Federal Tax Policy Issues
Tax legislation enacted over the past two decades has reduced Federal income taxes for both individual and business taxpayers. Many of the tax policy changes affecting both farm and nonfarm rural households enacted over the past two decades were temporary; however, the American Taxpayer Relief Act of 2012 made many of the expiring provisions permanent. Most recently, the Tax Cuts and Jobs Act (TCJA), passed in December 2017, made several changes to the tax code. The TCJA (temporarily) eliminates or modifies many itemized deductions and tax credits while lowering tax rates on individual and business income. (The individual income tax provisions under the Tax Cuts and Jobs Act are temporary and apply for taxable years beginning after December 31, 2017, and before January 1, 2026.)
While Federal estate and gift taxes account for a relatively small share of the Federal taxes paid by farm households, they may affect the ability of some farms to transfer the farm business to the next generation. The TCJA doubled the previous estate tax exemption amount to nearly $11.2 million per individual but kept the 40 percent maximum marginal rate for 2018. The TCJA continues previous law by allowing the basis in the property acquired from a decedent to be stepped-up to the value of the asset at the date of death.
Federal Income Tax and Farm Households
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 provisions specifically designed for farmers.
These tax benefits tend to accrue to those farms 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 their ability to claim farm losses for tax purposes because these losses can be counted against nonfarm income and thereby reduce overall taxes. At the same time, some farmers working full time on the farming operation do not generate enough taxable income—either farm or nonfarm—to fully use available tax benefits.
Examples of special tax treatment for farmers include cash accounting, multi-year averaging for farm income, accelerated depreciation, 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 occurred without tax incentives, and this may have 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 farm sole proprietorships have reported negative aggregate net farm income for tax purposes. These farm losses reduce taxes by offsetting taxable income from nonfarm sources.