Federal Estate Taxes
The Federal estate tax has applied to the transfer of property at death since 1916, as part of a unified system of transfer taxes. While the tax has been amended many times, the estate tax, as well as the gift tax (imposed upon transfers prior to a person's death) and generation-skipping transfer tax have never directly affected a large percentage of taxpayers. Under the current Federal estate tax system, individuals can transfer up to a specified amount in money and other property without incurring Federal estate tax liability. When property is transferred at death, it is generally the responsibility of the estate to pay any taxes due as a result of the transfer unless other arrangements for payment are made. Under present law, the estate of a decedent who, at death, owns assets in excess of the estate tax exemption amount ($5.45 million in 2016) must file a Federal estate tax return. However, only those returns that have a taxable estate above the exempt amount after deductions for expenses, debts, and bequests to a surviving spouse or charity are subject to tax at a graduated rate, up to a current maximum of 40 percent (see the table below on exemption amounts and tax rates).
Over the years, a number of targeted provisions have been enacted to reduce the burden of the estate tax on farms and small business owners. These include a special provision that allows farm real estate to be valued at farm-use value rather than at its fair-market value, and an installment payment provision. A provision aimed at encouraging farmers and other landowners to donate an easement or other restriction on development has also provided additional estate tax savings. Together, these provisions have reduced the potential impact of estate taxes on the transfer of a farm or other small business to the next generation.
Economic Growth and Taxpayer Relief Reconciliation Act of 2001
The Economic Growth and Taxpayer Relief Reconciliation Act of 2001 ("the 2001 Act") provided estate tax relief to farmers and other small business owners. The 2001 Act reduced Federal estate and gift tax rates and substantially increased the amount of property that can be transferred to the next generation free of Federal estate tax, culminating in the tax's complete repeal in 2010 (persons dying in 2010 owed no estate tax under the 2001 Act).
In addition to repealing the estate tax, the 2001 Act changed the treatment of unrealized gains at death, effective with estate tax repeal in 2010. Prior to 2010, the basis, which is the value used to determine gain/loss of assets acquired from a decedent, was stepped up to the estate's fair market value at the date of death. This "step-up in basis" rule essentially eliminated the recognition of income on the appreciation of the property that occurred prior to the property owner's death. Upon repeal of the estate tax in 2010, however, the step-up in basis rule was replaced with a modified carryover of the decedent's basis, with an adjustment amount of up to $1.3 million (plus an additional $3 million for transfers to a surviving spouse). This change added to the compliance burden since it was necessary to determine the cost or other basis of inherited assets. In farming, these assets may have been held for several decades with limited documentation on their original cost or the method in which they were acquired.
Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 ("the 2010 Act"), signed by the President in December 2010, extended and augmented the expiring provisions of the 2001 Act. Instead of allowing for the full repeal as planned in 2010, the law retroactively set a new tax exemption amount at $5,000,000 for an individual, and a maximum estate and gift tax rate of 35 percent, effective for 2010. The 2010 Act also reinstated the step-up in basis rule, and while most estates will owe fewer taxes under the $5 million and stepped-up basis provisions, some very large estates would owe less tax under the repeal and carryover basis provisions that applied under the original 2001 legislation. For deaths occurring in 2010, the law provided an election that allowed the estate to be treated under the 2001 law in which the estate tax was eliminated (year 2010) and the modified carryover basis rules applied. In addition, the 2010 Act provides that an estate of a decedent who is survived by a spouse may make a "portability election," which allows the surviving spouse to apply the decedent's unused exemption amount to the surviving spouse’s own transfers during life and at death.
American Taxpayer Relief Act of 2012
The American Taxpayer Relief Act of 2012 ("ATRA 2012") made permanent the estate tax provisions in the 2001 Act and subsequently modified by the aforementioned 2010 Tax Relief Act, including a unified exemption for estate and gift tax purposes of $5 million, indexed for inflation after 2011 ($5.45 million for 2016), a statutory maximum estate and gift tax rate of 40 percent, and the portability election of the exemption between spouses, allowing a decedent to elect to permit the surviving spouse to claim any unused exemption amount.
|Year||Estate tax exemption amount (dollars)||Highest marginal estate and gift tax rate (percent)|
|1The $5,000,000 exemption amount is indexed for inflation beginning in 2012.
Source: USDA, Economic Research Service, using Internal Revenue Code Section 2010.
Farm Household Estate Tax Forecast
Based on simulations using the age distribution of farm operators and standard mortality rates applied to the latest available farm-level survey data (from the 2015 Agricultural Resource Management Survey (ARMS)), it is estimated that only 1.7 percent of farm estates would be required to file an estate tax return for the 2016 tax year. A much smaller share of estates (0.42 percent) is estimated to owe any Federal estate tax. For the 2016 simulation, 38,328 estates were estimated to be created out of a total of 2.1 million family farms.
Based on model results that accounted for adjustments, deductions, and exemptions, total Federal estate tax liabilities on all farm estates in 2016 are estimated at $344 million. As shown in the above table, the exemption amount has grown considerably, while the maximum tax rate has fallen. Consequently, the share of estates required to file a return or pay taxes has fallen over the years.
Impact of the Federal Estate Tax Varies by Farm Size
While small family farms (those with under $350,000 in annual gross cash farm income, or GCFI) make up most of the estates and over half of estates that owe an estate tax, they contribute only around 20 percent of the total estimated farm estate tax liability. In contrast, midsize family farms (those with $350,000-$999,999 GCFI) and large-scale family farms (those with $1 million or more in GCFI)—which together only account for about 6 percent of all farm estates and about 40 percent of taxable farm estates—account for nearly 80 percent of total farm estate tax liability. Nonfamily farms are not included in this analysis.
Farm Assets Dominate All Other Assets in Farm Estates
Farm household estates include all assets owned by the farm household—such as land, buildings, machinery, farm financial assets, pre-paid insurance, livestock, and even the value of planted crops. Farm household estates also contain nonfarm assets, such as other nonfarm business interests and assets and the farmer’s personal assets: essentially everything owned by the estate that is not related to the farm business. Farm estates consist substantially of farm assets, but it varies by farm typology. Sixty-five percent of the value of small farm estates (farms with less than $350,000 GCFI) consists of the value of farm assets; while farm assets comprise 84 percent or more of the estates of midsize and larger farms. For the few farm estates that have a tax liability, the assets in the estates are overwhelmingly farming-related—ranging from 84 to 93 percent.
The Average Tax Rate Paid on Farm Estates is Far Lower than the Maximum Marginal Rate
Farm estates estimated to owe Federal estate taxes had on average a net worth of over $11.5 million and an average tax liability ascending to $1.7 million. The average, across all taxed estates, of the ratio of tax liability over adjusted estates (estates net of administrative costs and special use valuation deduction) was 15 percent. This measure is an estimate of what the average estate pays as an effective estate tax rate. This measure reduces the effects that outliers have in the average, but the tradeoff is an increase in statistical noise.
An alternative measure of the effective estate tax rate is produced by dividing total tax liabilities over the total value of adjusted estates. Measured this way, the effective estate tax rate is 20 percent. Estates of small farms were estimated to have the lowest average tax rate (11 percent), while estates of midsize and large-scale family farms were estimated to have average estate tax rates of around 24 percent. This measure has the advantage of lower statistical noise, but it counts all tax liabilities the same; thereby outliers, in terms of their individual effective tax rate, affect the measure more than the one presented in the previous paragraph.
Farm property also plays a role in the estate tax position of decedents who might not be farmers but nonetheless own farm property. According to Internal Revenue Service (IRS) data for 2015 (the latest year available), nearly one of every seven taxable estates had some farm assets. The IRS reports 639 taxable estates with farm property, and the average amount of farm property was $2.36 million.
For more information on the ERS estimation of the Federal estate tax impacts on farmers, see Documentation for Estate Tax Model.