[Federal Register Volume 67, Number 5 (Tuesday, January 8, 2002)]
[Rules and Regulations]
[Pages 817-822]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-183]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8972]
RIN 1545-AW05


Averaging of Farm Income

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the 
election to average farm income in computing tax liability. The 
regulations reflect changes to the law made by the Taxpayer Relief Act 
of 1997, as amended by the Tax and Trade Relief Extension Act of 1998, 
and provide guidance to individuals engaged in a farming business.

DATES: Effective Date: These regulations are effective January 8, 2002.
    Applicability Date: These regulations apply to taxable years 
beginning after December 31, 2001. However, taxpayers may rely on the 
rules in these final regulations in computing tax liability for taxable 
years beginning on or before December 31, 2001.

FOR FURTHER INFORMATION CONTACT: John M. Moran, (202) 622-4940 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507) 
under control number 1545-1662. 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.
    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.
    The burden for this requirement is reflected in the burden estimate 
for Schedule J. The estimated burden for the 2000 Schedule J is 2 hours 
per respondent.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:FP:S:O, 
Washington, DC 20224, and 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.
    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

    Section 1301 was added to the Internal Revenue Code (the Code) by 
section 933(a) of the Taxpayer Relief Act of 1997 (Public Law 105-34; 
(111 Stat. 788, 881-82)), as amended by section 2011 of the Tax and 
Trade Relief Extension Act of 1998 (Division J of H.R. 4328, Omnibus 
Consolidated and Emergency Supplemental Appropriations Act, 1999) 
(Public Law 105-277 (112 Stat. 2681, 2681-886, 2681-902)). On October 
8, 1999, a notice of proposed rulemaking (REG-121063-97) containing 
proposed regulations under section 1301 was published in the Federal 
Register (64 FR 54836). A number of comments responding to the notice 
were received and a public hearing was held on February 15, 2000. After 
consideration of the comments, the proposed regulations are adopted as 
revised by this Treasury decision.

Explanation of Provisions

Treatment of Wages

    The income averaging election is available only to individuals 
engaged in a farming business and only with respect to income from that 
business. The proposed regulations provide that farm income does not 
include wages but the notice of proposed rulemaking invited public 
comment on whether a different rule should apply to wages paid to a 
shareholder of an S corporation. Several comments on this issue 
supported a rule that would permit wages paid by an S corporation to a 
shareholder to qualify as income from a farming business, and the final 
regulations adopt this rule.
    This change results in comparable treatment for S corporation 
shareholders, partners, and sole proprietors. A sole proprietor's 
Schedule F income, whether attributable to capital or labor, is treated 
as income from the business conducted through the proprietorship. In 
the case of a partnership engaged in a farming business, income earned 
by the partners that is attributable to the farming business is 
similarly treated as farm income for purposes of the income averaging 
rules whether the income takes the form of a distributive share or a 
guaranteed payment.
    S corporations, like partnerships, are passthrough entities for 
Federal income tax purposes. In an S corporation, amounts paid to 
shareholders as wages would, if retained by the corporation, increase 
the shareholders' income qualifying for the income averaging election. 
There is no indication in the legislative history of section 1301 that 
Congress intended disparate treatment of S corporation shareholders 
depending on whether amounts are paid to the shareholders as wages or 
allocated to shareholders as a pro rata share of the corporation's 
income. Accordingly, the final regulations provide consistent treatment 
for shareholders in S corporations and partners in partnerships. Thus, 
a shareholder's income that is attributable to the S corporation's 
farming business qualifies as farm income for purposes of the income 
averaging rules whether paid to the shareholder as wages or allocated 
to the shareholder as a pro rata share.
    In contrast, a C corporation is not a passthrough entity for 
Federal income tax purposes. Accordingly, the final regulations do not 
treat any amounts

[[Page 818]]

paid by a C corporation to its shareholder-employees as farm income.

Treatment of Rental Income

    The proposed regulations contain no provision for treating rental 
income as income from a farming business. This is consistent with the 
general principle that lessors of farmland are not ordinarily treated 
as engaged in a farming business with respect to the leased land. 
Commentators were divided over whether rental income based on a 
tenant's production (e.g., a crop share) should be treated as income 
from a farming business for purposes of section 1301. The final 
regulations provide that income from such arrangements is treated, 
subject to an anti-abuse rule, as income from a farming business. This 
rule is consistent with the policy underlying section 1301 of limiting 
the adverse effects of a progressive rate structure on farmers whose 
income varies significantly from year to year in response to 
fluctuations in the farm economy. A landlord's income from a crop-share 
lease or similar arrangement is affected by fluctuations in the farm 
economy to the same extent as that of any other farmer. Moreover, 
regulations under other Code sections provide precedent for the rule in 
the final regulations. For example, a similar rule in the regulations 
under section 175 (relating to the deduction for certain soil and water 
conservation expenditures) treats a landlord who receives rent (either 
cash or in kind) based on farm production as engaged in the business of 
farming.
    Under the final regulations, a landlord's crop share income 
reported on Form 4835, ``Farm Rental Income and Expenses,'' Schedule F, 
``Profit or Loss From Farming,'' or Part II of Schedule E, 
``Supplemental Income or Loss,'' is eligible for income averaging if 
the landlord's share of a tenant's production is set in a written 
rental agreement before the tenant begins significant activities on the 
land. If a landlord receives a fixed rent or a share of a tenant's 
production that is set after the tenant begins significant activities, 
the landlord is not considered to be engaged in a farming business with 
respect to the leased land, and the rental income is not eligible for 
income averaging, even if the landlord materially participates in the 
tenant's farming business.

Treatment of Income From Partnerships

    A commentator asked whether income attributable to a farming 
business carried on by a partnership is farm income without regard to 
the size of a partner's interest in the partnership or the activities 
of the partner. The commentator also asked how the farm income of a 
partnership may be allocated. Farm income is allocated under the 
partnership rules in Subchapter K of the Code, and these regulations do 
not modify those rules. The final regulations, like the proposed 
regulations, permit income attributable to a farming business carried 
on by a partnership to be averaged without regard to the partner's 
level of participation in the partnership or size of ownership 
interest.

Effect of Adjustments

    A commentator requested that the final regulations expressly 
require an amended return if there is a change to a base year return as 
a result of either an IRS or taxpayer initiated adjustment. The IRS and 
Treasury do not believe that a special rule in the final regulations is 
necessary to address this point, as the situation is not unique to 
section 1301. If the election year tax liability is changed as a result 
of an adjustment to a base year, then, as with any correction, an 
amended return should be made for the election year if the statute of 
limitations is open.

Making, Changing, or Revoking an Election

    Under the proposed regulations an individual may not make a late 
election, change an election, or revoke an election unless there has 
been an adjustment to taxable income or tax liability or the 
Commissioner has consented. One comment suggested that these 
limitations on a taxpayer's ability to make, change, or revoke an 
election should be eliminated. This suggestion has been adopted. Under 
the final regulations, a taxpayer may make a late election, change an 
election, or revoke an election subject only to the generally 
applicable rules on the period of limitations on filing a claim for 
credit or refund.

Negative Taxable Income

    A number of commentators criticized the computational rules 
contained in Schedule J, Farm Income Averaging, for 1999 and earlier 
years. These rules prohibited the use of a negative amount for a base 
year's taxable income. The commentators suggested that taxpayers should 
be permitted to use a negative amount if appropriate adjustments are 
made for amounts, such as net operating losses, that may provide a tax 
benefit in another taxable year.
    The final regulations adopt this suggestion. Thus, a base year's 
taxable income may be negative but amounts, such as a net operating 
loss or certain capital losses, that may be deducted in one or more 
other taxable years in the form of a carryover or carryback must be 
added back in computing negative taxable income. The Schedule J for 
years after 1999 includes worksheets and instructions for determining 
negative taxable income for purposes of the income averaging 
computation.

Calculation of Section 1 Tax

    The proposed regulations provide that the tax is computed by 
reducing the election year taxable income by the applicable amount and 
increasing taxable income for the base years by one-third of that 
amount. One commentator suggested that taxable income for the election 
year should be computed by excluding the elected amount from the 
taxpayer's gross income. This would reduce adjusted gross income, which 
in turn might reduce the effect of limitations and phase-outs based on 
adjusted gross income. The statutory language unambiguously provides, 
however, that any election-year decrease (or base-year increase) must 
be made to taxable income. Moreover, consistent application of the rule 
suggested in the comment would require recomputation of adjusted gross 
income and all related limitations and phase-outs in base years. This 
would substantially increase the complexity of the income averaging 
computation. Accordingly, the final regulations do not adopt this 
suggestion.

Farm Income

    A commentator suggested that the final regulations list specific 
items of income and deductions to clarify which items are attributable 
to a farming business under section 1301. The regulations are not a 
suitable format for providing the comprehensive guidance requested 
because of the difficulty in identifying the myriad items of income and 
expense that may be attributable to a farming business and because, in 
each case, a determination based on specific facts and circumstances is 
necessary. Taxpayers are encouraged to raise questions they may have 
concerning any specific types of income so that guidance can be given 
by revenue ruling, instructions, or other appropriate means.
    The proposed regulations treat gain from the sale or other 
disposition of property (other than land) as attributable to a farming 
business if, taking into account all the facts and circumstances, the 
property was regularly used in the farming business for a substantial 
period of time. A commentator asked that the final regulations provide 
more specific

[[Page 819]]

guidance on what constitutes a substantial period of time. The final 
regulations provide that property that has always been used solely in 
the farming business by the individual is deemed to meet both the 
regularly used and substantial period tests. For property not used 
solely in the farming business, what constitutes regular use or a 
substantial period of time is likely to vary significantly, depending 
upon the facts of the taxpayer's business. Accordingly, the final 
regulations retain the facts-and-circumstances test for such property.
    The proposed regulations establish a presumption that sales or 
dispositions of property used in a farming business are attributable to 
that business if they occur within one year of its cessation. One 
comment expressed concern that this presumption may be construed as 
establishing a contrary presumption for sales or dispositions occurring 
after that one-year period. The comment suggested extending the period 
to two years, arguing that it is not uncommon for sales or dispositions 
of farm property to continue for more than one year after the cessation 
of the farming business, particularly in economically depressed areas.
    The final regulations do not adopt this suggestion. The regulatory 
presumption is, however, only a safe harbor for sales or dispositions 
of property occurring within the one-year period; no contrary 
presumption is stated or implied for sales or dispositions occurring 
after that period. Rather, the determination of whether those sales or 
dispositions are attributable to a farming business appropriately 
depends upon all the facts and circumstances.
    One commentator proposed an example to illustrate that elected farm 
income may not exceed taxable income, using a gross farm income amount 
reduced by farming deductions and the standard deduction. The 
regulations illustrate, as simply as possible, that elected farm income 
cannot exceed taxable income. These computations are illustrated in 
greater detail in Pub. 225, ``Farmer's Tax Guide,'' which provides a 
sample tax return including a Schedule J.
    Similarly, one commentator requested examples demonstrating 
calculations involving capital gains. Although no such examples are 
provided in the final regulations, Pub. 225 does provide an example, 
and the IRS will consider including other examples in future guidance.

Married Taxpayers

    Several comments were received regarding the application of the 
rules to married taxpayers. Two commentators asked how farm income 
reported on a joint return is associated with the proper spouse in a 
noncommunity property state. Two other commentators asked about the 
application of community property laws.
    The final regulations do not provide specific guidance on these 
issues. As a general matter, however, an individual's filing status 
does not affect determinations regarding whether the individual is 
engaged in a farming business or the amount of profit or loss from that 
business reported on the individual's Schedule F, Profit or Loss From 
Farming, or Schedule K-1, Partner's (Shareholder's) Share of Income, 
Credits, Deductions, etc. Thus, if only one spouse engages in farming 
in the election year, only that spouse may have elected farm income, 
and if both spouses engage in farming, each spouse may have elected 
farm income from the business in which that spouse is engaged. 
Similarly, as a general matter, community property laws determine 
income and property ownership for Federal income tax purposes. Although 
the Code may provide otherwise in specific instances, there are no such 
exceptions in either section 1301 or the final regulations.

Alternative Minimum Tax

    One commentator requested that the final regulations provide an 
example showing that the alternative minimum tax limits the benefits of 
an income averaging election. Although the final regulations do not 
provide an example of the application of the alternative minimum tax, 
they continue to note that the income averaging election does not apply 
for purposes of determining the alternative minimum tax in the election 
year or any base year, except to the extent the election is taken into 
account in determining the regular tax offset to the tentative minimum 
tax. There is no exception in the Code provisions relating to the 
alternative minimum tax that would permit the minimum tax to be 
computed without regard to the effect of farm income averaging on the 
regular tax.

Special Analyses

    It has been determined that these final regulations are 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 on the fact that the collection 
of information imposed by these regulations is not significant as 
reflected in the estimated burden of information collection for 
Schedule J, which is 2 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, 
the IRS submitted the notice of proposed rulemaking to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Drafting Information

    The principal author of these regulations is John M. Moran of the 
Office of Associate Chief Counsel, Procedure and Administration 
(Administrative Provisions and Judicial Practice Division). However, 
other personnel from the IRS and Treasury Department participated in 
their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 602 are 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 in part 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:

Income Averaging


Sec. 1.1301-1  Averaging of farm income.

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

[[Page 820]]

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; and
    (2) Determines the election year section 1 tax by determining the 
sum of--
    (i) The section 1 tax that would be imposed for the election year 
if taxable income for the year were reduced by elected farm income; 
plus
    (ii) For each base year, the amount by which the section 1 tax 
would be increased if taxable income for the year were increased by 
one-third of elected farm income.
    (b) Individual engaged in a farming business--(1) In general. 
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. Services performed as an 
employee are disregarded in determining whether an individual is 
engaged in a farming business for purposes of section 1301. 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.
    (2) Certain landlords. A landlord is engaged in a farming business 
for purposes of section 1301 with respect to rental income that is 
based on a share of production from a tenant's farming business and, 
with respect to amounts received on or after January 1, 2003, is 
determined under a written agreement entered into before the tenant 
begins significant activities on the land. A landlord is not engaged in 
a farming business for purposes of section 1301 with respect to either 
fixed rent or, with respect to amounts received on or after January 1, 
2003, rental income based on a share of a tenant's production 
determined under an unwritten agreement or a written agreement entered 
into after the tenant begins significant activities on the land. 
Whether the landlord materially participates in the tenant's farming 
business is irrelevant for purposes of section 1301.
    (c) Making, changing, or revoking an election--(1) In general. A 
farm income averaging election is made by filing Schedule J, ``Farm 
Income Averaging,'' with an individual's Federal income tax return for 
the election year (including a late or amended return if the period of 
limitations on filing a claim for credit or refund has not expired).
    (2) Changing or revoking an election. An individual may change the 
amount of the elected farm income in a previous election or revoke a 
previous election if the period of limitations on filing a claim for 
credit or refund has not expired for the election year.
    (d) Guidelines for calculation of section 1 tax--(1) Actual taxable 
income not affected. Under paragraph (a)(2) of this section, a 
determination of the section 1 tax for the election year involves a 
computation of the section 1 tax that would be imposed if taxable 
income for the election year were reduced by elected farm income and 
taxable income for each of the base years were increased by one-third 
of elected farm income. The reduction and increases required for 
purposes of this computation do not affect the actual taxable income 
for either the election year or the base years. Thus, for each of those 
years, the actual taxable income is taxable income determined without 
regard to any hypothetical reduction or increase required for purposes 
of the computation under paragraph (a)(2) of this section. The 
following illustrates this principle:
    (i) Any reduction or increase in taxable income required for 
purposes of the computation under paragraph (a)(2) of this section is 
disregarded in determining the taxable year in which a net operating 
loss carryover or net capital loss carryover is applied.
    (ii) The net section 1231 gain or loss and the character of any 
section 1231 items for the election year is determined without regard 
to any reduction in taxable income required for purposes of the 
computation under paragraph (a)(2) of this section.
    (iii) The section 68 overall limitation on itemized deductions for 
the election year is determined without regard to any reduction in 
taxable income required for purposes of the computation under paragraph 
(a)(2) of this section. Similarly, the section 68 limitation for a base 
year is not recomputed to take into account any allocation of elected 
farm income to the base year for such purposes.
    (iv) 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 the year for purposes of the computation under 
paragraph (a)(2) of this section.
    (v) 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 the year for purposes of the 
computation under paragraph (a)(2) of this section.
    (2) Computation in base years--(i) In general. As provided in 
paragraph (a)(2)(ii) of this section, the election year section 1 tax 
includes the amounts by which the section 1 tax for each base year 
would be increased if taxable income for the year were increased by 
one-third of elected farm income. For this purpose, all allowable 
deductions (including the full amount of any net operating loss 
carryover) are taken into account in determining the taxable income for 
the base year even if the deductions exceed gross income and the result 
is negative. If the result is negative, however, any amount that may 
provide a benefit in another taxable year is added back in determining 
base year taxable income. Amounts that may provide a benefit in another 
year include--
    (A) The net operating loss (as defined in section 172(c)) for the 
base year;
    (B) The net operating loss for any other year to the extent carried 
forward from the base year under section 172(b)(2); and
    (C) The capital loss deduction allowed for the base year under 
section 1211(b)(1) or (2) to the extent such deduction does not reduce 
the capital loss carryover from the base year because it exceeds 
adjusted taxable income (as defined in section 1212(b)(2)(B)).
    (ii) Example. The rules of this paragraph (d)(2) are illustrated by 
the following example:

    Example. In 2001, F and F's spouse on their joint return elect 
to average $24,000 of income attributable to a farming business. 
One-third of the elected farm income, $8,000, is added to the 1999 
base year income. In 1999, F and F's spouse reported adjusted gross 
income of $7,300 and claimed a standard deduction of $7,200 and a 
deduction for personal exemptions of $8,250. Therefore, their 1999 
base year taxable income is -$8,150 [$7,300-($7,200+$8,250)]. After 
adding the elected farm income to the negative taxable income, their 
1999 base year taxable income would be zero 
[$8,000+(-$8,150)=-$150]. If F and F's spouse elected to income 
average in 2002, and made the adjustments described in paragraph 
(d)(3) of this section to account for the 2001 election, their 1999 
base year taxable income for the 2002 election would be -$150.

    (3) Effect on subsequent elections--(i) In general. The reduction 
and increases in taxable income assumed in computing the election year 
section 1 tax (within the meaning of paragraph (a)(2) of this section) 
for an election year are treated as having actually occurred for 
purposes of computing the election year section 1 tax for any 
subsequent

[[Page 821]]

election year. Thus, if a base year for a farm income averaging 
election is also an election year for another farm income averaging 
election, the increase in the section 1 tax for that base year is 
determined after reducing taxable income by the elected farm income 
from the earlier election year. Similarly, if a base year for a farm 
income averaging election is also a base year for another farm income 
averaging election, the increase in the section 1 tax for that base 
year is determined after increasing taxable income by elected farm 
income allocated to the year from the earlier election year.
    (ii) Example. The rules of this paragraph (d)(3) are illustrated by 
the following example:

    Example. (i) In each of years 1998, 1999, and 2000, T had 
taxable income of $20,000. In 2001, 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 2001. Thus, for 
purposes of the computation under paragraph (a)(2) of this section, 
$3,000 of elected farm income is allocated to each of years 1998, 
1999, and 2000. T's 2001 tax liability is the sum of--
    (A) The section 1 tax on $21,000 (2001 taxable income minus 
elected farm income); plus
    (B) For each of years 1998, 1999, and 2000, the section 1 tax on 
$23,000 minus the section 1 tax on $20,000 (the amount by which 
section 1 tax would be increased if one-third of elected farm income 
were allocated to such year).
    (ii) In 2002, 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 2002. Thus, 
for purposes of the computation under paragraph (a)(2) of this 
section, $4,000 of elected farm income is allocated to each of years 
1990, 2000, and 2001. T's 2002 tax liability is the sum of--
    (A) The section 1 tax on $38,000 (2002 taxable income minus 
elected farm income); plus
    (B) For each of years 1999 and 2000, the section 1 tax on 
$27,000 minus the section 1 tax on $23,000 (the amount by which 
section 1 tax would be increased if one-third of elected farm income 
were allocated to such years after increasing taxable income for 
such years by the elected income allocated to such years from the 
2001 election year); plus
    (C) For year 2001, the section 1 tax on $25,000 minus the 
section 1 tax on $21,000 (the amount by which section 1 tax would be 
increased if one-third of elected farm income were allocated to such 
year after reducing taxable income for such year by the 2001 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 net operating loss 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. In general, farm income 
does not include compensation received by an employee. However, a 
shareholder of an S corporation engaged in a farming business may treat 
compensation received from the corporation that is attributable to the 
farming business as farm income.
    (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 
that was regularly used in the individual's farming business for a 
substantial period of time is treated as attributable to a farming 
business. For this purpose, the term property does not include land, 
but does include structures affixed to land. Property that has always 
been used solely in the farming business by the individual is deemed to 
meet both the regularly used and substantial period tests. Whether 
property not used solely in the farming business was regularly used in 
the farming business 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 only 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 gains 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. Subject to these limitations, an individual who has both 
ordinary and net capital gain farm income may elect to average 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 ordinary 
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 to average 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 $70,000 
($100,000 ordinary farm income minus $30,000 farm capital loss), 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 ($30,000 
loss limited by section 1211(b))+$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 $77,000 ($100,000 ordinary farm income 
minus $23,000 farm capital loss), 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, elected farm income is allocated to such year for 
purposes of paragraph (a)(2) of this section after the taxable income 
for such year has been annualized.
    (iii) Election year is a short taxable year. In applying paragraph 
(a)(2) of this section for purposes of determining tax computed on the 
annual basis (within the meaning of section 443(b)(1)) for an election 
year that is a short taxable year--
    (A) The taxable income and the electible farm income for the year 
are annualized; and

[[Page 822]]

    (B) The taxpayer may designate all or any part of the annualized 
electible farm income as elected farm income.
    (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 one or more of the base years, 
may still elect to average farm income using the single filing status 
used in the base year.
    (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 in determining the section 55 alternative minimum tax for any 
base year or the section 55(b) tentative minimum tax for the election 
year or any base year. The election does, however, apply in determining 
the regular tax under sections 53(c) and 55(c) for the election year.
    (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. In 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 beginning after December 31, 2001, except with respect to the 
written agreement requirement of paragraph (b)(2) of this section.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 3. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


    Par. 4. In Sec. 602.101, paragraph (b) is amended by adding an 
entry in numerical order to the table to read as follows:


Sec. 602.101  OMB control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described      control No.
------------------------------------------------------------------------
 
                  *        *        *        *        *
1.1301-1...................................................    1545-1662
 
                  *        *        *        *        *
------------------------------------------------------------------------


Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: December 12, 2001.
Mark Weinberger,
Assistant Secretary of the Treasury.
[FR Doc. 02-183 Filed 1-7-02; 8:45 am]
BILLING CODE 4830-01-P