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 ($5.25 million in 2013 for an individual) 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 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, an installment payment provision, and a special deduction for family-owned business interests. A provision aimed at encouraging farmers and other landowners to donate an easement or other restriction on development has provided additional estate tax savings. 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, in the June 2009 Amber Waves).
Economic Growth and Taxpayer Relief Reconciliation Act of 2001
Providing tax relief to farmers and other small business owners was a primary impetus for the Economic Growth and Taxpayer Relief Reconciliation Act of 2001 (the 2001 Act). 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 or 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 ($10 million for married couples) 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 to be treated under the 2001 law in which the estate tax was repealed but the modified carryover basis rules applied.
Present law estate tax exemption amount and tax rates, 2000-2013
Estate tax exemption amount
Highest marginal estate and gift tax rate
2000 675,000 55
2001 675,000 55
2002 1,000,000 50
2003 1,000,000 49
2004 1,500,000 48
2005 1,500,000 47
2006 2,000,000 46
2007 2,000,000 45
2008 2,000,000 45
2009 3,500,000 45
2010 5,000,000 35
2011 5,000,000 35
2012 1/ 5,120,000 35
2013 5,250,000 40
1/ The $5,000,000 exemption amount is indexed for inflation beginning in 2012.
Source: Internal Revenue Code Section 2010.
In addition to a new exclusion amount and tax rate, the 2010 Act added an important provision that will be beneficial to some farm businesses and households. The provision allowed any unused exemption amount of a decedent's estate to be transferred to a surviving spouse. Under this portability rule, if a spouse died after December 31, 2010, the survivor was granted the ability to use any unused exclusion amounts provided that a timely election is made on the filed estate tax return of the decedent. In practice, this means that in 2013 a married couple will have a combined exclusion of $10.5 million, even if the first spouse to die does not fully utilize their $5.25 million exemption amount.
The American Taxpayer Relief Act of 2012
The American Taxpayer Relief Act of 2012 ("the 2012 Act"), signed into law by the President in January 2013, sets the maximum estate tax rate of 40 percent, effective for estates of decedents dying after December 31, 2012. The 2012 Act also made the estate law provisions permanent, whereas previous legislative changes were limited by a sunset date. In this sense, barring further legislation of estate law, estate planners have firm guidance as to future estate tax parameters.
Since the passage of the 2001 legislation, the amount exempted from the estate tax has gradually increased from $675,000 in 2001 to $5.25 million in 2013 (for an individual). Today, the median wealth of farm households is almost nine times that of all U.S. households. Furthermore, since 2000, farm equity has more than doubled, primarily due to the increased value of farm real estate. As a result, farm estates are more likely to owe Federal estate taxes than the typical estate.
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The Federal estate tax applies to the transfer of property after death; it was repealed in 2010 but reinstated for 2011 and years thereafter. Under present law, the estate of a decedent who at death owns assets in excess of the estate tax exemption amount ($5.25 million in 2013 for an individual, $10.5 million for married couples) must file a Federal estate tax return, and those estates are subject to a 40 percent tax rate on the nonexempt amount. Based on simulations using farm-level survey data from the 2011 Agricultural Resource Management Survey (ARMS), in 2013, only about 2.7 percent of farm estates would be required to file an estate tax return, with a much smaller share of estates (about .6 percent) owing any Federal estate tax. Total Federal estate tax liabilities on all farm estates in 2013 are estimated at about 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.
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The impact of the Federal estate tax varies by farm type. ERS classifies 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), and midsize/large-scale family farms (GCFI $350,000 or more). Nonfamily farms are not included in this analysis. Based on 2011 ARMS data, the average value of farm assets for larger family farms was roughly $3.2 million. Thus, despite estate tax relief targeted to farmland (see Federal Estate Taxes Affecting Fewer Farmers but the Future Is Uncertain: Special-Use Valuation in the June 2009 issue of Amber Waves), an estimated 7.3 percent of the estimated 2,103 larger family farm estates (representing about 64 percent of all taxable farm estates) are likely to owe Federal estate taxes in 2013. These farms are nearly 13 times more likely to owe Federal estate taxes than other farms.
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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 2011 (the latest year available), nearly one out of every six taxable estates had some farm assets. While we estimate there were 230 taxable farm estates in 2011, the IRS reports 228 taxable estates with farm property. The average amount of farm property was $2.2 million. However, on average these farms had more nonfarm than farm assets. Since 2000, farm equity has more than doubled, primarily due to the increased value of farm real estate.