In farming, some years are better than others. Recognising that farm incomes can be volatile, Revenue introduced an income averaging mechanism several years ago whereby farmers can opt to be taxed on their average aggregate farming profits and losses over a five-year period rather than have their trading profits taxed based on a 12-month period as would otherwise be the case. Income averaging is only available to individual, full time farmers. Companies are not eligible to apply.
How Income Averaging Works
Income averaging is only available to individual, full-time farmers, farming solely or in partnership. Revenue rules state that farmers who, or whose spouses/civil partner, carry on another trade or profession or who, or whose spouses/civil partner, are directors of companies which carry on a trade or profession cannot elect for income averaging unless that trade or profession is in relation to on-farm diversification and is conducted on the farmland.
When you opt in to income averaging, your profits for the current tax year are aggregated with profits for the previous four years and then divided by 5. This gives your ‘average’ annual profit and is the basis on which your income tax is assessed.
Before opting in, it is advisable to talk to your accountant, particularly if you commenced trading or incurred trading losses in any of the relevant tax years as this will affect your eligibility.
Categories of farm businesses that are excluded from income averaging include those where a farmer, their spouse or civil partner carries on another trade or profession unless this is ancillary to the farm or there is a close operating link with the farming trade. Examples of ancillary trade that can be carried out on the farm include organic farming, pet farms, equestrian centres, and farm produce such as jams, chutneys, bread, sauces.
Where a farmer, their spouse or civil partner are the beneficial owners of, or can control (directly or indirectly), more than 25% of the ordinary share capital of a company that carries on a trade or profession, they are also excluded from income averaging.
Basis of assessment
The immediate four tax years prior to opting in are assessed using the general basis of assessment. Both profits and losses of the 5 years concerned in the averaging process are aggregated. In effect, this means that losses are treated as negative profits.
To avail of income averaging, you must have profits that are chargeable to tax. Therefore, if you did not make a profit in the immediate 4 prior tax years, you cannot opt for income averaging.
If you commenced trading in recent years, it is important to be aware that if your profits were calculated under commencement rules in one of more of the 4 years immediately preceding the current year, you will not be able to opt for income averaging.
Once you have opted in, you will be taxed under the income averaging rules for the year of the election and the next four years, assuming all qualifying conditions continue to be met. The minimum duration of averaging is 5 years after which you can revert to the normal basis of assessment by giving a notice to this effect on your income tax return for the year in question.
Stepping out of income averaging
For farmers with rising incomes, averaging can work out well in that it may temporarily release funds for use elsewhere in the business. However, if your income decreases, averaging can work against you as your average tax liability may be greater than the tax that would otherwise be payable for the year in question.
To overcome this difficulty, a new measure was introduced last year which allows farmers to temporarily ‘step out’ of income averaging for one year once every five years.
When you ‘step out’, you pay the tax due on the actual profits of the year in question as opposed to the average of the five-year aggregate amount that would be due under income averaging rules. This results in a deferred tax liability which is payable in instalments over the following 4 years.
Permanently opting out
As mentioned, the minimum duration of income averaging is 5 years. Once this period has elapsed, you can revert to the normal basis of assessment by giving a notice to this effect on your income tax return for the year in question. Before deciding to permanently opt out, keep in mind that any outstanding deferred tax will be payable immediately.
If you opt out of the averaging regime, you may subsequently re-elect income averaging, but only after your farming profits have been assessed under section 65(1) TCA for at least four years before re-electing.
If you are currently availing of income averaging and your income is down this year, 2018 could be the right moment to ‘step out’ for a year. Keep in mind, however, that you can only step out once every five years. If you have not so far opted in to income averaging, now is a good time to consider this option. Talking to your accountant before you complete your next tax return will help ensure you make the right decisions for your business.