Income averaging is no longer allowed by the IRS for general taxpayers. The Tax Reform Act of 1986 repealed it, and today only three narrow groups can still use a version of it: farmers, commercial fishermen, and individuals born before January 2, 1936, who receive a lump-sum distribution from a qualified retirement plan. Everyone else has to smooth out an unusually high-income year using other tools in the code.
Who Can Still Use Income Averaging
Two carve-outs survived the 1986 repeal, and they are unrelated to each other.
The first is for farmers and commercial fishermen, who can elect to average current-year farm or fishing income back across the three prior tax years using Schedule J.1Office of the Law Revision Counsel. 26 USC 1301 – Averaging of Farm Income Congress kept this option because commodity prices, weather, and catch volumes create income swings the taxpayer cannot plan around.
The second is for a shrinking group of retirees. If you were born before January 2, 1936, and receive a qualifying lump-sum distribution from an employer retirement plan, you can still elect a special averaging calculation on Form 4972.2Internal Revenue Service. Form 4972 – Tax on Lump-Sum Distributions Everyone else is outside both provisions.
How Schedule J Works for Farmers and Fishermen
The mechanism is straightforward. You take all or part of your current-year farm or fishing income and divide it equally among the three prior tax years. Your tax is recalculated as if each of those years had earned an extra third of that amount, and the totals are added together. Because those earlier years likely fell in lower brackets, the blended rate usually beats what you would owe if the full spike were taxed in the current year. The whole bill is still paid in the current year; nothing actually moves backward. You make the election by filing Schedule J with Form 1040.3Internal Revenue Service. 2025 Instructions for Schedule J (Form 1040)
What Income Qualifies
Eligible income includes profits from cultivating land, raising livestock, operating a nursery, and running a commercial fishing operation. Gain from selling equipment and structures you used regularly in the business for a substantial period also qualifies, and if you sell that property within a year of leaving the business, it is presumed to be attributable to the farming or fishing operation.3Internal Revenue Service. 2025 Instructions for Schedule J (Form 1040)
Land itself does not qualify. The statute specifically excludes gain or loss from selling land, along with development rights and grazing rights.1Office of the Law Revision Counsel. 26 USC 1301 – Averaging of Farm Income Barns, grain bins, and other structures attached to the land do qualify.4eCFR. 26 CFR 1.1301-1 – Averaging of Farm and Fishing Income A farmer selling acreage with a processing facility has to separate the two, and only the structure portion goes on Schedule J.
What the Election Does Not Cover
Schedule J reduces your regular federal income tax and nothing else. Self-employment tax is calculated on your net earnings regardless of the averaging election, so a $40,000 self-employment tax bill stays a $40,000 bill.
The election is also disregarded when computing the Alternative Minimum Tax. You calculate your tentative minimum tax as if you had never made the averaging election.4eCFR. 26 CFR 1.1301-1 – Averaging of Farm and Fishing Income For a high-income farmer, AMT can claw back some or all of the savings that Schedule J produces on the regular tax side, so running the numbers both ways before filing is worth doing.
The 10-Year Option for Pre-1936 Retirees
The second surviving form of averaging is much narrower. If you were born before January 2, 1936, and receive a lump-sum distribution from a qualified retirement plan, you can elect the 10-year tax option on Form 4972. The distribution is treated as though you received it in equal installments over ten years, using a pre-1986 rate schedule with rates from 11% to 50%. You can also elect to treat the pre-1974 portion as capital gain taxed at a flat 20%, and the two elections can be combined.5Internal Revenue Service. Topic No. 412, Lump-Sum Distributions
To qualify, the distribution has to represent the participant’s entire balance from all of the employer’s qualified plans of one kind (pension, profit-sharing, or stock bonus), received in a single tax year. The election can only be used once per plan participant after 1986. A beneficiary receiving the distribution after the participant’s death can also use Form 4972 if the participant was born before January 2, 1936, and doing so does not affect any election the beneficiary might later make for their own plan.2Internal Revenue Service. Form 4972 – Tax on Lump-Sum Distributions
One caution: because the pre-1987 rate schedule tops out at 50%, the Form 4972 calculation can produce a higher tax bill than current ordinary rates for smaller distributions. Compare it against treating the distribution as ordinary income under today’s brackets before making the election.
Options If You Don’t Qualify
Most taxpayers with a high-income year fall outside both carve-outs. The code still offers several ways to blunt the impact, and used in combination they can approximate what averaging once did.
Retirement Plan Contributions
Contributions to tax-deferred retirement accounts reduce adjusted gross income dollar for dollar in the year you make them, pulling income out of your top bracket. For 2026, the limits are $24,500 in employee deferrals for a 401(k) or 403(b), with an $8,000 catch-up at age 50 or older; the SECURE 2.0 super catch-up raises that to $11,250 for ages 60 through 63. Traditional IRAs allow $7,500, with a $1,100 catch-up at 50 or older.6Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500 A SEP-IRA allows up to 25% of compensation, capped at $72,000, which can shelter a substantial portion of a strong self-employment year.7Internal Revenue Service. SEP Contribution Limits (Including Grandfathered SARSEPs)
A self-employed person using a Solo 401(k) can defer even more, since the employer contribution is calculated separately from the elective deferral side.
Installment Sales
Selling a business, investment property, or other substantial asset in a single year can produce a tax spike that looks a lot like what averaging used to fix. The installment method addresses this directly. As long as at least one payment arrives after the close of the tax year in which the sale occurs, you can report gain proportionally as payments come in.8Office of the Law Revision Counsel. 26 USC 453 – Installment Method
A $2 million sale paid out over five years shows roughly $400,000 of gain per year instead of the full amount up front. Two limitations matter: inventory and dealer sales are excluded, and any depreciation recapture must still be recognized in the year of sale regardless of when payments arrive.8Office of the Law Revision Counsel. 26 USC 453 – Installment Method
Net Operating Loss Carryforwards
When allowable business deductions exceed income for the year, the resulting net operating loss can be carried forward indefinitely to offset income in future years.9Office of the Law Revision Counsel. 26 USC 172 – Net Operating Loss Deduction
The catch is that an NOL carryforward can only offset up to 80% of taxable income in any given year, so bad years cannot zero out a good year completely; 20% of taxable income is always exposed.9Office of the Law Revision Counsel. 26 USC 172 – Net Operating Loss Deduction Farming losses are an exception to the no-carryback rule and can be carried back two years, giving farmers one more tool for smoothing income across years.