Income averaging and capital gains
Income averaging remains in effect for farmers only. Farmers can elect an amount of their current farm income to divide equally among the previous three years. The amount applied to the previous three years is added to the previous year's taxable income. Savings result if the previous year's income was taxed at a lower tax rate than the current year. This election applies to any income that is attributable to a farm business. Farm income includes items of income, deduction, gain and loss attributable to the individual's farming business. This includes:
- net Schedule F income,
- an owner's share of net income from an S corporation, partnership, or limited liability company,
- wages received by an S corporation shareholder from the S corporation and
- gain from the sale of assets used in the farming business and reported on Form 4797 and/or Schedule D (Form 1040) but not gain from the sale of land or timber.
Farmers are allowed to use a negative farm income for calculations in the base year. However, this loss carried from the base year to other years in the calculation, must be removed from the base year calculation to prevent a double tax benefit.
In addition, the taxpayer will lose a portion of the benefit of the income averaging if the calculation reduces the regular tax liability below that calculated using the Alternative Minimum Tax (AMT) method.
If a farmer liquidates their farm business, the gain or loss is attributable to a farming business for income averaging only if the property is sold within a reasonable period of time. One year is considered a reasonable period of time.
Capital gains tax changes
Currently, 0% and 15% capital gains rates are permanent. A 20% rate becomes effective after 2012 for high income taxpayers. Long-term capital gains and qualified dividends are taxed as follows:
- 0% for taxpayers in the 10% and 15% tax brackets.
- 15% for taxpayers in the 25, 28, 33 and 35% bracket.
- 20% (up from 15%) to the extent taxpayers are in the 39.6% income tax bracket ($400,000 for single filers, $450,000 for married filers and $425,000 for head of household filers).
- 25% on recaptured section 1250 gain.
- 28% on collectibles.1
For sales of Section 1250 property (primarily refers to buildings and structures), any long-term capital gain attributable to depreciation (other than depreciation recapture as ordinary income) is taxed at a maximum rate of 25%. Generally, the un-recaptured Section 1250 gain is calculated as the smaller of (1) depreciation or (2) total gain less any recaptured depreciation that is taxed at ordinary rates (that is accelerated depreciation in excess of SL).2
Collectables such as coins, firearms, stamps, etc. are taxed at a rate of 28%.
In Minnesota, capital gains are taxed as ordinary income. The Minnesota income tax rates are 5.35%, 7.05%, 7.85% and 9.85% depending upon income level.
Note: This information piece is offered as educational information only and is not intended to be tax, legal or financial advice. For questions specific to your farm business or individual situation, consult with your tax preparer.
- National Association of Tax Professionals.
- Premium Quickfinder Handbook, 2008 Edition. Thomson Reuters.
- Minnesota Department of Revenue.
1 National Association of Tax Professionals.
2 Premium Quickfinder Handbook, 2008 Edition, Thomson Reuters, p. 7-4