Documentation for Estate Tax Model
The following documentation addresses the modeling of the Federal estate tax. The estate tax is a tax on the transfer of property at death. Model documentation includes a description of data sources, assumptions, and estimation methods.
The estate tax model was first developed in 2009 (see Federal Tax Policies and Farm Households, EIB-54, May 2009) and uses data from multiple Government agencies, including USDA, Social Security Administration, and Internal Revenue Service (IRS).
- Agricultural Resource Management Survey (ARMS) provides the financial and demographic information for farm households.
- Mortality Tables from the Social Security Administration Actuary Life Tables, showing the probability of a person’s death before their next birthday, given their age.
- NASS June Area Survey provides cash rental rate information for cropland by State. The data is used to compute the tax relief provided by valuing farmland for its agricultural use, as allowed by law.
- Farm Credit System Bank Loan Interest Rates IRS-published interest rates are used for computing the special-use valuation provision.
This section provides a broad and nontechnical explanation regarding the estimation of estate tax components for farm households. The exemptions, limits, tax rates, special deductions and, other items of the model are based on the Federal estate tax code (Chapter 11 of the Internal Revenue Code) for the relevant year. For technical details of the model, see Appendix C of Estimated Effects of the Tax Cuts and Jobs Act on Farms and Farm Households (ERR-252, June 2018).
We make two important assumptions when estimating the estate tax liabilities that rely on estate heirs being motivated to maximize consumption over their lifetime. There may be instances and exceptions for which heirs are otherwise motivated.
- Married households: Since 1982, the estate tax code allows for tax-exempt transfer of estates from the deceased spouse to the surviving spouse. As a result, we assume that the surviving spouse chooses to defer any estate tax payments until his/her death. Additionally, we assume that each partner in a married household hold equal shares of property, assets, and debt.
- Special Use Valuation (SUV): The Federal estate tax code allows qualifying farm estates to value their land at its actual, rather than potential, use, under the condition that such land will remain farmland for ten years. We assume that all farm estates that qualify will take this deduction.
For the cases in which we forecast estate taxes using ARMS data from a previous year, for example, estimating 2018 estates taxes using 2017 data, we inflate the assets and net worth values (simultaneously to avoid capturing the inflation value twice in net worth) consistent with predicted changes in the most recent USDA/ERS Farm Sector Income and Finances forecast. The implicit assumption is that assets and net worth for all individuals in our sample will change by the same percentage.
Estimating Net Taxable Estate Values
Because we cannot access administrative data on estate tax filings, we use ARMS data and an actuarial table showing the probability of death to estimate the number of farm estates that are created in a given year. The total expected number of farm estates is estimated as the weighted sum of the probability of death across all farm households.
The net worth of the estate is then calculated for each farm household. Net worth is defined as the sum of farm and nonfarm assets minus farm and nonfarm debts. The value of the estate is equal to farmer's net worth minus an “administrative” cost, set to 4 percent of the farmer’s gross worth (based on IRS tabulations).
According to the provisions of the tax code, estates are required to file a tax return only in cases where the gross estate value exceeds the estate tax exemption for that year ($11.18 million for an individual in 2018, an amount that is indexed for inflation). Since we don't know which farmers died during the year, we use the expected value of the estate created, i.e., the probability that an estate is created times their estate value. If the expected gross value of an estate is above the exemption limit then the model assumes a return is required for that estate. Summing the probabilities across all estates with an expected value above the exemption provides the estimated number of estate tax returns by farmers.
Not all estates that file an estate tax return have a tax liability. For example, surviving spouses will defer the payment of estate taxes until their own death, resulting in no estate tax liability for that year. Since 1982, surviving spouses could transfer the estate of their deceased spouse in a tax-free manner; however, it was not until 2010 that they were allowed to transfer the unused estate tax exemption from their deceased spouses and add it to their own estate tax exemption. Given that there is no penalty for deferring taxes until death (in the sense of losing exemptions) we assume that surviving spouses will defer any tax payment till death.
Qualifying farm estates can reduce the value of their estate using the SUV provision. To qualify for SUV, the farm estate must pass two tests:
- Test 1: the adjusted farm real property (farm property minus farm debt) must be at least 25 percent of the adjusted gross estate.
- Test 2: farm net worth must be at least 50 percent of the adjusted gross estate.
A farm estate that passes both tests can substitute the value of the property dedicated to its actual use, rather than its fair market value based on potential use, up to the stipulated maximum amount. The SUV is computed using cash rents, farm bank loan interest rates, and farm property taxes under the formula found in Section 2032A of the IRS Tax Code.
Estate taxes are assessed on the difference between the taxable estate value (inclusive of applicable SUV deductions) and the estate tax exemption amount for the year. We compute the expected tax liability using the Federal estate tax brackets and rates specified in the tax code. Total estimated tax liability is the weighted sum of the tax liabilities times the probability of creation of an estate. The effective estate tax rate is the total estimated tax liabilities as a share of total adjusted estate values for estates with a tax liability.
Updates and Revisions to the Model
The current version of the estate tax model contains changes that are likely to result in differences in the estimated variables relative to estimates published before 2016 that were obtained using the original model. The most notable changes to the original model are:
- Probability of being married: In the original model, the likelihood of being married was set to the proportion of married people in the United States. In the current version of the model, we use individual-level data from ARMS. This change is significant since around 80 percent of the surveyed farm households in ARMS (2015) are married, which is much higher than the proportion of United States population that is married (around 48 percent, according to the American Community Survey).
- Special use valuation: The current version of the estate tax model is the first to incorporate this provision using data for cash rents, farm bank system loan rates, and property taxes.
- Mortality rates: The current version of the model uses the most recent data (released in 2016) from the SSA on mortality rates.
- The current model also includes the "portability" provision. After 2010, surviving spouses may transfer not only the estate of their deceased spouses (in a tax-free manner) but also their estate tax exemption.