Federal tax policies not only influence the financial well-being
of farm families but also can have important effects on the number
and size of farms, their organizational structure, and their use of
land, labor, and capital. Federal taxes represent about
three-quarters of the total tax burden on farm households.
The most significant Federal taxes paid by farmers are income,
social security, self-employment, and estate taxes.
In recent years, Federal income taxes on both farm income and
income earned off the farm accounted for nearly two-thirds of
farmers' total Federal tax burden. Tax legislation enacted
over the last decade has reduced Federal income taxes for both
individual and business taxpayers. The cumulative effect of
these Federal income tax policy changes has been the lowest Federal
income tax burden on farm income and investment in
decades.
While Federal estate and gift taxes only account for about 2-3
percent of the Federal tax burden, their potential effect on the
ability to transfer the farm business to the next generation has
been an important concern for both farmers and policymakers.
Changes to estate and gift tax policies, including those contained
in the Economic Growth and Taxpayer Relief Reconciliation Act of
2001 have reduced tax rates and raised the value of property that
can be transferred to the next generation free of the Federal
estate tax.
Federal tax policies are also of considerable importance to the
financial well-being of rural households. Rural taxpayers
have lower incomes and higher poverty rates than urban
taxpayers. As a result, they have benefited from the expanded
use of the Federal tax code to provide income support to low-income
households, primarily through the use of refundable tax
credits. These credits have provided a substantial boost in
income and have reduced the rural poverty rate.
Many of the tax policy changes affecting both farm and rural
households enacted over the last decade are temporary.
The approaching expiration of these polices in the context of
increasing budget deficits and growing interest in fundamental tax
reform provides uncertainty as to the future structure of the
Federal tax system. Significant changes to these Federal tax
policies would be of considerable importance to both farm and rural
households.
Federal Income Taxes
The Federal income tax is a progressive tax imposed on net
income. Taxable income is computed by subtracting allowable
adjustments, deductions, and personal exemptions from total income.
Numerous provisions of Federal income tax law allow taxpayers to
reduce their tax liability if they undertake certain tax-favored
activities. Farmers benefit from both general tax provisions
available to all taxpayers and from provisions specifically
designed for farmers.
These tax benefits generally accrue to those with higher
incomes--generally large farms with high farm income and very small
farms with high levels of off-farm income. Although very small
farms do not generate enough farm income to support a family, most
small farms benefit from farm losses for tax purposes because these
losses reduce taxes on nonfarm income. At the same time, many
farmers devoting full time to the farming operation do not generate
enough taxable income--either farm or nonfarm--to fully utilize
available tax benefits.
Examples of special tax treatment for farmers include cash
accounting, farm income averaging, depreciation, the current
deductibility of certain capital costs, and capital gains treatment
for certain assets used in farming. These and other provisions
reduce the farm income tax base. Such incentives have likely
encouraged greater investment in productive capacity than would
have been warranted without tax incentives, and this has affected
farmland prices, organizational structure, and farm
profitability.
The favorable tax treatment for farm income is reflected in the
size of farm profits and losses reported for income tax purposes.
Since 1980, IRS data indicate that farmers have reported negative
aggregate net farm income for taxes. These farm losses reduce taxes
by offsetting taxable income from nonfarm sources.