CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

PAPER

JULY 2005

Effects of the

Federal Estate

Tax on Farms

and Small

Businesses

CBO

Top: Photodisc/GettyImages; Bottom: Ron Nichols/USDA

The Congress of the United States O Congressional Budget Office

CBO

Effects of the Federal Estate Tax on

Farms and Small Businesses

July 2005

A

PAPER
Note

Numbers in the text, tables, and figures of this report may not add up to totals because of 

rounding.
Preface

Critics of the federal estate tax argue that it can hinder families who wish to pass on a 

farm or small business, because heirs must sometimes liquidate the farm or business to pay the 

tax. This Congressional Budget Office (CBO) paper—prepared at the request of the Ranking 

Democratic Member of the Senate Finance Committee—examines the effects of the estate tax 

on small businesses and family farms, focusing on how it might alter the behavior of farmers 

and small-business owners during their lives and on the extent to which their estates have 

enough liquid assets to pay the estate taxes owed. The paper also looks at the impact on those 

groups of setting the amount of assets exempt from the estate tax at $1.5 million, $2 million, 

or $3.5 million. In keeping with CBO’s mandate to provide objective analysis, this paper 

makes no recommendations.

Robert McClelland, formerly of CBO’s Tax Analysis Division, wrote the paper—with additional supporting analysis from Ed Harris—under the direction of Roberton Williams and 

Thomas Woodward. Ben Vallis performed some of the computations used in the analysis, and 

Perry Beider provided useful comments.

Christian Spoor edited the paper, and Loretta Lettner proofread it. Denise Jordan-Williams 

prepared early drafts of the text, tables, and figures. Maureen Costantino produced the cover 

and prepared the report for publication. Lenny Skutnik produced the printed copies, and 

Annette Kalicki and Simone Thomas prepared the electronic version for CBO’s Web site 

(www.cbo.gov).

Douglas Holtz-Eakin

Director

July 2005

Summary vii

Provisions of the Estate Tax That Affect Farms and 

Small Businesses 2

What Is a Small Business? 3

Potential Effects of the Estate Tax on the Behavior of 

Farmers and Business Owners 4

Why Do People Accumulate Assets? 4

Lessons from the Income Tax 6

Affordability of the Estate Tax 8

Characteristics of Estates Filing Returns 

in 1999 and 2000 9

Estates with Insufficient Liquid Assets 

to Pay the Estate Tax 12

Effects of Permanently Raising the Exemption Amount 13

Appendix: Translating the Estate Tax into an Income Tax 17

CONTENTS
vi EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES

Tables

1. Scheduled Changes in Tax Rates and Exemption Amounts for 

Estate and Gift Taxes Under EGTRRA 2

2. Income Tax Rates Equivalent to a 43 Percent or 14 Percent 

Estate Tax 6

3. Characteristics of Estates That Filed Estate Tax Returns in 1999 

or 2000 9

4. Estates Filing Estate Tax Returns in 1999 or 2000, by Decedent’s 

Marital Status 10

5. Common Occupations and Industries of Decedents Whose Estates 

Filed Estate Tax Returns in 2000 11

6. Characteristics of Farmers’ and Small-Business Owners’ Estates 

That Filed Estate Tax Returns in 2000 12

7. Minority Discounts Claimed by Estates Filing Estate Tax Returns 

in 2000, by Type of Asset 13

8. Number of Estates Filing Returns and Number with Insufficient 

Liquidity to Pay the Estate Tax in 2000, Under Various 

Exemption Levels 15

9. Income Tax Rates Equivalent to the Estate Tax, Under Various 

Exemption Levels, for Estates Claiming the QFOBI Deduction 

in 2000 16

A-1. Income Tax Rates Equivalent to a 43 Percent or 14 Percent Estate 

Tax, by Rate of Return and Years Until Death 18

Figures

1. Distribution of Gross Value and Estate Tax Liability of Estates 

Filing Estate Tax Returns in 1999 11

2. Assets of Estates Filing Estate Tax Returns in 1999 or 2000 14

Boxes

1. Estate Taxes Levied by States 3

2. How the Estate Tax Defines a Family-Owned Business 5

3. Estimating the Number of Estates Belonging to Farmers 8
Summary

Recent discussion of the federal estate tax has 

focused in part on how it affects family farms and small 

businesses—particularly the possibility that having to pay 

the tax might jeopardize those operations. Analysis by the 

Congressional Budget Office (CBO) and others points to 

few strong conclusions, both because available evidence is 

limited and because existing tax data make it difficult to 

determine which estates are those of farmers or smallbusiness owners.

Under current law, if someone dies in 2005 and leaves an 

estate worth more than $1.5 million, the estate must file a 

return and pay taxes of 43 percent to 47 percent on assets 

(minus various deductions) above that dollar threshold.1

Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), estate tax rates will decline 

—and the amount of net assets exempt from taxation will 

increase—through 2009, at which point the tax will 

equal 45 percent of an estate’s net assets over $3.5 million. The estate tax is then eliminated in 2010. However, 

if EGTRRA expires as scheduled in 2011, the tax will be 

reinstated that year, at rates ranging from 41 percent to 

60 percent on net assets of more than $1 million. The 

federal estate tax is projected to raise around $20 billion 

to $30 billion in revenues annually through 2011 and 

roughly double that amount in the next few years thereafter.

In recent years, fewer than 2 percent of all estates have 

had to pay estate taxes. But critics argue that the tax may 

pose a particular hardship for a small business or family 

farm. If building up such an enterprise results in a taxable 

estate without enough liquid assets to pay estate taxes, 

heirs may have to wholly or partially liquidate the business or farm. Purchasing sufficient life insurance might 

prevent that problem, but the ongoing cost of paying premiums would reduce the cash flow available to invest in 

the enterprise. In addition, critics charge, because the 

estate tax lowers the rewards from investment, a business 

owner or family farmer wishing to leave the enterprise to 

his or her heirs may be less inclined to invest in it or to 

hire workers—or may even be dissuaded from starting 

the business.

The amount of estate tax owed on a farm or business can 

be reduced in several ways. If a decedent has left heirs 

minority interests in a business, the estate may claim a 

reduced value for those interests for tax purposes, thus 

lowering the taxable value of the estate. In addition, until 

2004, family-owned businesses could take a special 

deduction—the qualified family-owned business-interest 

(QFOBI) deduction—to lower their estate taxes. Moreover, certain types of businesses can spread their tax payments over 15 years in some circumstances. For farmers, a 

special method of calculating the value of a family farm 

can lower the amount of estate tax owed. Finally, as the 

amount of assets exempt from taxation increases under 

EGTRRA, the estate tax will affect fewer small businesses 

and farms (at least until the law expires).

Possible Effects of the Estate Tax 

on Entrepreneurship

Economic studies have had limited success in identifying 

how the estate tax may influence the behavior of farmers 

and small-business owners. Those effects depend on the 

underlying motives of the individual entrepreneur, which 

are themselves unclear. At one extreme, if business owners 

or farmers leave estates only because they die before managing to spend all of their accumulated assets, the existence of the estate tax will have no impact on their entrepreneurial behavior. However, if they intend all along to 

leave estates and thereby pass on active businesses, the 

estate tax could affect how much they invest in their 

farms or businesses. Because the tax reduces the after-tax 

return on investment, it could lead people to invest less 

than they would otherwise (or leave them with less 

money to invest if they held assets in liquid form or 

bought life insurance to cover future estate tax pay1. The estate might also have to pay income taxes, but this analysis 

focuses only on estate taxes.
viii SUMMARY

ments). Conversely, because the tax reduces the net size of 

estates, people might choose to save and invest more to 

offset it.

Unfortunately, research into the estate tax has not reached 

strong conclusions about the relative strength of such 

incentives. A large body of research has, however, found 

that income taxes may discourage entrepreneurial effort. 

Because the estate tax can be seen as equivalent to an 

additional income tax, the observed reactions of farmers 

and business owners to the income tax suggest that the 

estate tax may also reduce entrepreneurial effort.

Affordability of the Estate Tax

Information about whether the estates of farmers and 

small-business owners can afford to pay estate taxes 

comes primarily from tax returns. CBO’s analysis examined data from estate tax returns filed in 1999 and 2000 

(the most recent data available when the analysis was conducted). Determining from tax returns what constitutes a 

family farm or small business is difficult, however. Returns identify the decedent’s occupation and industry, but 

those categories are broad. For lack of better identifiers, 

this analysis considered the estates of farmers to be those 

reporting an occupation of either farmer or farm worker 

(about 4,500 estates per year) and the estates of smallbusiness owners to be those claiming the QFOBI deduction (about 1,500 per year).

According to those definitions, the estates of farmers were 

smaller than the average estate in 1999 and 2000, and 

estates claiming the QFOBI deduction were generally 

larger than average. That situation, combined with the 

progressivity of the estate tax, meant that the typical effective tax rate for farmers (the share of wealth they paid 

in estate taxes) was lower than the average for all estates, 

whereas the typical effective tax rate for estates claiming 

the QFOBI deduction exceeded that average. 

The vast majority of estates, including those of farmers 

and small-business owners, had enough liquid assets to 

pay the estate taxes they owed. However, estates involving 

farms or small businesses were less likely than the average 

estate to have sufficient liquid assets to cover their estate 

taxes. In 2000, about 8 percent (or 138) of the estates of 

farmers who left enough assets to owe estate taxes faced a 

tax payment that exceeded their liquid assets, compared 

with about 5 percent of all estates that owed taxes. For 

estates claiming the QFOBI deduction, the corresponding figure was about 34 percent (or 164 estates). Those 

numbers are upper bounds, however, because the definition of liquid assets used on estate tax returns excludes 

some money held in trusts, which could also be used to 

pay estate taxes. 

For returns filed in 2000, the threshold for filing was 

gross assets worth at least $650,000 or $675,000, depending on the year of death—less than half the 2005 

level of $1.5 million. Had the current filing threshold 

been in effect in 2000, far fewer estates, especially those 

of farmers, would have had to file estate tax returns.

The scheduled expiration of EGTRRA in 2011 has 

engendered uncertainty and led to proposals that would 

permanently extend the higher exemption levels and 

lower tax rates in EGTRRA. This analysis looked at the 

effects of freezing the exemption level at three amounts: 

$1.5 million, $2.0 million, or $3.5 million. Any of those 

exemption levels, along with a 48 percent tax rate and a 

large QFOBI deduction, would substantially reduce the 

number of small businesses and farmers affected by the 

estate tax.
Effects of the Federal Estate Tax on

Farms and Small Businesses

The United States has had an estate tax since 1916, 

when the tax was imposed to offset a decline in tariff revenues caused by World War I.1

 Lawmakers have altered 

the estate tax many times, raising the top statutory rate to 

as much as 77 percent and increasing or decreasing the 

amount of assets exempt from taxation. Most recently, 

the Taxpayer Relief Act of 1997 (TRA-97) and the Economic Growth and Tax Relief Reconciliation Act of 2001 

(EGTRRA) modified the estate tax in ways that will 

cause it to change every year through 2011.

Under those laws, a unified credit applies to the sum of 

all taxable gifts made during a taxpayer’s lifetime plus the 

value of assets left at death.2

 In 2005, the credit effectively shelters up to $1.5 million from the unified estate 

and gift taxes.3

 Only estates worth more than that 

amount must file an estate tax return, a provision that 

leaves the vast majority of estates exempt—fewer than 2 

percent have to file returns. In calculating whether those 

estates owe estate taxes, various deductions and exemptions are permitted. For example, a surviving spouse can 

inherit an unlimited amount without paying taxes. That 

option, combined with the use of a “bypass trust,” allows 

married couples to double the amount of wealth that can 

go to their heirs without taxation.4

 Assets bequeathed to 

qualified charities are deductible from the value of the 

estate, as are such items as funeral expenses and executors’ 

commissions. The resulting net estate is subject to tax 

rates of 43 percent to 47 percent (depending on its size); 

if the amount of tax owed exceeds the unified credit, the 

estate must pay the excess.5 In recent years, just under 

half of the estates filing returns have been liable for estate 

taxes.

The amount of assets exempt from the estate tax has been 

raised—and the top tax rate reduced—in recent years 

under TRA-97 and EGTRRA. Those trends are scheduled to continue for the next five years (see Table 1). 

TRA-97 initially sheltered up to $600,000 from taxation, 

an amount that was scheduled to rise to $1 million by 

2006 before EGTRRA accelerated the increase. Under 

TRA-97, estate tax rates ranged from 37 percent to 55 

percent, although a 5 percent surtax on estates valued 

between $10 million and $17.184 million phased out the 

benefit of the unified credit, effectively raising the marginal tax rate (the rate on an additional dollar of wealth) 

to 60 percent for estates in that range.

1. For a history of the estate tax through 2000, see Joint Committee 

on Taxation, Description and Analysis of Present Law and Proposals 

Relating to Federal Estate and Gift Taxation, JCX-14-01 (March 

14, 2001).

2. Taxpayers are currently allowed to give $11,000 annually to each 

of any number of recipients without paying gift taxes (a threshold 

that rises by $1,000 for every 10 percent increase in the consumer 

price index). The unified credit applies to any gifts in excess of the 

annual limit.

3. Taxable gifts that cumulatively total more than $1 million are subject to gift taxes. At death, estate taxes are levied on the sum of 

cumulative taxable gifts and the value of the taxable estate. The 

estate tax liability on that sum is reduced by any gift taxes paid 

previously.

4. In essence, a trust is created at the first spouse’s death with assets 

equal to the amount exempt from taxation. The surviving spouse 

is the beneficiary of the trust, with the heirs becoming the beneficiaries when the surviving spouse dies. Because the size of the trust 

equals the exemption level, creation of the trust does not trigger 

the estate tax, and wealth above the exemption amount may be 

passed on to the spouse tax-free through the unlimited spousal 

deduction. When the surviving spouse dies, tax is due on the 

wealth bequeathed to heirs in excess of the exemption level, but 

none is due on the trust because it is not part of the second 

spouse’s estate.

5. For more details about the estate tax, see Jane G. Gravelle and 

Steven Maguire, Estate and Gift Taxes: Economic Issues, Report for 

Congress RL30600 (Congressional Research Service, updated 

June 24, 2005).
2 EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES

Table 1.

Scheduled Changes in Tax Rates and Exemption Amounts for Estate and 

Gift Taxes Under EGTRRA

Source: Congressional Budget Office.

Note: EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001; n.a. = not applicable.

a. Between 2002 and 2005, the credit for estate taxes levied by states was reduced by 25 percentage points each year and replaced by a 

deduction. Thus in 2005, estates could only deduct estate taxes paid to states. (See Box 1.)

b. Under EGTRRA, the estate tax will be repealed in 2010, and the maximum tax rate on gifts will equal the top individual income tax rate, 35 

percent.

c. Estates valued at $10 million to $17.184 million are subject to a maximum tax rate of 60 percent in order to eliminate the value of the 

exempt amount of assets. Estates valued at more than $17.184 million are taxed at an average rate of 55 percent.

Under EGTRRA, the maximum tax rate was lowered to 

50 percent in 2002; it is scheduled to fall to 45 percent 

by 2007. The amount of wealth exempt from taxation 

rose to $1 million in 2002 and $1.5 million in 2004 and 

will increase to $2 million in 2006 and $3.5 million in 

2009. In 2010, the estate tax will be eliminated. The following year, however, with the scheduled expiration of 

EGTRRA, the estate tax will be reinstated at the levels 

defined in TRA-97: an effective exemption of $1 million 

and a maximum tax rate of 55 percent. (EGTRRA also 

affected the estate taxes levied by many states; for details, 

see Box 1.)

Critics of the estate tax argue that it may pose a special 

hardship for families trying to pass along a farm or small 

business. This analysis evaluates the evidence of the tax’s 

effects on those operations, focusing on how it might influence the behavior of farmers and small-business owners during their lives and the extent to which their estates 

lack enough liquid assets to pay estate taxes. The analysis 

also looks at how raising the exemption amount would 

affect the number of estates that lack sufficient liquid

assets to cover their estate tax liabilities.

Provisions of the Estate Tax That

Affect Farms and Small Businesses

Lawmakers first made special provisions for small businesses under the estate tax in 1958 when the Small Business Tax Revision Act allowed some estates containing 

“closely held businesses” to pay their estate taxes over 10 

years.6

 Subsequent laws added other provisions targeted 

toward estates that include farms or small businesses.

B The Tax Reform Act of 1976 allowed estates to value 

farms and closely held businesses at their “current use” 

value rather than their “highest and best use” value, 

with the stipulation that heirs keep the property in its 

current use for at least 15 years. The law also extended 

to 14 years the period over which estates with closely 

held business assets could pay estate taxes.

2002a 41 50 1.0 50 1.0

2003a 41 49 1.0 49 1.0

2004a 43 48 1.5 48 1.0

2005a 43 47 1.5 47 1.0

2006 45 46 2.0 46 1.0

2007-2008 45 45 2.0 45 1.0

2009 45 45 3.5 45 1.0

2010b 0 0 n.a. 35 1.0

After 2010 41 55/60 c 1.0 55/60 c 1.0

(Percent) (Percent) (Millions of dollars) (Percent) (Millions of dollars)

Estate Tax Gift Tax

Lowest Tax Rate Highest Tax Rate Exemption Amount Highest Tax Rate Exemption Amount

6. A closely held business is defined as either a sole proprietorship or 

a partnership or corporation in which one-fifth of the business’s 

value is included in determining the gross estate or in which there 

are 45 or fewer owners. The value of the business is defined in 

terms of the total capital (for partnerships) or the voting stock (for 

corporations).
EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES 3

B The Economic Recovery Act of 1981 shortened to 10 

years the period during which heirs had to continue 

using farms or closely held businesses to be able to 

value assets at their current use and increased to 

$750,000 the maximum reduction from using that 

valuation; liberalized the conditions under which 

estates with closely held businesses could pay estates 

taxes over time; and extended the opportunity to pay 

taxes over time to certain holding companies.

B TRA-97 provided an exclusion of up to $675,000 for 

qualified family-owned business-interest (QFOBI) 

assets, in addition to the basic exclusion available to all 

estates.7

The current-use provisions in the 1976 law are one 

method whereby estates can lower their tax liability by 

discounting (claiming a reduced value of) assets that are 

subject to the estate tax. Another approach, which is particularly important to family farms and small businesses, 

involves minority discounts. Those discounts reflect the 

fact that a minority share in an ongoing business operation is generally worth less than the equivalent share of 

the market value of the whole business, because the 

majority owners can act in ways that adversely affect the 

value of the minority owner’s share. (For example, if the 

majority owners were also officers of the company, they 

could enact policies that would increase their income at 

the expense of minority owners’ assets.) Heirs to a family 

farm or small business often receive minority interests in 

the operation; in that case, the estate can reduce its tax 

liability by claiming minority discounts.

What Is a Small Business?

Examining how the estate tax affects small businesses is 

hampered by the lack of a clear consensus about what 

constitutes a small business. The Small Business Administration, for example, defines a small business as one that 

is “independently owned and operated” and that meets 

certain limits on the number of employees and average 

annual revenue. Those limits vary by industry, however, 

ranging from 100 to 1,500 employees and from 

$750,000 to $28.5 million in annual revenue.8

 Similar 

Box 1.

Estate Taxes Levied by States

In addition to the federal government, many states 

impose taxes on large estates. Prior to the enactment 

of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), every state and the 

District of Columbia levied a tax on estates that was 

at least equal to the amount of state-level estate taxes 

allowed as a credit on the federal estate tax return. 

Most states used that federal credit to determine the 

size of their estate tax levy: 32 states and the District 

of Columbia defined their tax levels on the basis of 

the federal tax credit in effect on the date of a person’s death, and five states used the federal credit in 

effect on a specific date. The other 13 states either 

assessed inheritance taxes on heirs or charged their 

own estate tax and used the federal credit as a minimum tax in cases in which the state tax was less than 

the federal credit.

EGTRRA phased out the federal credit for state estate taxes over four years, replacing it with a deduction in 2005. Eliminating the credit meant that state 

estate taxes would disappear for the 32 states and the 

District of Columbia that tied their tax directly to 

the federal credit. Seven of those states and the District acted to “decouple” their tax from the federal 

credit, redefining the levy to equal the federal credit 

on a date before the passage of EGTRRA. The other 

25 states allowed their estate taxes to phase out with 

the federal credit and thus are levying no state-level 

estate tax in 2005.

7. EGTRRA implicitly repealed the exclusion for family-owned 

business interests in 2004 because the amount of the effective 

exemption in that year—$1.5 million—exceeded the $1.3 million 

previously available to small businesses by combining the QFOBI 

and the general estate tax exemption. EGTRRA continued the 

provisions allowing special valuation and tax-deferral options for 

farms and small businesses, however.

8. See Small Business Administration, “Size Standards,” at http://

app1.sba.gov/faqs/faqindex.cfm?areaID=15.
4 EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES

variation exists in the standards used in the tax code: a 

small business can have gross receipts of no more than 

$500,000 for calculating certain excise taxes but up to 

$50 million for some stock sales.9

Laws governing the federal income tax establish three 

types of small businesses: S corporations, limited partnerships, and sole proprietorships. S corporations and limited partnerships are generally treated as “pass-through” 

entities, meaning that income from the business is taxed 

at the individual level, not the corporate level. An S corporation may have no more than 35 owners of its stock; 

no such limit exists for a limited partnership. A sole proprietorship is any taxpayer who has income from a business and files a Schedule C along with his or her federal 

income tax return. Sole proprietors must pay payroll taxes 

(both the employer’s and employee’s shares) on their earnings but may use business and home-office deductions 

not available to regular wage and salary workers.10

Laws governing the federal estate tax define two forms of 

small businesses: family-owned businesses (which are eligible for the QFOBI deduction) and closely held businesses. A family-owned business must satisfy a lengthy set 

of requirements on ownership and income (see Box 2). A 

closely held business has no constraints on its size but 

faces other limits. All sole proprietorships qualify as 

closely held businesses, but partnerships and corporations 

must meet one of two requirements: the estate must own 

at least 20 percent of the business’s value or the business 

must have no more than 45 partners or shareholders.

The variety of definitions and forms of small business 

that exist precludes a comprehensive examination of the 

effect of the estate tax on small businesses. Instead, this 

analysis examines the business forms that have been previously studied or for which data are available. For example, when using data from tax returns, the analysis defines 

a small business as one for which an estate claimed a 

QFOBI deduction.

Potential Effects of the Estate Tax 

on the Behavior of Farmers 

and Business Owners

How farmers and owners of small businesses react to the 

estate tax is a central consideration in determining its 

effects. One possibility is that, like others who do not 

expect their estates to be large enough to be subject to the 

tax, people in those groups do not alter their behavior in 

response to the estate tax. Alternatively, like others who 

expect to owe the tax, they may choose to save more than, 

less than, or the same as they would have otherwise. In 

addition, they may have different motives than the rest of 

the population or face different incentives as a result of 

the targeted provisions of the estate tax. Little direct evidence exists about the effects of the estate tax on entrepreneurial effort. However, like the income tax, the estate tax 

may reduce business investment and hiring by farmers 

and business owners to some degree and thus slow the 

rate of growth of their enterprises. 

Why Do People Accumulate Assets?

The estate tax potentially reduces the inheritance available to heirs. Whether the tax affects decisions about how 

much to work and save depends on people’s motives. At 

one extreme, people may save only to meet their own 

retirement needs and leave estates because they unintentionally fail to spend all of their assets. In that case, estates 

will not play a role in their planning, so they should act 

no differently in the face of the estate tax. At the other 

extreme, people may intend to leave the largest possible 

estate to their heirs. In that case, by raising the cost of 

leaving assets to heirs, the estate tax may lead them to 

work, save, and invest less during their life. Or, by reducing the after-tax size of the inheritances that heirs receive, 

it may lead such savers to work, save, and invest more to 

compensate for the loss to taxes. 

Observed behavior offers mixed evidence about people’s 

motives in regard to their potential estates. On the one 

hand, the very existence of bequests—intentional or 

otherwise—may argue that saving is not driven solely by 

one’s needs during one’s lifetime. People can purchase 

annuities, which give them regular payments until death 

and leave nothing to their heirs, or reverse mortgages, 

which provide them with a stream of income in life at the 

expense of not passing their home equity on to their

9. See Joint Committee on Taxation, Overview of Present Law and 

Selected Proposals Regarding the Federal Income Taxation of Small 

Business and Agriculture, JCX-19-0 (March 2001).

10. C corporations are omitted here because they have no limit on 

their number of shareholders and are not pass-through entities. 

Another type of business, a limited liability corporation, is defined 

by state law and may be a partnership or an S corporation.
EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES 5

heirs.11 The infrequency with which people choose those 

investments (even in light of their costs from adverse 

selection) suggests that individuals accumulate assets with 

the intention of leaving bequests.

On the other hand, surveys of the wealthy indicate that 

passing on assets to heirs is not their primary reason for 

saving.12 Moreover, people who want to maximize their 

bequests should act to minimize the estate and gift taxes 

they will pay. But analysis has shown that many individuals fail to take obvious steps to reduce those taxes; for 

example, many people whose estates will be taxed do not 

use the annual gift tax exemption of $11,000 per recipient per donor.13

Box 2.

How the Estate Tax Defines a Family-Owned Business 

To qualify as a family-owned business—and thus be 

able to claim the qualified family-owned businessinterest (QFOBI) deduction on an estate tax return—a business owned at least partly by an estate 

must be either a sole proprietorship or an entity to 

which one of the following three conditions applies: 

B At least 50 percent of the entity is owned by the 

decedent or members of the decedent’s family; 

B At least 70 percent of the entity is owned by 

members of two families, and at least 30 percent 

is owned by the decedent or members of the decedent’s family; or 

B At least 90 percent of the entity is owned by 

members of three families, and at least 30 percent 

is owned by the decedent or members of the decedent’s family.

The business must satisfy other requirements as well:

B It cannot have been publicly traded within three 

years of the decedent’s death. 

B No more than 35 percent of the business’s adjusted ordinary gross income for the year of the 

decedent’s death can be income from a personal 

holding company. 

B The decedent must have been a citizen or resident 

of the United States at the date of death, and the 

business must be located in the United States.

B The business interest must be includable in the 

gross estate.

B The interest must have passed to or been acquired 

by a qualified heir from the decedent. 

B The adjusted value of the qualified family-owned 

business interest must exceed 50 percent of the 

adjusted gross estate. (That value is reduced to the 

extent that the business holds passive assets or excess cash or marketable securities.)

B The decedent or a member of the decedent’s family must have owned the business for five of the 

eight years before the decedent’s death. In addition, the decedent’s family must have materially 

participated in the business for five of those eight 

years.

11. See Edward J. McCaffery, “Grave Robbers: The Moral Case 

Against the Death Tax,” Tax Notes, vol. 85, no. 11 (December 13, 

1999), pp. 1429-1443.

12. See Christopher Carroll, “Why Do the Rich Save So Much?” in 

Joel Slemrod, ed., Does Atlas Shrug? The Economic Consequences of 

Taxing the Rich (New York: Russell Sage and Harvard University 

Press, 2000), pp. 465-484.

13. Because $11,000 may be passed by each parent to each heir taxfree, two parents leaving an estate to two heirs could give them up 

to $44,000 per year without taxation. However, parents typically 

give far less than that maximum. See James Poterba, “Estate and 

Gift Taxes and Incentives for Inter Vivos Giving in the United 

States,” Journal of Public Economics, vol. 79, no. 1 (January 2001), 

pp. 237-264; and Kathleen McGarry, “The Cost of Equality: 

Unequal Bequests and Tax Avoidance,” Journal of Public Economics, vol. 79, no. 1 (January 2001), pp. 179-204.
6 EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES

Lessons from the Income Tax

The estate tax could affect farmers and business owners 

differently from other people because of the business 

aspects of their wealth accumulation. In one survey, 

some small-business owners stated that the high levels of 

the estate tax were powerful disincentives to invest and 

hire new employees.14 Economic studies of the estate tax 

have not reached strong conclusions about its effects on 

entrepreneurial behavior. However, estate taxes reduce 

after-tax returns on investment just as income taxes do, 

and a large body of research suggests that the income tax 

discourages entrepreneurial effort to some degree.15

To cast the burden of the estate tax in a more familiar 

form, the Congressional Budget Office (CBO) translated 

the estate tax into its income tax equivalent. That translation involved calculating what income tax rate, if applied 

annually to an entrepreneur’s income for a certain number of years, would result in the same amount of assets 

after death as an estate tax with a flat 43 percent rate (the 

lowest applicable rate in 2005 under EGTRRA). Although actual situations would be complicated by issues

Table 2.

Income Tax Rates Equivalent to a 

43 Percent or 14 Percent Estate Tax

(Percent)

Source: Congressional Budget Office.

Note: Each entry equals the annual income tax rate imposed on 

capital income that would yield the same total asset value at 

death as assets subject to an estate tax of either 43 percent 

or 14 percent (but not subject to income taxes), assuming a 

given rate of return on capital and a given life expectancy.

a. The minimum estate tax rate in 2005.

b. The typical estate tax that estates would have owed had the tax 

rates of 2005 been in effect in 2000.

such as a person’s reason for leaving an estate and by 

uncertainty about when the person will die, CBO made 

several simplifying assumptions for the analysis: that all 

income is invested at a fixed rate of return, that all returns 

are reinvested in the farm or business, and that the owner 

knows when he or she will die. Applying that translation 

to predicted estate taxes, as calculated using a simplified 

version of CBO’s estate tax model, provides estimates of 

the equivalent income tax rates that an entrepreneur 

faces. (The appendix explains CBO’s method in more 

detail.)

In some circumstances, the estate tax is equivalent to a 

high marginal income tax rate. For example, a 31 percent 

income tax imposed annually on earnings from an investment that yielded 6 percent a year for 20 years would 

result in the same after-tax wealth as a 43 percent tax on 

that investment 20 years from now (see Table 2). Thus, 

for a person who expects to live 20 years, a 43 percent 

estate tax is equivalent to a 31 percent income tax (assuming a 6 percent rate of return).16

Higher rates of return and longer life spans are both 

associated with lower income tax rates, because deferring 

14. See Joseph H. Astrachan and Robert Tutterow, “The Effect of 

Estate Taxes on Family Business: Survey Results,” Family Business 

Review, vol. 9, no. 3 (September 1996), pp. 303-314.

15. See Donald Bruce, “Effects of the United States Tax System on 

Transitions into Self-Employment,” Labour Economics, vol. 7, 

no. 5 (2000), pp. 545-574; Robert Carroll and others, “Personal 

Income Taxes and the Growth of Small Firms,” in James Poterba, 

ed., Tax Policy and the Economy (Cambridge, Mass.: MIT Press, 

2001), pp. 121-147; Robert Carroll and others, “Entrepreneurs, 

Income Taxes and Investment” in Joel Slemrod, ed., Does Atlas 

Shrug? The Economic Consequences of Taxing the Rich (New York: 

Russell Sage and Harvard University Press, 2000), pp. 427-455; 

Robert Carroll and others, “Income Taxes and Entrepreneurs’ Use 

of Labor,” Journal of Labor Economics, vol. 18, no. 2 (2000), 

p. 324-351; Julie B. Cullen and Roger H. Gordon, Taxes and 

Entrepreneurial Activity: Theory and Evidence in the U.S., Working 

Paper No. 9015 (Cambridge, Mass.: National Bureau of Economic Research, June 2002); Robert W. Fairlie and Bruce D. 

Meyer, “Trends in Self-Employment Among White and Black 

Men: 1910-1990,” Journal of Human Resources, vol. 35, no. 4 

(2000), pp. 643-669; William M. Gentry and R. Glenn Hubbard, 

“Tax Policy and Entry Into Entrepreneurship” (draft, June 2004); 

Douglas Holtz-Eakin, John W. Phillips, and Harvey S. Rosen, 

“Estate Taxes, Life Insurance and Small Business,” Review of Economics and Statistics, vol. 83, no. 1 (February 2001), pp. 52-63; 

David Joulfaian and Mark Rider, “Differential Taxation and Tax 

Evasion by Small Business,” National Tax Journal, vol. 51, no. 4 

(December 1998), pp. 676-687; and Herbert J. Schuetze, “Taxes, 

Economic Conditions and Recent Trends in Male Self-Employment: A Canada-U.S. Comparison,” Labour Economics, vol. 7, 

no. 5 (2000), pp. 507-544. 16. By comparison, the top statutory income tax rate is 35 percent.

Rate of 20 Years 30 Years 20 Years 30 Years

Return Until Until Until Until 

on Capital Death Death Death Death

6 31 26 9 7

8 28 22 8 6

10 25 19 7 5

Estate Taxa Estate Taxb

43 Percent 14 Percent
EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES 7

taxes rather than paying them annually yields benefits. 

Under an income tax, realized returns from an investment are taxed before they are reinvested, whereas the 

estate tax only taxes those returns at the end of the 

owner’s life. In essence, returns grow on a “pretax” basis 

with respect to the estate tax, yielding a greater after-tax 

estate than would a tax of the same rate that was applied 

as returns were reinvested. A greater rate of return increases that gap, so a given estate tax translates into a 

lower equivalent income tax when rates of return are 

higher.17 For example, a life expectancy of 30 years and a 

rate of return of 6 percent suggest an equivalent income 

tax of 26 percent (see Table 2). But a 10 percent rate of 

return—about the annual nominal increase in stock 

indexes since World War II—over 30 years suggests an 

equivalent income tax of 19 percent.

Looking at the income tax rates implied by a 43 percent 

estate tax is appropriate for entrepreneurs whose net 

worth is already large enough that their estates would 

incur tax liability if they died immediately, because every 

additional dollar they saved would be taxed at a marginal

rate of 43 percent or more under the estate tax. Many 

farms and small businesses are currently worth less than 

$1.5 million, however, and owners of those enterprises 

would face no estate tax were they to die immediately. If 

the owner’s decision to reinvest in the farm or business 

determines whether an estate will exceed the filing threshold for the estate tax, then the average tax rate may be a 

more appropriate comparison than the marginal tax rate. 

Had the estate tax rates of 2005 been in effect in 2000, 

the typical estate tax (for those owing tax under current 

exemptions and rates) would have been about 14 percent 

of the gross estate. That rate implies much lower income 

tax rates for every rate of return (see Table 2). For example, a person expecting to live 20 years and earning a 6 

percent return faces estate taxes equivalent to an income 

tax of 9 percent; with a life expectancy of 30 years and a 

10 percent rate of return, the estate tax is equivalent to 

only a 5 percent income tax.

A more realistic picture comes from simulating equivalent 

income tax rates using information on actual estates that 

filed estate tax returns in 2000 and claimed QFOBI 

deductions. The question posed in that analysis is, What 

income tax rate applied to an investment made earlier in 

a decedent’s life would yield the same after-tax wealth at 

the time of death as the person’s actual estate, net of estate 

taxes? To simulate that rate, CBO assumed that the person invested an amount at age 45 large enough to grow, 

by 4 percent annually, to the gross estate reported on the 

estate tax return.18 The analysis suggests that under 2000 

estate tax law, two-thirds of such estates with gross assets 

of more than $675,000 (the filing threshold that year) 

would have owed no estate taxes, so the equivalent income tax for them was zero. On average for all such 

estates filing returns in 2000, estate taxes were equivalent 

to a 4 percent income tax applied annually over the simulated investment period. For only those estates with estate 

tax liability, the average equivalent income tax rate was 11 

percent, and the median rate was 9 percent.

The estate tax differs from the income tax in that it comes 

due not at a fixed date but rather at an unknown time in 

the future. Because the returns and assets of an enterprise 

vary over time, the amount of estate tax due also varies.19

That variation could be particularly risky for a farmer or 

business owner: if the estate does not hold enough liquid 

assets to pay the estate tax, then heirs could be forced to 

sell the farm or business.

That problem can be ameliorated with life insurance, 

although predicting what the value of the business will be 

at the time of the owner’s death may be difficult.20 However, the proceeds from life insurance are themselves 

subject to estate taxes, unless owners employ devices such 

as an irrevocable life insurance trust.21 Alternatively, a 

farmer or business owner might elect to keep enough liquid assets on hand to pay the estate tax, providing greater

17. The inverse relationship between rate of return and equivalent 

income tax rate also implies that to the extent that higher rates of 

return are associated with greater risk, an estate tax encourages 

risk-taking more than an income tax does.

18. With no knowledge of the amount or timing of actual investments, CBO assumed that the person made the full investment at 

age 45 and reinvested all returns in the farm or business. If death 

occurred before age 55, the analysis assumed that the investment 

took place 10 years before death. In all cases, the simulation 

assumed a 4 percent annual rate of return, roughly the historical 

average. 

19. See James Poterba, “The Estate Tax and After-Tax Investment 

Returns,” in Joel Slemrod, ed., Does Atlas Shrug? The Economic 

Consequences of Taxing the Rich (New York: Russell Sage and Harvard University Press, 2000), pp. 329-349.

20. See Douglas Holtz-Eakin, John W. Phillips, and Harvey S. Rosen, 

“Estate Taxes, Life Insurance and Small Business,” Review of Economics and Statistics, vol. 83, no. 1 (February 2001), pp. 52-63.

21. Such devices must be used with caution because a business owner 

cannot borrow against an irrevocable life insurance trust, even if 

the survival of the business is at stake.
8 EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES

flexibility in access to funds. Whether through life insurance premiums or personal saving, paying the estate tax 

can be translated from a lump-sum payment into a series 

of expenditures similar to regular income tax payments.22

Affordability of the Estate Tax

Unlike the issue of whether the estate tax influences 

behavior, which must be examined through surveys and 

economic modeling, the issue of whether estates can 

afford to pay taxes can be addressed using more-concrete 

data. The estate tax return that must be filed within nine 

months of a person’s death (if the gross value of the estate 

exceeds the filing threshold) contains a variety of information: the value of the estate before and after various 

credits and deductions; the decedent’s occupation and 

industry; and the estate’s assets, such as personal residence, business assets, liquid assets, and so forth. CBO 

used data from estate tax returns filed in 1999 and 2000 

(the most recent years for which data were available when 

the analysis was conducted) to compare the size of estates 

left by farmers and small-business owners with those of 

the population at large and to compare estates’ tax liability with their liquid assets. 

Box 3.

Estimating the Number of Estates Belonging to Farmers 

Along with using the number of estates claiming the 

qualified family-owned business-interest deduction 

to indicate small businesses, the Congressional Budget Office used two methods to estimate the number 

of farmers represented on estate tax returns. The 

broader measure defined a farmer as anyone who was 

reported to have worked in the “agricultural crop” or 

“livestock” industry or anyone whose occupation was 

listed as “nonhorticultural farmer,” “farm worker,” 

“farm supervisor,” or “farm manager.” That definition included people not usually considered farmers, 

such as bookkeepers and secretaries working for 

dairy farms, investors in farm real estate, and commodity brokers. The narrower measure defined a 

farmer as anyone who worked in one of those two 

industries and had one of those four occupations. 

The two definitions yielded similar samples of estates 

(see the table at right).

Even that narrower definition may be far too broad, 

however: almost 40 percent of the estates in that 

sample reported no farm assets. Defining a farmer 

only as a nonhorticultural farmer working in the 

agricultural crop or livestock industry would substantially reduce the number of estates but not alter 

the conclusions of the analysis. Similarly, defining a 

farmer’s estate as one in which farm assets accounted 

for at least 35 percent of the gross value of the estate 

would not qualitatively change the conclusions. 

(That definition would result in a sample size of 

about 5,500 estates in 2000.) Further, some estates 

may have listed farm assets in other categories, such 

as limited partnership assets. Because only the largest 

estates are required to file returns, the estates considered in this analysis belong to wealthy people in 

farming industries, not to subsistence farmers or 

migrant workers. 

Gross Estates of Farmers in 2000

Source: Congressional Budget Office based on data from the 

Internal Revenue Service’s Statistics of Income files.

a. The distance between the 75th percentile and the 25th 

percentile.

5,308 4,641

Average 1,814,000 1,801,000

Median 987,000 982,000

Standard deviation 19,737,000 20,861,000

Interquartile rangea 647,000 640,000

5th percentile 660,000 664,000

95th percentile 3,182,000 3,035,000

Total Number of Estates

Gross Value of Estate (Dollars)

Sample Sample

Broad Narrow

22. Note that money allocated to paying estate taxes does not leave 

the economy, so there is little change in economic activity. Life 

insurance premiums and money deposited in financial institutions 

are both loaned and invested.
EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES 9

Several factors complicate those comparisons. First, the 

distribution of estates filing estate tax returns is extremely 

asymmetrical. The average size of an estate filing a return 

may therefore be a misleading indicator of the overall 

group, because a small number of very large estates can 

dramatically raise the average. For that reason, this analysis reports not only averages but also medians (the midpoint of a distribution) and other percentile statistics that 

shed more light on the distribution of estates. 

Second, the information about occupation, industry, and 

assets reported on estate tax returns makes it difficult to 

identify whether a decedent owned a family farm or small 

business. Thus, CBO had to make assumptions in classifying estates, and those classifications are only approximate (see Box 3 for more details). For the purposes of this 

analysis, a small-business estate is defined as one claiming 

a QFOBI deduction—about 1 percent of the estates filing returns in 2000.23 A farm estate is one in which the 

decedent is identified as a “farmer” or “farm worker” of 

any kind—about 4 percent to 5 percent of estates filing 

returns. Because of those data limitations, CBO’s analysis 

may have omitted some estates that contained small businesses and may have included too few or too many family 

farms. 

Characteristics of Estates Filing Returns 

in 1999 and 2000

The distribution of assets reported on estate tax returns is 

highly skewed. In all, about 104,000 estates, with an 

average worth of $1.9 million, filed returns in 1999, and 

about 108,000 estates, with an average worth of $2.0 million, filed returns in 2000 (see Table 3). Those average 

values do not represent the typical estate: 80 percent of 

the estates that filed returns were worth less than the average.24 The median estate filing a return had a net worth 

of about $1.0 million in 1999 and in 2000. (The filing

Table 3.

Characteristics of Estates That Filed 

Estate Tax Returns in 1999 or 2000

Source: Congressional Budget Office based on data from the 

Internal Revenue Service’s Statistics of Income files.

Note: Estates are subject to the tax law in effect in the year of 

death, but they do not have to file estate tax returns until 

nine months after the date of death. As a result, returns filed 

in a given year may be subject to different tax law. Returns 

filed in 1999 or 2000 could claim different effective exemptions, depending on the date of death: $625,000 for 1998, 

$650,000 for 1999, or $675,000 for 2000.

a. The distance between the 75th percentile and the 25th percentile.

b. CBO included only estates that owed taxes on the estate remaining at death. Estates that had paid gift taxes but did not owe 

additional estate taxes upon death were excluded. There were 

fewer than 500 such estates in 2000.

23. CBO used that definition rather than sole proprietorship because 

although it is possible to identify sole proprietors from income tax 

returns, the same is not the case with estate tax returns. Those 

returns need not note the presence of a Schedule C in a decedent’s 

final income tax filing, and the required reporting of types of 

assets in an estate cannot reliably identify all sole proprietors.

24. That asymmetry can be seen another way: the 5th percentile of 

estates filing returns in 1999 was about $648,000, meaning that 

95 percent of estates filing returns were at least that large. If the 

distribution of assets was symmetrical, the 95th percentile would 

be about $1.35 million; that is, only 5 percent of estates would 

exceed that amount. The actual 95th percentile is $4.7 million.

103,993 108,322

Average 1,899,000 2,024,000

Median 1,027,000 1,092,000

Standard deviation 8,770,000 10,016,000

Interquartile rangea 861,000 888,000

5th percentile 648,000 684,000

95th percentile 4,700,000 4,924,000

49,869 52,000

Average 2,410,000 2,540,000

Median 1,171,000 1,231,000

Standard deviation 12,087,000 13,787,000

Interquartile rangea 1,037,000 1,077,000

5th percentile 726,000 753,000

95th percentile 6,207,000 6,358,000

Average 460,000 469,000

Median 125,000 131,000

Standard deviation 2,360,000 1,939,000

Interquartile rangea 304,000 306,000

5th percentile 7,000 6,000

95th percentile 1,682,000 1,762,000

Total Number of Estates

Gross Value of Estate (Dollars)

Total Number of Estates

1999 2000

Estates Filing Tax Returns

Estates Owing Estate Tax

b

Gross Value of Estate (Dollars)

Amount of Tax Paid (Dollars)
10 EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES

Table 4.

Estates Filing Estate Tax Returns in 1999 or 2000, by Decedent’s Marital Status

Source: Congressional Budget Office based on data from the Internal Revenue Service’s Statistics of Income files.

thresholds in those years ranged from $625,000 to 

$675,000, depending on a person’s year of death.)

More than half of the estates filing returns in 1999 and 

2000 had a net value that was too low to owe any estate 

tax. The most common reason was the unlimited spousal 

bequest: almost three-quarters of decedents whose estates 

owed no tax were married. (See Table 4 for information 

on the marital status of decedents whose estates filed 

returns.) Fewer than half of estates that filed a return 

owed any tax, and those estates were generally larger than 

ones with no tax liability. The average size of those estates 

was $2.4 million in 1999 and $2.5 million in 2000, with 

median values about half as large (see Table 3). On average, their tax payments were about $460,000 in 1999 

and $469,000 in 2000. The median payment was much 

smaller: about $125,000 in 1999 and $131,000 in 

2000.25 The relatively large difference between the average tax paid and the median tax paid reflects the topheavy distribution of estates and the progressivity of the 

estate tax. 

Because the estate tax is progressive, larger estates pay a 

disproportionate share of estate taxes. In 1999, for example, the bottom 20 percent of estates that filed returns accounted for only about 7 percent of the total gross value 

of estates filing returns (see Figure 1). That bottom 20 

percent of estates paid less than 1 percent of total estate 

taxes collected. Likewise, the top 50 percent of estates 

accounted for 79 percent of the gross value and paid 96 

percent of the taxes. Even within that group, the distribution of wealth and estate taxes was extremely uneven. The 

richest 10 percent of estates filing returns held 45 percent 

of the wealth and paid two-thirds of the taxes, and the 

richest 2 percent of estates (those larger than $8.6 million) owned about 25 percent of the wealth and paid 

about 40 percent of all estate taxes.26 (Total estate tax 

collections were $22.9 billion in 1999 and $24.4 billion 

in 2000.)27

As noted above, tax laws allow wide variation in the size 

of a small business—when size limits exist at all—which 

means that there is no inherent reason to presume that 

the typical estate of a small-business owner that files an 

estate tax return will be either smaller or larger than the 

typical estate filing a return. Moreover, although about 6 

percent of estate tax returns report farming, forestry, or 

fishing as the decedent’s occupation, and a similar share 

lists agricultural production as the decedent’s industry 

(see Table 5), nothing in the definitions of those terms 

limits them to either small family farms or large agribusinesses.

In 2000, estates that claimed the QFOBI deduction were 

larger than a typical estate: their average value was $3.1 

million (compared with $2.0 million for all estates filing 

returns), and their median value was $1.3 million (compared with $1.1 million for all estates). By contrast, people identified as farmers or farm workers left estates that 

were smaller than a typical estate: an average value of $1.8

8,151 8,726 5,301 6,060

45,378 48,198 6,078 5,824

44,948 46,164 34,535 36,307

5,516 5,234 3,956 3,808 _______ _______ ______ ______

Total 103,993 108,322 49,869 52,000

Widowed

Separated, Divorced, or Unknown

Estates Filing Tax Returns Estates Owing Estate Tax

Never Married

Married

1999 2000 1999 2000

25. In those years, the average tax payment equaled 13 percent of the 

value of the estate, and median payment equaled 10 percent.

26. It is important to note that those statistics include only the wealth 

of estates filing returns—a small fraction of all personal wealth in 

the United States.

27. Barry W. Johnson and Jacob M. Mikow, “Federal Estate Tax 

Returns, 1998-2000,” Statistics of Income Bulletin (Spring 2002), 

Figure M, p. 145, available at www.irs.gov/pub/irs-soi/00esart. 

pdf.
EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES 11

Figure 1.

Distribution of Gross Value and 

Estate Tax Liability of Estates Filing 

Estate Tax Returns in 1999

(Percent)

Source: Congressional Budget Office based on data from the 

Internal Revenue Service’s Statistics of Income files.

Note: The Lorenz curves shown here sort estates by size from 

smallest to largest and show the cumulative percentage of 

gross value or taxes for each cumulative percentage of 

estates. For example, the bottom 50 percent of estates filing 

returns accounted for about 20 percent of the gross value of 

estates filing returns (Point A) and paid about 4 percent of 

total estate taxes (Point B).

million in 2000 and a median value of $987,000 (see 

Table 6).

Although several provisions of estate tax law can reduce 

the burden on farms and family businesses, few estates 

took advantage of them in 1999 or 2000. CBO estimates 

that about 600 estates employed the special-use valuation 

of assets in 1999; that figure rose to about 1,100 estates 

in 2000. Slightly fewer than 900 estates used the QFOBI 

deduction in 1999, and almost 1,500 used it in 2000. 

Between 500 and 700 estates deferred their taxes in 1999 

and 2000. 

The number of estates that claimed minority discounts 

on business assets in 2000 was much larger: just over 

8,000. Many of the discounts appear to have been used 

by estates with small-business or farm assets (see Table 7). 

Closely held stock was the asset most commonly discounted and also had the highest average discount in dollar terms ($670,000). The largest average percentage discount (51 percent) was taken for undeveloped land or 

farmland, although those assets had the smallest average 

discount in dollars ($67,000). Those numbers are somewhat unreliable, however, because some estates may have 

used minority discounting informally without recording 

it on their estate tax return, and some may have established limited partnerships for reasons unrelated to a 

small business.

Even among estates that claimed the QFOBI deduction, 

little is known about the nature of the small business, and 

those estates varied widely in the types of assets they reTable 5.

Common Occupations and Industries 

of Decedents Whose Estates Filed 

Estate Tax Returns in 2000

Source: Congressional Budget Office based on data from the 

Internal Revenue Service’s Statistics of Income files.

0

10

20

30

40

50

60

70

80

90

100

0 10 20 30 40 50 60 70 80 90 100

Gross Value

of Estates

Estate Tax

Paid

A

B

($600,000)

($679,000)

($744,000)

($813,000)

($908,000)

($1,027,000)

($1,207,000)

($1,465,000)

($1,887,000)

($2,936,000)

Gross Value

Professional Specialty Occupations 30

Executive and Managerial Occupations 27

Sales Occupations 17

Administrative Support Occupations 9

Farming, Forestry, and Fishing Occupations 6

Precision Production, Craft, and Repair Occupations 4

Operators, Fabricators, and Laborers 2

Technicians 2

Service Occupations 2

Military 1

Professional and Related Services 29

Manufacturing 15

Finance, Insurance, and Real Estate 14

Retail Trade 12

Public Administration 7

Agricultural Production 6

Transportation, Communications, Utilities 6

Construction 5

Wholesale Trade 2

Personal Services 2

Entertainment and Recreational Services 1

Mining 1

Forestry, Fisheries, and Agricultural Services 1

Percentage

of Total

Occupation

Industry
12 EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES

Table 6.

Characteristics of Farmers’ and Small-Business Owners’ Estates 

That Filed Estate Tax Returns in 2000

Source: Congressional Budget Office based on data from the Internal Revenue Service’s Statistics of Income files.

Note: QFOBI = qualified family-owned business interest.

a. Using the broad sample discussed in Box 3.

b. The distance between the 75th percentile and the 25th percentile. 

ported. For example, in 2000, only about one-third of 

estates claiming a QFOBI deduction owned closely held 

stock, and just over half had any farm assets. Only 8 percent showed limited partnership assets, and just 12 percent reported “other non-corporate business assets.”28

About 8 percent of the QFOBI estates reported none of 

those types of assets. Of farmers’ estates, about two-thirds 

reported farm assets, and nearly four-fifths included 

undeveloped land or farmland.

Estates with Insufficient Liquid Assets 

to Pay the Estate Tax

About 5 percent of the estates that owed estate taxes in 

1999 or 2000 had a tax liability that exceeded their liquid 

assets (such as bonds, corporate stock, bank accounts, 

and insurance). That result is perhaps not surprising 

given that liquid assets made up more than 60 percent of 

the wealth of estates filing returns in those years (see 

Figure 2), whereas the estates that owed taxes faced effective tax rates that were much lower than that: an average 

rate of 13 percent and a median rate of 10 percent.29 The 

large proportion of wealth held as liquid assets relative to 

the effective tax rate suggests that many estates may have 

been able to pay their estate taxes without liquidating 

business assets or personal residences (which constituted 

22 percent and 7 percent, respectively, of the wealth of all 

estates filing returns). Moreover, the definition of liquid 

assets used on estate tax returns excludes money held in 

certain types of trusts, such as life insurance trusts, that 

could be used to pay estate taxes. Thus, 5 percent was the 

maximum share of total estates with liquidity problems in 

those years.

For farmers, business assets made up a much larger proportion of estates’ wealth: 51 percent in 1999 and 43 percent in 2000. Liquid assets made up a smaller, but still 

substantial, share of their estates: just over 40 percent in 

both years. That smaller proportion of liquid assets suggests that estate taxes may be more likely to exceed liquid 

assets for estates of farmers, potentially requiring estates 

to liquidate other assets. However, farm estates are generally small, and the estate tax therefore consumes a smaller 

percentage of the gross estate (an average of 11 percent 

and a median of 9 percent in 2000). In fact, tax data 

show that in 1999, about 12 percent of farmers’ estates 

that owed estate taxes faced a liability greater than their 

liquid assets. In 2000, the corresponding figure was 8 

percent.

108,322 5,308 1,469

Average 2,024,000 1,814,000 3,122,000

Median 1,092,000 987,000 1,346,000

Standard deviation 10,016,000 19,737,000 22,630,000

Interquartile rangeb 888,000 647,000 1,276,000

5th percentile 684,000 660,000 726,000

95th percentile 4,924,000 3,182,000 7,605,000

Total Number of Estates

Gross Value of Estate (Dollars)

Estates Claiming 

Estates of Farmersa

All Estates Filing

Tax Returns QFOBI Deduction

28. Assets of that type are defined as “assets identified as used in an 

enterprise owned by the decedent/donor, either as a sole proprietor, or as a partner in a business partnership.”

29. Those effective tax rates are measured as the amount of estate tax 

owed as a percentage of the gross estate.
EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES 13

Table 7.

Minority Discounts Claimed by Estates Filing Estate Tax Returns in 2000, 

by Type of Asset

Source: Congressional Budget Office based on data from the Internal Revenue Service’s Statistics of Income files.

That situation is more pronounced for estates claiming 

the QFOBI deduction. Business assets made up at least 

75 percent of those estates’ wealth, on average.30 In addition, the average tax owed was a higher percentage of the 

gross estate for those estates than for estates in general (14 

percent compared with 13 percent for all estates filing 

returns). As a consequence, one-third of estates claiming 

the QFOBI deduction and owing taxes in 2000 could 

not pay the estate tax out of their reported liquid assets. 

As before, the fact that liquid assets do not include some 

trusts means that that figure represents the maximum 

number of estates with insufficient liquid assets to pay the 

estate tax.

Effects of Permanently Raising 

the Exemption Amount

As noted above, the estate tax is scheduled to be phased 

out under EGTRRA until it is eliminated in 2010, but 

then it will be reinstated in 2011. Rather than follow that 

schedule, lawmakers could freeze the parameters of the 

estate tax at levels set for years before 2010. CBO looked 

at the effects of keeping the tax rate at 48 percent (the top 

rate in 2004) and freezing the amount of assets exempt 

from taxation at either $1.5 million (the level for 2004 

and 2005), $2 million (the level that will apply from 

2006 through 2008), or $3.5 million (the level set for 

2009).

Had any of those exemption amounts been in effect in 

2000, far fewer estates would have needed to file estate 

tax returns (see Table 8). With an exemption level of $1.5 

million, about 34,000 estates (rather than 108,000) 

would have had to file a return; with a $2 million exemption, about 21,000 would have filed; and under a $3.5 

million exemption, about 9,000 would have filed. The 

reductions in the number of estates actually owing taxes 

would have been similar. Moreover, with an exemption 

level of $1.5 million, only 740 estates would have had 

insufficient liquid assets to pay the estate tax. That number would have fallen below 200 if the exemption level 

had been $3.5 million. (Again, those totals probably 

overestimate the number of estates with taxes in excess 

of liquid assets because they do not reflect money held in 

trusts.)

Those higher exemption amounts would have an even 

greater impact on farmers. Had the exemption level been 

$1.5 million, only about 1,000 estates of farmers (rather 

than 4,600) would have had to file. That number would 

have dropped below 200 if the exemption level had been 

$3.5 million. Fewer than 15 of those estates would have

Asset

Closely Held Stock 3,413 670 30

Limited Partnerships 1,304 542 33

Residential Real Estate 1,193 126 16

Undeveloped Land or Farmland 1,183 67 51

Real Estate Partnerships 1,091 346 28

Personal Residence 676 80 18

Other Noncorporate Business Assets 473 380 30

Farm Assets 261 283 24

Mortgages and Notes 139 185 24

Depletable/Intangible 130 167 22

of Estates

Number Thousands

of Dollars

Average Discount

Percentage of

Undiscounted Value

30. Some of the assets included as “business assets” may not be used 

by small businesses. For example, limited partnerships may exist 

solely to allow heirs to receive minority discounts, and real estate 

other than personal residences may include vacation homes. Thus, 

the measures used here represent an upper bound on the percentage of assets devoted to small businesses.
14 EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES

Figure 2.

Assets of Estates Filing Estate Tax Returns in 1999 or 2000

Source: Congressional Budget Office based on data from the Internal Revenue Service’s Statistics of Income files.

Notes: Liquid assets include government and private-sector bonds, bond funds, corporate stock, cash and cash management accounts, and 

insurance. Business assets consist of real estate (except a personal residence), real estate partnerships, closely held stock, mortgages 

and notes, farm assets, limited partnerships, and other noncorporate business assets. Other assets comprise annuities, art, and all 

other assets except personal residences. Asset values were augmented to correct for minority discounts.

QFOBI = qualified family-owned business interest.

Liquid

Assets

 (65%)

Business

Assets

 (22%)

Personal

Residence

 (7%)

Other

Assets

 (6%)

Liquid

Assets

 (60%)

Business

Assets

 (22%)

Personal

Residence

 (7%)

Other

Assets

 (10%)

Liquid

Assets

Business (41%)

Assets

 (51%)

Personal

Residence

 (4%)

Other

Assets

 (4%)

Liquid

Assets

 (42%) Business

Assets

 (43%)

Personal

Residence

 (3%)

Other

Assets

 (12%)

Liquid

Assets

 (19%)

Business

Assets

 (75%)

Personal

Residence

 (3%)

Other

Assets

 (3%)

Liquid

Assets

 (14%)

Business

Assets

 (80%)

Personal

Residence

 (3%)

Other

Assets

 (3%)

1999 2000

All Estates

Estates of Farmers and

Farm Workers

Estates Claiming the

QFOBI Deduction
EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES 15

Table 8.

Number of Estates Filing Returns and Number with Insufficient Liquidity to Pay 

the Estate Tax in 2000, Under Various Exemption Levels

Source: Congressional Budget Office based on data from the Internal Revenue Service’s Statistics of Income files.

a. Liquid assets include government and private-sector bonds, bond funds, corporate stock, cash and cash management accounts, and insurance. The number of estates with insufficient liquidity is an upper bound on the actual number because estimates of liquidity do not 

include money held in some trusts, which could also be used to pay estate taxes.

b. Estate tax returns filed in 2000 could be for people who died in either the last nine months of 1999 or in 2000. The actual estate tax 

exemption was that in effect on the date of death: $650,000 in 1999 or $675,000 in 2000.

c. Using the narrow sample discussed in Box 3.

lacked sufficient liquidity to pay the estate tax, even without using trusts.

The effects would be similar, though slightly smaller, for 

estates claiming the QFOBI deduction. About 700 of 

them (instead of 1,500) would have filed returns under a 

$1.5 million exemption, and just over 200 would have 

filed if the exemption had been $3.5 million. The number of QFOBI estates potentially facing a liquidity problem in 2000 would have fallen by three-quarters, to about 

40, if the exemption had been $3.5 million. (That figure 

assumes that estates would have faced the same limits on 

the QFOBI deduction that actually applied in 2000. If 

the deduction had been set at $10 million, as some people have proposed, all QFOBI estates would have had 

sufficient liquidity to pay the estate tax in 2000.)

Raising the exemption level would also lower the income 

tax rates that are equivalent to the estate tax. Repeating 

the simulation performed above for estates that filed 

estate tax returns in 2000, but applying larger exemption 

amounts, yields lower equivalent income tax rates. With a 

$1.5 million exemption, the median income tax rate that 

is equivalent to the estate tax is only 2 percent for estates 

that claimed the QFOBI deduction in 2000; with a $3.5 

million exemption, that median rate falls below 1 percent 

(see Table 9). Under 2000 law, one-third of estates taking 

the QFOBI deduction owed estate taxes, with an average 

equivalent income tax rate of 11.4 percent. With a $1.5 

million exemption, the number of such estates with estate 

tax liability would have fallen by more than half, but their 

equivalent income tax rate would have risen to 13.2 percent, reflecting the fact that the estates paying taxes

Exemption

Amount

Actualb 108,322 52,000 2,834

$1.5 Million 33,685 13,771 740

$2.0 Million 20,997 6,337 366

$3.5 Million 9,210 3,676 182

Actualb 4,641 1,659 138

$1.5 Million 1,005 300 27

$2.0 Million 578 123 15

$3.5 Million 187 65 13

Actualb 1,470 485 164

$1.5 Million 692 223 82

$2.0 Million 440 135 62

$3.5 Million 223 94 41

All Estates

Estates of Farmersc

Estates Claiming Qualified Family-Owned Business-Interest Deduction

Tax Returns

Estates Owing

Estate Tax

Estates with

Insufficient Liquid Assets

to Pay Estate Tax Liability

a

Estates Filing
16 EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES

Table 9.

Income Tax Rates Equivalent to the Estate Tax, Under Various Exemption Levels, 

for Estates Claiming the QFOBI Deduction in 2000

(Percent)

Source: Congressional Budget Office based on data from the Internal Revenue Service’s Statistics of Income files.

Notes: QFOBI = qualified family-owned business interest.

Average and median entries equal the annual income tax rate imposed on capital income that would yield the same total asset value at 

death as assets subject to estate tax (but not subject to income taxes) under the relevant exemption amount. Those values are based 

on simulations that used data on actual wealth reported on estate tax returns and assumed that assets grew at an annual rate of 4 percent from age 45 until actual age at death (or for 10 years if the person died before age 55). Because they apply to the specific individuals for whom estate tax returns were filed in 2000, the values shown here differ from the hypothetical cases shown in Tables 2 and 

A-1.

a. More than half of the estates that had to file returns in 2000 and that claimed the QFOBI deduction did not owe any estate taxes (because 

of that and other deductions and exemptions), so the median equivalent income tax rate is zero. 

b. The exemption amount under 2000 law was $675,000.

would have been relatively large and thus have faced 

higher estate tax rates. With a $2 million or $3.5 million 

exemption, fewer than one-tenth of the estates that filed 

returns in 2000 and claimed the QFOBI deduction 

would have owed tax, and their equivalent income tax 

rate would have averaged less than 12 percent.

Estate Tax 

Exemption Amount

2000 Tax Lawb 3.6 0 33 11.4 9.1

$1.5 Million 2.0 0 15 13.2 11.2

$2.0 Million 1.1 0 9 11.8 12.4

$3.5 Million 0.7 0 6 11.1 9.6

Tax Rate Tax Ratea Tax Rate Tax Rate

Average Median Percentage of

QFOBI Filers Owing Estate Tax

QFOBI Filers

All QFOBI Filers

Average Median
Appendix:

Translating the Estate Tax into an Income Tax

By reducing the return on capital income, the 

estate tax affects people in much the same way that an 

income tax does. Calculating the income tax that is 

equivalent to the estate tax simply involves equating the 

net estates under an income tax and under an estate tax 

(assuming that the decedent reinvested all capital income 

in his or her enterprise), as follows:

1) W[1+r(1-tI)]s

 = W(1+r)s - [TE(W[1+r]s) - TE(W)]

where,

W = wealth currently available to the individual, 

r = annual rate of return on an investment, 

tI = marginal income tax rate, 

s = years remaining in the person’s life, and 

TE(*) = the estate tax function. 

The left-hand side of the equation is the net estate remaining when the rate of return is reduced by an income 

tax. The right-hand side is the net estate remaining when 

the estate is reduced by the estate tax due on earnings accumulated over s years.1

Subtracting TE(W), the estate tax on existing wealth, in 

the bracketed term on the right-hand side is necessary for 

two reasons. First, the estate tax on existing wealth is a 

fixed cost and does not represent an incentive to individuals. Second, if it was not subtracted, an income tax on 

W would have to be included on the left-hand side, unnecessarily complicating the calculation.

Equation 1 is equivalent to: 

2) 1+r(1-tI) = (1+r)z1/S

where,

z = 1 - [TE(W[1+r]s

) - TE(W)]/[W(1+r)s], or the percentage of wealth retained after paying the estate tax on

earnings. 

The left-hand side of equation 2 describes the one-year 

percentage increase in wealth after paying the income tax. 

The right-hand side of equation 2 describes the one-year 

percentage increase in wealth after paying an annuitized 

version of the estate tax.

Solving equation 2 for tI yields:

3) tI = [(1+r)(1 - z1/s)]/r

The term (1-z1/s) is the estate tax generated by one year of 

returns. Even with the lowest applicable marginal tax rate 

of the estate tax, 43 percent, the equivalent income tax 

rate can be quite high (see Table A-1). 

That approach can easily be extended to incorporate 

three important factors. First, the uncertainty of a person’s life span can be included by calculating equation 2 

for every s and taking the expected value, using the appropriate mortality tables. Second, the analysis assumes that 

someone wishes to leave a bequest and saves 100 percent 

of his or her capital income. If the person does not care 

about leaving a bequest, the equivalent income tax rate is 

zero. The analysis can incorporate a rate of saving of less 

than 100 percent of capital income simply by lowering 

the rate of return. Third, if the decision about whether to 

1. An alternative method is described in James Poterba, “The Estate 

Tax and After-Tax Investment Returns,” in Joel Slemrod, ed., Does 

Atlas Shrug? The Economic Consequences of Taxing the Rich (New 

York: Russell Sage and Harvard University Press, 2000), pp. 329-

349. In that method the income tax in a given year is compared to 

the expected value of the estate tax in that year (i.e., the probability of dying multiplied by the estate tax due). The method here 

compares the reduction in assets passed to heirs caused by the 

income tax and the estate tax.
18 EFFECTS OF THE FEDERAL ESTATE TAX ON FARMS AND SMALL BUSINESSES

Table A-1.

Income Tax Rates Equivalent to a 43 

Percent or 14 Percent Estate Tax, by 

Rate of Return and Years Until Death

(Percent)

Source: Congressional Budget Office.

Note: Each entry equals the annual income tax rate imposed on 

capital income that would yield the same total asset value at 

death as assets subject to an estate tax of either 43 percent 

or 14 percent (but not subject to income taxes), assuming a 

given rate of return on capital and a given life expectancy. 

a. The minimum estate tax rate in 2005.

b. The typical estate tax that estates would have owed had the tax 

rates of 2005 been in effect in 2000.

reinvest returns determines whether the estate will be 

large enough to owe estate taxes, then 43 percent is not 

the applicable marginal tax rate. For owners of farms or 

small businesses who are contemplating whether to reinvest the income from the enterprise, the effective (that is, 

the average) estate tax rate may be more appropriate. 

That rate—approximately 14 percent—results in subRate of stantially lower equivalent income taxes.

Return

on Capital 10 20 30 40 50

2 41 38 36 34 32

4 39 34 30 27 24

6 37 31 26 22 18

8 35 28 22 18 15

10 33 25 19 15 12

12 32 22 17 13 10

2 13 12 11 10 10

4 12 10 9 8 7

6 11 9765

8 11 8654

10 10 7543

12 96543

43 Percent Average Estate Tax Ratea

14 Percent Average Estate Tax Rateb

Years Until Death