This chapter provides an overview of the most significant Federal taxes affecting farmers (income, self-employment, and estate/gift tax) and how they affect farm businesses and farm households. Among this chapter’s highlights:
- Farmers, like other taxpayers, are subject to a variety of taxes at all levels of government. Federal taxes account for about three-quarters of total tax burden on farm households (see more on taxes paid by farmers).
- In recent years, Federal income taxes on both farm and nonfarm income accounted for nearly two-thirds of farmers’ total Federal tax burden, while Social Security and self-employment taxes represented nearly a third. These taxes can have a significant effect on the financial well-being of farm households, with impacts varying by farm household type (see more on Federal income and Social Security taxes).
- Federal estate and gift taxes can affect the ability to transfer the farm business to the next generation as land values have greatly appreciated, and average farm size has grown in recent years. However, tax changes have significantly reduced the share of farm estates that owe Federal estate taxes (see more on Federal estate taxes).
Taxes Paid by Farmers
Farmers, like other taxpayers, are subject to a variety of taxes at all levels of government. At the Federal level, these include income taxes, Social Security and self-employment taxes, and estate taxes. At the State and local level, the most significant taxes are on property and income. Other taxes such as excise taxes, corporate income taxes, and retail sales taxes are significant for only a small number of farmers.In 2004 (the latest year complete Federal, State, and local tax data are available for farmers), farmers as a whole paid:
- $21.0 billion in Federal income taxes (49.4% of their total tax payments)
- $10.6 billion in Social Security and self-employment taxes (24.9%)
- $4.9 billion in State and local property taxes (11.5%)
- $5.1 billion in State and local income taxes (12.0%)
- $0.9 billion in Federal estate taxes (2.1%).
These taxes—$32.5 billion at the Federal level and $10.0 billion at the State and local level—were levied on nearly $142 billion in farm and nonfarm income reported by farm households for Federal tax purposes.The Social Security tax total includes both self-employment taxes on farm income plus the employees’ share of the payroll tax on wages.While, in the aggregate, Federal income taxes impose the largest tax burden on the broadest group of farmers, the relative importance of the different taxes varies for individual farmers with the size and other aspects of the farm business and household. The average effective Federal income tax rate for all farmers was about 15 percent in 2004. Most farmers, though, pay less tax than the aggregate rate suggests. About 60 percent of farmers have income of less than $50,000 and have an average effective Federal income tax rate below the Social Security tax rate.
State and local governments rely on individual and corporate income taxes, sales taxes, and property taxes.
Individual income taxes exist in 43 States, and while the rates vary, they are less than Federal income tax rates.
The average effective State income tax rate for all farmers was about 4 percent and was fairly constant across all income levels.
Sales tax rates vary widely by location, but purchases of farm inputs are often exempt from retail sales taxes.
While many States have reduced their reliance on property taxes, real estate taxes are the most important State and local tax for many farmers.
Farmers have large investments in land, as well as improvements and buildings that are subject to taxation.
Property taxes vary widely based on local tax jurisdictions.
All States currently have some form of preferential property assessment that taxes farmland based on its agricultural value rather than its fair market value.
Such assessment is especially important where urban sprawl has raised land prices
Federal Income and Social Security Taxes
Federal Income Taxes
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 from provisions specifically designed for farmers.
These tax benefits generally accrue to those 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 farm losses for tax purposes because these losses reduce taxes on nonfarm income.
At the same time, many farmers devoting full time to the farming operation do not generate enough taxable income—either farm or nonfarm—to fully utilize available tax benefits.
Examples of special tax treatment for farmers include cash accounting, farm income averaging, depreciation, the current deductibility of certain capital costs, 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 been warranted without tax incentives, and this has 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 farmers have reported negative aggregate net farm income for taxes.
These farm losses reduce taxes by offsetting taxable income from nonfarm sources.
Farm profits, losses and net loss on Schedule F
Examining losses by size of business receipts provides additional insight into the reporting of farm losses for tax purposes.
Based on IRS data, farms with business receipts less than $50,000 reported an aggregate net farm loss of $13.5 billion in 2004.
Only those farms with sales in excess of $100,000 reported a small aggregate net farm profit, for a total of $1.1 billion.
While accounting for only about 12 percent of farmers, these farms accounted for about 80 percent of total farm business receipts.
Social Security Taxes
Unlike Federal income tax rates, which rise as income increases, the Social Security tax is a flat rate with a maximum taxable amount.
Farmers pay self-employment taxes on their net farm income from Schedule F, on partnership income, and on net income from any nonfarm businesses.
Farmers and spouses with off-farm employment pay Social Security taxes on their wages.
Social Security taxes have risen over the years due to increases in the tax rate and the amount of income subject to the tax.
The rate increases began in 1983 and by 1990 had risen to the current 15.3 percent (7.65 percent for both the employer and employee).
The 15.3-percent rate is comprised of the 12.4-percent old-age and survivor disability insurance (OASDI) tax plus the 2.9-percent Medicare hospital insurance (HI) tax. All self-employment income is subject to the Medicare tax portion.
Only the first $106,800 of earned income (in 2009) is subject to OASDI.
While both Social Security tax rates and the amount of income subject to tax have increased, total self-employment taxes paid by farmers have not increased as fast.
The primary reason is the drop in the number of farms reporting a farm profit—from 44 percent in 1989 down to about 25 percent in 2006.
Federal Estate Taxes
The Federal estate tax has applied to the transfer of property at death since 1916.
While the tax has been amended many times, the estate tax and the companion gift tax imposed upon transfers prior to a property owner’s death 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.
The estate of a decedent who, at death, owns assets in excess of the estate tax exemption amount ($3.5 million in 2009) 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 45 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 its 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).
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.
However, like many other provisions in the 2001 Act, the estate tax changes will sunset (expire) at the end of 2010.
Estate tax exemption amount and tax rates, 2001-2011
||Estate tax exemptionamount
||Highest marginal estateand gift tax rate
||Estate tax repealed
||35 (gift tax rate)
|1/ In 2011, exemption amounts and estate tax rates revert to law prior to the 2001 Act.Source: Internal Revenue Code Section 2010.
Since passage of the legislation, the amount exempted from the estate tax has gradually increased from $675,000 in 2001 to $3.5 million in 2009.
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’ 2007 Agricultural Resource Management Survey (ARMS), about 2.9 percent of the 38,234 farm estates projected for 2009 are estimated to have assets in excess of $3.5 million and would be required to file an estate tax return.
After deductions, slightly more than half of these farm estates are likely to owe tax.
These taxable farm estates have an average net worth of $7.0 million, with the average taxable estate owing about $1.1 million.
The impact of the Federal estate tax varies by farm type.
ERS classifies farms as
intermediate family farms (annual sales less than $250,000 and primary occupation is farming),
and commercial farms (annual sales greater than $250,000).
A relatively larger share of commercial farms are projected to owe Federal estate taxes in 2009.
The average value of farm assets for commercial farms was roughly $2.9 million in 2007, based on the most recent data available from ARMS.
Thus, despite estate tax relief targeted to farmland (see Special-Use Valuation), an estimated 10 percent of all commercial farm estates are likely to owe Federal estate taxes in 2009. Commercial farms are 10 times more likely to owe Federal estate taxes than other farms.
Current Law Provides for Repeal and Uncertainty
Under the 2001 Act, the Federal estate tax is repealed completely in 2010.
The gift tax remains in effect with a $1 million exemption and a 35-percent maximum tax rate.
However, since the 2001 estate tax changes are scheduled to expire at the end of 2010, this repeal is only temporary.
The resurrected tax in 2011 reverts to the law in place prior to the 2001 changes.
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 increase the share of estates that owe Federal estate tax and will result in significantly higher Federal estate tax revenues.
Since 2000, farm equity has more than doubled, primarily due to the increased value of farm real estate.
As a result, under current law, it is estimated that as many as 1 of every 10 farm estates would owe estate tax in 2011.
Total payment amounts that year could increase to about $2.55 billion—nearly 300 percent more than the estimated amount owed by farm estates in 2009.In addition to repealing the estate tax, the 2001 Act changed the treatment of unrealized gains at death, effective with estate tax repeal.
Under current law, the basis (which is the value used to determine gain or loss) of assets acquired from a decedent is stepped up to the estate’s fair market value at the date of death.
This “step-up in basis rule” essentially eliminates 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, the step-up in basis rule is replaced with a 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 will add to compliance burdens since it will be 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.
The heirs of some farm estates that would owe no Federal estate tax or capital gains tax under current law would be faced with this compliance burden and could owe taxes upon the sale of the inherited assets.
The number of estates with unrealized gains above the step-up amount is estimated to exceed the number of estates that currently owe estate taxes.