Last year was a perceived tough one for farming. However, not all farms had it as tough as thought. A good back-end weather wise led to increased output, particularly in dairying, leaving increased profit.
Income volatility measures are limited in the Irish tax code, although this may change in the future.
Income averaging was introduced in 1974 as a measure to allow a smoothing of farm incomes over a three-year average period.
The purpose was to ensure that farmers paid tax on an even amount of profit over this three-year period.
In 2015, with increased volatility a change was made in that the averaging period was changed from three to five years.
Under three-year averaging
Under five-year averaging
However, if we looked at 2016 and if this person had a further drop in income in 2016, then the effect would have been.
The averaged profit in this case would have been €45,000, resulting in a tax liability on €15,000 of income that was effectively deferred from other years.
This diverting of profits would have resulted in cashflow difficulties for this individual in 2016 with tax being liable on €45,000.
Recognising the problems, the budget successfully brought a relieving mechanism whereby the farmer could opt to be taxed on the actual profits, ie €30,000 and defer €15,000 over a couple of years to spread the tax cost over a few years.
This was a major change and should be looked on as an incremental change.
A lot of negativity has been written about averaging but this is written from the perspective of looking at it in one year only instead of over a number of years.
If averaging is used correctly and income is rising or income is fluctuating, averaging will in most cases be beneficial.
However, most people only focus on averaging when income is falling, forgetting about the benefits that may have arisen in other years.
Averaging is not the panacea for volatility but is a mechanism that is useful as a medium- to longer-term solution.
Like all tax breaks, there are a number of tax traps that can work against you.
Options to manage volatility
A drystock farmer changed his system to dairy over the last number of years –profit €150,000 in 2016. Without income averaging, his tax bill would be in the region of €50,000.
With averaging, the position is:
However, on averaging, he will be taxed on €73,000 before capital allowance thus reducing his tax bill to approximately €15,000.
However the high profit will be in the equation for the next number of years.
If we take a reverse case where profits have dropped significantly, the averaging is a major disadvantage.
However, if you opt out of averaging in a bad year you will not be able to re-enter for five years.
Averaging is a tool that must be used and looked at over the medium term as against one year. Remember, with averaging tax planning within the farm gate is harder.
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