[Federal Register Volume 64, Number 195 (Friday, October 8, 1999)]
[Proposed Rules]
[Pages 54836-54840]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-26226]


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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

[[Page 54837]]

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:

[[Page 54839]]

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