income averaging

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To use income averaging, the taxpayer must have earned taxable income for a particular year that exceeds 140 percent of his or her average taxable income for the previous three years.

I don't understand this text . Can you explain with an example ? is it 140 % for all the 3 previous years ?

Nah ....This is bit hard . any example please .

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@tintin,

"Income averaging" is a very specific tax term. What this means is that if someone has a year with highly unusual income that instead of paying all that tax to the government in one year, they can average the income from three years and pay on the average amount each year. But to qualify, that high income year must be more than 40% higher than the average of the three.

Example. In year one, you make $80,000. In year two, you make $80,000. In year three you make $140,000. The average of these three is $100,000. The high year ($140,000) is 140% of the average, so you could choose to pay taxes on $100,000 each year instead of $80K/$80K/$140K. This might save you money.

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@engineer,

irrk ...little bit data problem...let me use 'year' vs ' income' using your data.

I have read your post but the doubt is not yet clear ..so I am writing back in a simpler way where I'm stuck .Can you please take a look at it ?

say ,
in 2007 --->$80,000
in 2008--->$80,000
in 2009--->$140,000

So, previous 3 years done.

(a)Now say his income in 2010 is say $150000 ...will he get the benefit ? how do you calculate now ?

(b)Now say his income in 2010 is say $40000 ...will he get the benefit ? how do you calculate now ?

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@tintin,

Three previous years average is $100K. $150 is 150% of that value, so yes, he can average. If you income is low, income averaging is not beneficial, so you would not use it if your income is $40K

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@engineer,

Ok. I got that part now.

But can you please tell how much tax to be given ?

It says

State X’s income-averaging law allows a portion of one’s income to be taxed at lower rate than the rate based on one’s total taxable income. People using income averaging owe less tax for that year than they would without income averaging.

In our example , say for 2010 he is earning $150,000 . Now , how much he has to pay tax actually? our text says 'allows a portion of one’s income to be taxed at lower rate than the rate based on one’s total taxable income.

I'm not sure about the amount of tax here ...thats my doubt.

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@tintin,

Are you saying he will pay the tax for $100,000 (average value) though his income his $150,000 in 2010 ? thats beautiful.

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@tintin,

No, he will have to pay taxes on all of it, but he can spread it out instead of paying in a single year. Also, higher rates kick in as you make more, so this allows some income to stay in lower brackets.

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@engineer,

Please allow me to restate and tell me if I have it. In the case of someone who makes $150K in 2010 and his 3 year average is $100K: he can pay tax on 100K this year. Then add 25K income to each of the following years. So in the end he pays tax on all $150K, but at lower rates.

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tintin, are you talking about federal taxes or state taxes? Your example is talking about a state income tax. I believe that income averaging is restricted to fishermen and farmers at the federal level.

Quote:

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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

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@JPB,

Income averaging for farmers works like this: Take the year's humongous government subsidy and divide it into thirds. Remit one third to your Senator and one third to your representative in Congress. In each succeeding year you get to keep it all yourself, unless a new member of either body is elected.

If either member of either body is caught fooling around with members that they've met in a bathroom stall, they forfeit their third, which then becomes part of the coffee fund for either the House or the Senate depending on which body that particular member's member belongs to.

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@JTT,

Exactly!

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@JPB,

Good morning JPB.

In a scenario where an individual made roughly 10k and 16k in the previous 2 years(also receiving an earned income credit for those years), then in the 3rd year made 64k would it make sense for the individual to average the higher income?

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income averaging

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