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 million in 2011) 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 35 percent ( see table).
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 Special Provisions Benefit Farmers, in the June 2009 issue of 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 owe 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 added 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, extends and augments the expiring provisions of the 2001 Act. Instead of allowing for the full repeal as planned in 2010, the law retroactively sets a new tax exemption amount at $5,000,000 for an individual, and a maximum estate and gift tax rate of 35%, effective for 2010. The 2010 Act also reinstates 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 new law provides 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
Year
Estate tax exemption amount
Highest marginal estate and gift tax rate
Dollars Percent
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/ 5,000,000 35
2013 2/ 1,000,000 55
1/ The $5,000,000 exemption amount will be indexed for inflation beginning in 2012.
2/ In 2013, exemption amounts and estate tax rates revert to law prior to the 2001 Act.
Source: Internal Revenue Code Section 2010.
In addition to a new exclusion amount and tax rate, the 2010 Act adds an important provision that will be beneficial to some farm businesses and households. The new law allows any unused exemption amount of a decedent's estate to be transferred to a surviving spouse. Under this portability rule, if a spouse dies after December 31, 2010, the survivor is 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 a married couple will have a combined exclusion of $10 million, even if the first spouse to die does not fully utilize their $5 million exemption amount. The new provisions are in effect through December 31, 2012.
Since the passage of the 2001 legislation, the amount exempted from the estate tax has gradually increased from $675,000 in 2001 to $5 million in 2010. The median wealth of farm households is about five times that of all U.S. households. As a result, farm estates are more likely to owe Federal estate taxes than the typical estate.
Based on simulations using farm-level survey data from ERS' 2009 Agricultural Resource Management Survey (ARMS), about 1.2 percent of the 41,688 individual farm estates projected for 2011 are estimated to have assets in excess of $5 million and would be required to file an estate tax return. After deductions, less than half of these farm estates are likely to owe tax. These taxable farm estates have an average net worth of $10 million--including non-farm wealth--with the average taxable estate owing about $1.3 million.
Share of farm operator estates with returns and taxes, 2011
chart data
The impact of the Federal estate tax varies by farm type. ERS classifies farms as rural residence farms (retirement and residential/lifestyle farms), intermediate family farms (annual sales less than $250,000 and primary occupation is farming), and commercial farms (annual sales greater than $250,000). Based on the 2009 ARMS data, the average value of farm assets for commercial farms was roughly $2.8 million. Thus, despite estate tax relief targeted to farmland (see Special-Use Valuation in the June 2009 issue of Amber Waves), an estimated 4.2 percent of the estimated 2,309 commercial farm estates are likely to owe Federal estate taxes in 2011. Commercial farms are 14 times more likely to owe Federal estate taxes than other farms.
Share of farm estates required to file a tax return and pay estate taxes, by farm type, 2011
chart data
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 2009, one out of every eight taxable estates had some farm property. While we estimate there were 359 taxable farm estates in 2009, the IRS reports 1,846 taxable estates with farm property. The average amount of farm property was $1.796 million. However, on average these farms had more nonfarm than farm assets.
Present Law Provides Uncertainty
Under the 2010 Act, after December 31, 2012 the Federal estate tax will revert to the pre-2001 law. As a result, the exempt amount would return to $1 million and the top tax rate would revert to 55 percent. The reversion to pre-2001 law, if it occurs, will substantially increase the share of estates that owe Federal estate tax and will result in significantly higher Federal estate tax revenues.
The share of farm estates required to file a return and pay Federal estate tax could rise sharply in 2013
chart data
Since 2000, farm equity has more than doubled, primarily due to the increased value of farm real estate. As a result, if the estate tax reverts to pre-2001 law, it is estimated that as many as 1 of every 10 farm estates would owe estate tax in 2013. Total payment amounts that year could increase to about $3.1 billion--nearly 10 times the estimated amount owed by farm estates in 2011.
