are specifically requested regarding whether wages

paid to a shareholder of an S corporation may be electible farm income.

All comments will be available for public inspection and copying.

A public hearing has been scheduled for February 15, 2000,

beginning at 10 a.m. in room 2615 of the Internal Revenue Building,

1111 Constitution Avenue, NW., Washington, DC. Due to building security

procedures, visitors must enter at the 10th Street entrance, located

between Constitution and Pennsylvania Avenues, NW. In addition, all

visitors must present photo identification to enter the building.

Because of access restrictions, visitors will not be admitted beyond

the immediate entrance area more than 15 minutes before the hearing

starts. For information about having your name placed on the building

access list to attend the hearing, see the FOR FURTHER INFORMATION

CONTACT section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who

wish to present oral comments at the hearing must submit electronic or

written comments and an outline of the topics to be discussed and the

time to be devoted to each topic (signed original and eight (8) copies)

by January 14, 2000. A period of 10 minutes will be allotted to each

person for making comments. An agenda showing the scheduling of the

speakers will be prepared after the deadline for receiving outlines has

passed. Copies of the agenda will be available free of charge at the

hearing.

Drafting Information: The principal author of these regulations is

John M. Moran, Office of Assistant Chief Counsel (Income Tax &

Accounting). However, other personnel from the IRS and Treasury

Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendment to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding

an entry in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.1301-1 also issued under 26 U.S.C. 1301(c). * * *

Par. 2. An undesignated center heading and Sec. 1.1301-1 are added

immediately following the center heading ``Readjustment of Tax Between

Years and Special Limitations'' to read as follows:

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Income Averaging

Sec. 1.1301-1 Averaging of farm income.

(a) Overview. An individual engaged in a farming business may elect

to compute his or her current year (election year) income tax liability

under section 1 by averaging, over the prior three-year period (base

years), all or a portion of the individual's current year electible

farm income (as defined in paragraph (e)) of this section. To average

farm income, the individual--

(1) Designates all or a portion of his or her electible farm income

for the election year as elected farm income;

(2) Allocates one-third of the elected farm income to each of the

three base years; and

(3) Determines the election year section 1 tax by determining the

sum of--

(i) The election year section 1 tax without regard to the elected

farm income; plus

(ii) For each base year, the increase in section 1 tax attributable

to the elected farm income allocated to such year.

(b) Individual engaged in a farming business. Farming business has

the same meaning as provided in section 263A(e)(4) and the regulations

thereunder. An individual engaged in a farming business includes a sole

proprietor of a farming business, a partner in a partnership engaged in

a farming business, and a shareholder of an S corporation engaged in a

farming business. An individual is not required to have been engaged in

a farming business in any of the base years in order to make a farm

income averaging election.

(c) Making, changing, or revoking an election--(1) Making an

election. A farm income averaging election is made by filing Schedule

J, Farm Income Averaging, with an individual's timely filed (including

extensions) Federal income tax return for the election year.

(2) Making a late election, or changing or revoking an election--

(i) Adjustments in an election or base year. An individual who has an

adjustment for an election year or any base year may make a late farm

income averaging election, change the amount of elected farm income in

a previous election, or revoke a previous election, if the period of

limitation on filing a claim for credit or refund has not expired for

the election year. For purposes of this paragraph (c)(2), an adjustment

is any change in taxable income or tax liability that is permitted to

be made by filing an amended Federal income tax return or a change in

taxable income or tax liability made as the result of an IRS

examination.

(ii) No adjustment. If an individual does not have an adjustment

described in paragraph (c)(1)(i) of this section, the individual may

not make a late farm income averaging election, change the amount of

elected farm income in a previous election, or revoke a previous

election, without the consent of the Commissioner.

(d) Calculation of section 1 tax--(1) In general. The section 1 tax

for the election year is determined by allocating elected farm income

to the base years only after all other adjustments and determinations

have been made. For example, any net operating loss (NOL) carryover or

net capital loss carryover is applied to an election year before

allocating elected farm income to the base years. Similarly, the

determination of whether there is a net section 1231 gain or loss in

the election year and the determination of the character of the section

1231 items are made before allocating elected farm income to the base

years. The allocation of elected farm income to the base years does not

affect any determination (other than the calculation of the section 1

tax attributable to the elected farm income) with respect to the

election year or the base years. Thus, for example, in applying the

section 68 overall limitation on itemized deductions to the election

year, adjusted gross income for the election year includes any elected

farm income allocated to the base years. Similarly, the section 68

limitation for a base year is not recomputed to take into account any

allocation of elected farm income to such base year. The calculation of

the section 1 tax on elected farm income allocated to a base year is

made without any additional adjustments or determinations with respect

to such year. For example, if a base year had a partially used capital

loss, the remaining capital loss may not be applied to reduce the

elected farm income allocated to such year. Similarly, if a base year

had a partially used credit, the remaining credit may not be applied to

reduce the section 1 tax attributable to the elected farm income

allocated to such year.

(2) Base year was previously an election year or another base year.

If a base year for a current farm income averaging election was

previously an election year for another farm income averaging election,

the base year's section 1 tax is determined after reducing the base

year's taxable income by the elected farm income for that prior

election year. If a base year for a current farm income averaging

election was previously a base year for another farm income averaging

election, the base year's section 1 tax is determined after increasing

the base year's taxable income by the elected farm income allocated to

that year by that prior election.

(3) Example. The rules of paragraph (d)(2) of this section are

illustrated by the following example:

Example. (i) In each of years 1996, 1997 and 1998, T had taxable

income of $20,000. In 1999, T had taxable income of $30,000 (prior

to any farm income averaging election) and electible farm income of

$10,000. T makes a farm income averaging election with respect to

$9,000 of his electible farm income for 1999. Thus, $3,000 of

elected farm income is allocated to each of years 1996, 1997 and

1998. T's 1999 tax liability is the sum of--

(A) The section 1 tax on $21,000 (1999 taxable income minus

elected farm income); plus

(B) For each of years 1996, 1997, and 1998, the section 1 tax on

$23,000 minus the section 1 tax on $20,000 (the increase in section

1 tax attributable to the elected farm income allocated to such

year).

(ii) In 2000, T has taxable income of $50,000 and electible farm

income of $12,000. T makes a farm income averaging election with

respect to all $12,000 of his electible farm income for 2000. Thus,

$4,000 of elected farm income is allocated to each of years 1997,

1998 and 1999. T's 2000 tax liability is the sum of--

(A) The section 1 tax on $38,000 (2000 taxable income minus

elected farm income); plus

(B) For each of years 1997 and 1998, the section 1 tax on

$27,000 minus the section 1 tax on $23,000 (the increase in section

1 tax attributable to the elected farm income allocated to such

years after increasing such years' taxable income by the elected

income allocated to such year by the 1999 farm income averaging

election); plus

(C) For year 1999, the section 1 tax on $25,000 minus the

section 1 tax on $21,000 (the increase in section 1 tax attributable

to the elected farm income allocated to such year after reducing

such year's taxable income by the 1999 elected farm income).

(e) Electible farm income--(1) Identification of items attributable

to a farming business--(i) In general. Farm income includes items of

income, deduction, gain, and loss attributable to the individual's

farming business. Farm losses include a NOL carryover or carryback, or

a net capital loss carryover, to an election year that is attributable

to a farming business. Income, gain or loss from the sale of

development rights, grazing rights, and other similar rights is not

treated as attributable to a farming business. Farm income does not

include wages.

(ii) Gain or loss on sale or other disposition of property--(A) In

general. Gain or loss from the sale or other disposition of property

(other than land,

[[Page 54840]]

but including a structure affixed to the land) that was regularly used

in the individual's farming business for a substantial period of time

is treated as attributable to a farming business. Whether property was

regularly used for a substantial period of time depends on all of the

facts and circumstances.

(B) Cessation of a farming business. If gain or loss described in

paragraph (e)(1)(ii)(A) of this section is realized after cessation of

a farming business, such gain or loss is treated as attributable to a

farming business if the property is sold within a reasonable time after

cessation of the farming business. A sale or other disposition within

one year of cessation of the farming business is presumed to be within

a reasonable time. Whether a sale or other disposition that occurs more

than one year after cessation of the farming business is within a

reasonable time depends on all of the facts and circumstances.

(2) Determination of amount that may be elected farm income--(i)

Electible farm income. The maximum amount of income that an individual

may elect to average (electible farm income) is the sum of any farm

income and gain minus any farm deductions or losses (including loss

carryovers and carrybacks) that are allowed as a deduction in computing

the individual's taxable income. However, electible farm income may not

exceed taxable income. In addition, electible farm income from net

capital gain attributable to a farming business cannot exceed total net

capital gain. An individual who has both ordinary and net capital gain

farm income may elect (up to electible farm income) any combination of

such ordinary and net capital gain farm income.

(ii) Examples. The rules of paragraph (e)(2)(i) of this section are

illustrated by the following examples:

Example 1. A has farm gross receipts of $200,000 and farm

ordinary deductions of $50,000. A's taxable income is $150,000

($200,000-$50,000). A's electible farm income is $150,000, all of

which is ordinary income.

Example 2. B has ordinary farm income of $200,000 and nonfarm

losses of $50,000. B's taxable income is $150,000 ($200,000-

$50,000). B's electible farm income is $150,000, all of which is

ordinary income.

Example 3. C has a farm capital gain of $50,000 and a nonfarm

capital loss of $40,000. C also has ordinary farm income of $60,000.

C has taxable income of $70,000 ($50,000-$40,000+$60,000). C's

electible farm income is $70,000. C can elect up to $10,000 of farm

capital gain and up to $60,000 of farm ordinary income.

Example 4. D has a nonfarm capital gain of $40,000 and a farm

capital loss of $30,000. D also has ordinary farm income of

$100,000. D has taxable income of $110,000 ($40,000-

$30,000+$100,000). D's electible farm income is $100,000 ordinary

farm income minus $30,000 farm capital loss, or $70,000, all of

which is ordinary income.

Example 5. E has a nonfarm capital gain of $20,000 and a farm

capital loss of $30,000. E also has ordinary farm income of

$100,000. E has taxable income of $97,000 ($20,000-$23,000

+$100,000). E has a farm capital loss carryover of $7,000 ($30,000-

$23,000 allowed as a deduction). E's electible farm income is

$100,000 ordinary farm income minus $23,000 farm capital loss, or

$77,000, all of which is ordinary income.

(f) Miscellaneous rules--(1) Short taxable year--(i) In general. If

a base year or an election year is a short taxable year, the rules of

section 443 and the regulations thereunder apply for purposes of

calculating the section 1 tax.

(ii) Base year is a short taxable year. If a base year is a short

taxable year, the increase in section 1 tax attributable to the elected

farm income allocated to such year is determined after the taxable

income for such year has been annualized.

(iii) Election year is a short taxable year. If an election year is

a short taxable year, any elected farm income is first annualized

before being allocated to the base years. The increase in section 1 tax

attributable to the elected farm income allocated to the base years is

the same part of the tax computed on an annual basis as the number of

months in the short election year is of 12 months.

(2) Changes in filing status. An individual is not prohibited from

making a farm income averaging election solely because the individual's

filing status is not the same in an election year and the base years.

For example, an individual who files married filing jointly in the

election year, but filed as single in all of the base years, may still

elect to average farm income.

(3) Employment tax. A farm income averaging election has no effect

in determining the amount of wages for purposes of the Federal

Insurance Contributions Act (FICA), the Federal Unemployment Tax Act

(FUTA), and the Collection of Income Tax at Source on Wages (Federal

income tax withholding), or the amount of net earnings from self-

employment for purposes of the Self-Employment Contributions Act

(SECA).

(4) Alternative minimum tax. A farm income averaging election does

not apply for purposes of determining the section 55 alternative

minimum tax in the election year or any base year. However, an election

will apply for purposes of determining the regular tax under sections

53(c) and 55(c).

(5) Unearned income of minor child. In an election year, if a minor

child's investment income is taxable under section 1(g) and a parent

makes a farm income averaging election, the tax rate used for purposes

of applying section 1(g) is the rate determined after application of

the election. With respect to a base year, however, the tax on a minor

child's investment income is not affected by a farm income averaging

election.

(g) Effective date. The rules of this section apply to taxable

years ending on or after the date of publication of the Treasury

decision adopting these rules as final regulations in the Federal

Register.

John M. Dalrymple,

Acting Deputy Commissioner of Internal Revenue.

[FR Doc. 99-26226 Filed 10-7-99; 8:45 am]

BILLING CODE 4830-01-U