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**FARM AND RURAL TAX POLICY**

***Background***

Federal tax policies not only influence the financial well-being of farm
families but also can have important effects on the number and size of
farms, their organizational structure, and their use of land, labor, and
capital. The most significant Federal taxes paid by farmers are income,
social security, self-employment, and estate taxes. In recent years,
Federal income taxes on both farm income and income earned off the farm
accounted for nearly two-thirds of farmers\' total Federal tax burden.

At the State and local level, farmers are subject to a variety of taxes,
including income, sales, and property taxes. Of these, the most
significant are State and local real estate taxes.

Tax legislation enacted in the last 4 years has reduced Federal income
taxes for both individual and business taxpayers. For individual
taxpayers, this legislation has reduced marginal income tax rates,
increased standard deduction allowances, lowered tax rates on capital
gains and dividends, increased savings incentives, raised child and
earned income credit amounts, and eliminated the marriage penalty for
low-income households. Federal tax policies affecting businesses have
also been modified, including reduced tax rates on business investment
and manufacturing income.

[Implications for Farmers and Ranchers]{.underline}

Most farm income is taxed as individual income rather than as corporate
income. As a result, farmers and many other small businesses are major
beneficiaries of the recent tax changes since they benefit not only from
the lower individual tax rates and other changes aimed at all taxpayers,
but from faster write-off of investment in machinery, equipment, and
other eligible capital purchases and from the newly enacted
manufacturers\' deduction.

The cumulative effect of these Federal income tax policy changes has
been the lowest Federal income tax burden on farm income and investment
in decades. Like all households, about one out of every three farm
households now owes no Federal income tax, with some actually receiving
a refundable child or earned income credit. The average Federal tax rate
is estimated to have been reduced from 18 percent in 2000 to about 14
percent for 2005, providing farm households with an estimated \$4
billion in tax relief.

Farming requires large investments in farm machinery, equipment, and
other capital purchases. The tax treatment of these investments is of
considerable importance to the farm sector. The reduction in 2003 of the
tax rate to 15 percent and lower on dividends and capital gains is
especially significant for farmers. Forty percent of all farmers report
some capital gains, nearly double the share for all taxpayers. The
average amount of capital gain reported by farmers is about 50 percent
higher than the average capital gain reported by other taxpayers.

The Jobs and Growth Tax Relief Reconciliation Act of 2003 raised the
amount of investment that can be expensed from \$25,000 to \$100,000,
and that was extended through 2007 by the American Jobs Creation Act of
2004, with the amount adjusted for inflation. Today, most farmers are
able to deduct their entire 2005 capital investments. This increased
capital expensing allowance reduces the effective tax rate on farm
capital and greatly simplifies the recordkeeping burden associated with
the depreciation of capital purchases.

The potential effect of Federal estate and gift taxes on farmers and
other small business owners has been an important concern for farmers
and policymakers. Over the years, this has led to the enactment of a
number of targeted provisions, including a provision that allows farm
real estate to be valued at its farm use value rather than its fair
market value.

Changes have also been made to Federal estate and gift tax policies,
including those contained in the Economic Growth and Taxpayer Relief
Reconciliation Act of 2001. These changes reduced tax rates and raised
the value of property that can be transferred to the next generation
free of the estate tax to \$2 million in 2006. Despite these changes,
appreciating land values and increasing farm sizes have led to a larger
share of farm estates being subject to the Federal estate tax. While
about 1 percent of all estates currently owe Federal estate tax,
approximately 4 percent of all farm estates and nearly 18 percent of
commercial farm estates currently owe estate taxes.

Under current law, the amount of property that can be transferred free
of estate tax will continue to increase until it reaches \$3.5 million
in 2009. The estate tax is scheduled to be repealed completely in 2010.
However, since the 2001 changes are scheduled to sunset in 2011, this
repeal is only temporary. The resurrected tax in 2011 reverts to the law
in place prior to the 2001 changes. It is estimated that this reversion
will result in as many as 10 percent of all farm estates and about 25
percent of commercial farm estates owing Federal estate tax.

***General Opinions Expressed***

-   Many supported eliminating the estate tax and removing the capital
    gains tax on agricultural land to allow farming operations to be
    passed on to the next generation and to keep production agriculture
    land in production.

-   Others suggested that property taxes be based on actual use, not
    highest and best use.

-   Some suggested tax incentives to encourage retiring farmers who help
    out younger farmers by conveying equipment or land.

-   Some suggested individual risk management savings accounts with
    matching USDA funds be established for farmers.

-   Many commenters supported tax credits for organic farming while
    others encouraged tax rebates to producers for their use of fuel,
    herbicides, and fertilizer in the production of all crops.

-   Others suggested tax credits for individuals using renewable fuels
    such as biodiesel and ethanol.

-   Commenters called for USDA to lift the prohibition on loan
    guarantees used in conjunction with State-sponsored beginning-farmer
    "aggie" bonds.

***Detailed Suggestions Expressed***

-   Efforts such as the New Homestead Act offer tax and other incentives
    to attract new rural residents. Such initiatives should be pursued
    by Federal policymakers in cooperation with the States.

-   Inflated land prices and rental rates are financial challenges to
    beginning farmers. USDA should level the playing field by enacting
    agricultural tax reform to remove incentives that favor investors
    and wealthy farmers over those of more limited means.

-   USDA programs should help sustain and enhance family farms by
    providing economic and tax incentives and credits for soil and water
    conservation without escalating advantages to nonfarm investors.

-   The Federal Government should accelerate depreciation on farm
    equipment.

-   Modify the Internal Revenue Code Section 1031 tax-deferred exchange
    rules to reduce upward spiral in land values and allow for
    investment in value-added processing plants.

-   The Federal Government should retract the \$14 billion in tax breaks
    to the oil industry and give it to biofuels development.

-   Develop a fuel tax credit for transportation to global markets,
    thereby decreasing our export price.

-   All products imported into this country should be required to meet
    the same high standards of domestic producers. If not, levy a tax on
    those countries not meeting our standards.

-   Farm land and structures should be exempt from school taxes on
    property and be replaced with a per capita or income tax so that
    each person pays a fair share for his or her education or children's
    education.

-   The Federal Government should not allow other countries to sell
    resources in the United States cheaper than we can produce them. Tax
    imports from other countries on resources already produced by the
    United States.