Averaging of Farm Income

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [REG-121063-97] RIN 1545-AX01

TITLE: Averaging of Farm Income

AGENCY: Internal Revenue Service (IRS), Treasury.

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

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 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
§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 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 applied 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 A 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 §1.1301-1 are added
immediately following the center heading A Readjustment of Tax
Between Years and Special Limitations @ to read as follows:

INCOME AVERAGING

§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 B

(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 B

(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 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, 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.

Acting Deputy Commissioner of Internal Revenue
John M. Dalrymple

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