Prior to the 1987 tax year, any taxpayer who experienced a large bulge in annual income such as from a huge work bonus or big sales commission, or a financial windfall such as from lottery jackpot winnings, could use income averaging to reduce his tax bill. Since 1987, according to FinancialDictionary.com, the federal tax code requires taxes on an extraordinary income bulge to be paid in full in the year the money was paid, regardless of whether this pushes the taxpayer into a higher tax-rate bracket. The major exceptions are for farmers and fishermen, who are still allowed to use income averaging.
Farmers and Fishermen
Income averaging for farmers and fishermen works like this: They take this year's big income bulge and divide it into thirds. They recalculate their income taxes for this year and the preceding two years based on one-third of the income bulge being posted in each of the three years. According to HoneckOtoole.com, this effectively increases their taxable income for the preceding years while reducing it for the current year. Under the graduated income tax system, the tax rate applied to these revised annual income figures would increase, but by much less than if the entire income bulge were to be taxed this year. The net result is to lower the total tax owed on the income bulge.
Read more: IRS Tax Filing Income Averaging Information | eHow.com http://www.ehow.com/about_6633178_irs-filing-income-averaging-information.html#ixzz1IZtxsgbT