Potential changes to the taxation of capital gains on death for family farms have been a hot topic in farming circles over the past six months. Capital gains studies from EY, Texas A&M, University of Kentucky and Iowa State University released in the spring and summer illustrate the potential impacts on American farmers and ranchers. Last week, the USDA’s Economic Research Service released an analysis of the American Families Plan, which proposes to eliminate the enhanced basis for inherited assets over $1 million for estates of individuals and 2 million dollars for the estates of married couples while deferring capital gains tax on business assets as long as the business remains family owned. The results echo many of the points made by economists and tax scholars throughout the current discussion.
Much of the debate around the AFP proposal has centered on the “exemption” or more specifically, the deferral of capital gains liability for farms that continue to be operated by the family after the intergenerational transfer. Some analysts equate the postponement with no impact. In their view, either there is capital gains tax due upon death or there is none. The ERS model, which indicates that under the proposed plan, only 1.1% of estates created would be liable for capital gains tax on death, appears to support this view of AFP. Seen in this light, 98.9% of farms are not affected by the changes.
However, other analysts, including many economists, tax experts and the American Farm Bureau Federation, argue that deferred capital gains taxes can have significant implications for a farm, even if it continues to be operated by the family. Indeed, it is easy to say that taxes will be deferred, but it is difficult to enshrine that deferral in law in a way that matches the intent, and even more difficult for farmers to maintain that deferral. There are many ways “continuing to be family operated” could go wrong, including how “family” is defined by the IRS versus how the USDA defines it, changes to the family status, rules regarding recovery and changes to rules regarding material participation, to name a few. So while the intention to defer taxes may be good, those deferred taxes can hang over an operation like a dark cloud. Deferred taxes can impact a farmer’s ability to obtain operating loans, make organizational changes, and generally operate the farm or ranch optimally. Importantly, the ERS model shows that under the proposed plan, 18.2% of estates created should not have tax on death, but could potentially have deferred tax on farm gains.
When deferred taxes are not considered the same as no taxes, the importance of the data source used by ERS in this study, the USDA Farm Resource Management Survey, becomes more evident. . ARMS is the only national survey that provides observations of farm business economics, including income tax returns, financial balance sheets and indicators, and US farm household demographics – all designed to be statistically representative of all types of farms. agricultural households and agricultural regions of the country. Jointly sponsored by ERS and the USDA’s National Agricultural Statistics Service, ARMS has been conducted annually since 1996.
For this study, ARMS data was examined by farm size; small farms have a gross cash farm income (GCFI) less than $350,000, medium-sized farms have a GCFI between $350,000 and $1 million, large farms have a GCFI between $1 million and $5 million and very large farms have a GCFI greater than $5 million. As a reminder, GCFI is annual income before expenses and includes cash receipts, farming-related income, and government farm program payments. It is important to note the significant difference between the GCFI and the actual return for operators – the inclusion of expenses. Over the past decade, returns to operators have averaged just 17% of the GCFI. So please keep this in mind when thinking about truss sizes.
When combined, the ERS study found that 1.1% of farms would owe capital gains taxes on death, 18.2% would owe no capital gains taxes. values at death, but could have a deferred tax liability if the farm assets do not remain owned and operated by the family. , and 80.7% would have no change in their capital gains tax liability. However, when the impact of the AFP proposal is considered through the lens of farm size, we learn more about the types of farms that would be affected. The study found that among small farms with a GCFI of less than $350,000, 83% would have no capital gains liability, 16% would have deferred liabilities, and 1% would be liable for income taxes. capital gains at death. It is perhaps unsurprising that the results change dramatically as farm size increases. As shown in Figure 2, 64% of medium-sized farms, 77% of large farms, and 94% of very large farms would have deferred capital gains tax due to the AAE.
Another interesting lens through which to view results is the production value for the affected areas. With this in mind, the 18.2% of created wealth that would not be liable for capital gains tax on death but which might be liable for deferred tax accounted for the vast majority – 63.2% – of the production value of the heritage created. The 80.7% of created estates that would not be liable for capital gains tax on death represented just over a third – 34.6% – of the production value of created estates. The 1.1% of created estates that would be liable for capital gains tax on death was only 2.1% of the production value of created estates.
The effect on family farms of changes in the taxation of capital gains upon death is an important contribution to the debate on changes in the taxation of capital gains. The exploitation of ARMS data makes it possible to specify the share of created assets which could potentially have deferred taxation of capital gains weighing on intergenerational holdings. The use of ARMS data also adds important context by highlighting that it is the very farms that produce the vast majority of food, feed and fiber in the country.