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 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 (see "Federal Estate Taxes Affecting Fewer Farmers but the Future Is Uncertain: Special Provisions," Amber Waves, June 2009).
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 afore mentioned 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 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.
Based on simulations using the latest available farm-level survey data from the 2014 Agricultural Resource Management Survey (ARMS), for the 2015 tax year, we estimate only 3.0 percent of farm estates would be required to file an estate tax return, with a much smaller share of estates (about 0.8 percent) owing any Federal estate tax. Total Federal estate tax liabilities on all farm estates in 2015 are estimated at over half a billion dollars. Historically, these amounts have been much higher. Since 2000, 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.
The impact of the Federal estate tax varies by farm typology. ERS classifies small family farms as retirement/off-farm occupation family farms with gross cash farm income (GCFI) under $350,000, farming occupation family farms with GCFI under $350,000 and primary occupation is farming; midsize family farms are farms with GCFI between $350,000 and $1,000,000; and large-scale family farms are farms with GCFI $1,000,000 or more. Nonfamily farms are not included in this analysis. For tax year 2015, the average value of farm assets for larger family farms was roughly $4.6 million. Thus, despite estate tax relief targeted to farmland (see "Federal Estate Taxes Affecting Fewer Farmers but the Future Is Uncertain: Special-Use Valuation," Amber Waves, June 2009), an estimated 13.3 percent of the estimated 1,350 mid-size and large family farm estates are likely to owe Federal estate taxes for tax year 2015. In contrast, less than 1 percent (0.2 percent) of small farm estates is estimated to owe a tax. Estates of mid-size and large family farms represent 71.4 percent of all taxable farm estates and owe 88.1 percent of the Federal estate tax liability of all farm estates.
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 non-farm assets, such as other non-farm business interests and assets and the farmer’s personal assets: essentially everything owned by the estate that is not related to the farm business. Naturally, farm estates consist substantially of farm assets, but it varies by farm typology. Fifty-six percent of small farm estates (farms with less than $350,000 gross cash farm income) are made up of farm assets; while farm assets comprise 78 percent or more of the estates of mid-sized and larger farms. For the few farm estates that have a tax liability, the assets in the estates are overwhelmingly farming-related—ranging from 87 to 95 percent.
The Average Tax Rate Paid on Farm Estates is Far Lower than the Maximum Marginal Rate
On average, a farm estate that owed Federal estate tax had a net worth of $13.5 million and a tax liability of $2.6 million, paying an average tax rate of 19 percent. Estates of small farms paid the lowest average tax rate (11 percent), while estates of large-scale family farms paid an average estate tax rate of 24 percent.
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 2014 (the latest year available), nearly one out of every six taxable estates had some farm assets. The IRS reports 660 taxable estates with farm property, and the average amount of farm property was $3.6 million.