United States 

Department of 

Agriculture

Economic

Research

Service

Economic

Information 

Bulletin

Number 107

February 2013

The Potential Impact of Tax 

Reform on Farm Businesses 

and Rural Households

James M. Williamson

Ron Durst

Tracey Farrigan
www.ers.usda.gov

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Recommended citation format for this publication:

Williamson, James M., Ron Durst, and Tracey Farrigan. The Potential Impact 

of Tax Reform on Farm Businesses and Rural Households, EIB-107, U.S. 

Department of Agriculture, Economic Research Service, February 2013.
United States

Department

of Agriculture

www.ers.usda.gov

A Report from the Economic Research Service

Abstract

Several proposals calling for fundamental reform of the Federal income tax system have 

been put forth, including a report by the co-chairs of the National Commission on Fiscal 

Responsibility. The primary elements of reform—eliminating tax preferences, restructuring capital gains and dividend tax rates, lowering rates on individual income, and 

reducing the number of tax brackets—could have a signifi cant impact on the after-tax 

income and well-being of both farm businesses and rural households. This report uses 

published and special tabulation data obtained from the Internal Revenue Service, farmlevel data from USDA’s Agricultural Resource Management Survey, and data from the 

American Housing Survey to examine the current tax situation for farm households and 

to evaluate the importance of various Federal income tax policies. For farm households, 

the effect of reform will primarily depend upon changes to existing treatment of investment and business income, including several important business deductions. In contrast, 

changes to existing individual tax credits, especially refundable tax credits, will likely be 

of greater signifi cance to nonfarm rural households.

Keywords: farm households, tax reform, income tax, tax rates, Federal tax policy, farm 

losses, refundable credits, tax deductions, rural households, tax preferences

Acknowledgments

The authors thank Rick Reeder, Dan Milkove, Mary Ahearn, and Pat Sullivan of USDA’s 

Economic Research Service (ERS); Larry Ozanne of the Congressional Budget Offi ce; 

and Guido van der Hoeven of North Carolina State University for their helpful comments 

and suggestions. The authors also thank Dale Simms for his help editing and preparing 

the report for publication and Cynthia A. Ray for the design and layout of the report.

James M. Williamson

Ron Durst

Tracey Farrigan

The Potential Impact of Tax 

Reform on Farm Businesses 

and Rural Households

Economic

Information 

Bulletin

Number 107

February 2013
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Contents

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Objectives of Fundamental Tax Reform . . . . . . . . . . . . . . . . . . . . . . . . . . 3

 Simplifying the Tax System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

 Improving Effi ciency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

 Equity Concerns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Reform Proposals. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Taxation of Farm Income Under Proposed Reform. . . . . . . . . . . . . . . . . 8

 Most Federal Income Tax for Farm Households Is Paid on 

 Off-Farm Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

 Farmers Realize a Greater Share of Their Income From Capital Gains

 Than the Average Taxpayer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

 Limits on Accelerated Capital Cost Recovery Could Affect Farmers’

 Capital Purchase Decisions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

 Income Averaging. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

 Domestic Production Activities Deduction. . . . . . . . . . . . . . . . . . . . . . . 15

 Self-Employed Health Insurance Deduction. . . . . . . . . . . . . . . . . . . . . . 16

Taxation of Rural Households Under Proposed Reform . . . . . . . . . . . . 17

 Rural Homeowners Are Less Likely To Benefi t From Mortgage 

 Interest Deduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

 Low-Income Rural Families Rely Heavily on Refundable Credits . . . . 19

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Appendix Tables 1 and 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
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Summary

What Is the Issue?

Proposals calling for fundamental tax reform have once again called attention 

to a tax system that many regard as overly complex, ineffi cient, and inequitable. Proponents of reform see this as an opportune time for a comprehensive overhaul of the tax system because major features of the system are set 

to change, although some were recently made permanent by the American 

Taxpayer Relief Act of 2012. 

Several proposals calling for fundamental reform of the Federal income 

tax system have been put forth, including a report by the co-chairs of the 

National Commission on Fiscal Responsibility (NCFRR), a bipartisan reform 

panel created by the President in 2010 to address the fi scal stability of the 

United States. The primary elements of proposed reform—eliminating tax 

preferences, restructuring capital gains and dividend tax rates, lowering rates 

on ordinary income, and reducing the number of tax brackets—could have a 

signifi cant impact on the after-tax income and well-being of both farm businesses and rural households. 

What Did the Study Find?

The primary goals of tax reform are to simplify the tax system, making 

compliance easier and reducing economic distortions induced by the system, 

while preserving its progressive nature. While reform may improve societal 

welfare, the current tax system contains features that provide substantial 

benefi t to farm businesses in the form of reduced rates on capital gains, 

accelerated cost recovery provisions, and other special deductions for farm 

production activities. Since most farms are operated as sole proprietors, 

partnerships, or other noncorporate entities and taxed under the individual 

income tax, reform of the individual income tax structure is of greatest 

importance to most farmers. However, reform of the corporate income tax 

could also affect important business tax provisions for farmers, including 

those taxable under the individual income tax. 

In particular, reducing or eliminating deductions for capital purchases and 

raising capital gains taxes could increase the farmer’s tax base and raise 

the tax rate paid on a signifi cant portion of their income. These effects will 

vary by farm size. Offsetting these effects, though, is the proposed reform 

of the marginal tax rate structure. A reduced number of brackets and lower 

rates could mitigate the effect of a potentially larger tax base for many U.S. 

farm households.

In 2010, about 38 percent of U.S. farmers, defi ned as taxpayers who fi led a 

Schedule F with their Form 1040, reported some capital gains—nearly three 

times the share for all other taxpayers—totaling $28.4 billion. The average 

amount of capital gain reported by farmers was also more than double the 

average capital gain reported by other taxpayers. If capital gains are taxed 

at rates equal to income tax rates, farmers will face higher tax liabilities on 

capital gains income, even if ordinary tax rates are reduced. 
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Farming requires large investments in machinery, equipment, and other 

depreciable capital. In 2010, U.S. farmers reported a total of $29 billion on 

capital purchases, and those making investments made an average of $32,000 

in annual capital purchases. Proposed restrictions on current expensing and 

accelerated recovery of capital purchases could increase taxable income, 

especially during the early years following tax reform. Under present law, the 

maximum expensing amount is $500,000, but will drop to $25,000 in 2014 

(as provided by the American Taxpayer Relief Act of 2012). While fewer 

than 20 percent of small farms (those with less than $250,000 of gross sales) 

invest more than $25,000, nearly 54 percent of commercial farms (farms with 

at least $250,000 of gross sales) invest more than that amount. Thus, investment by commercial farms will be affected the most by a substantially lower 

expensing amount. This could lead to increased taxable income and reduced 

capital investment by these farms.

Commercial farms are also the primary benefi ciaries of the domestic production activities deduction for manufacturers. While only about 7 percent of 

farms claimed the deduction, the total amount deducted was $1.25 billion. 

For these farms, eliminating the deduction could add an average of about 

$9,000 to their taxable income. 

About one out of seven farmers uses the self-employed health insurance 

deduction in any given year. In 2010, these farmers deducted an average 

of $6,173 for a total of $1.684 billion in health insurance premiums. Over 

50 percent of farm households obtain their insurance through off-farm 

employment of the operator or spouse, which helps account for the low 

number of farmers claiming the deduction. Many other farmers are over 

age 65 and are covered by Medicare or other Government programs. 

Nonetheless, tax reform that eliminates the deduction for premiums on 

health insurance purchased by the self-employed could increase taxable 

income for some farmers. 

Tax reform would affect rural nonfarm households differently than farm 

and urban households. Rural taxpayers are likely to have lower incomes and 

be older than urban households. Given their lower income, rural nonfarm 

households are less likely to benefi t from tax deductions, exemptions, 

exclusions, or deferrals, because they either lack eligible expenses to exceed 

the standard deduction or otherwise do not qualify for the tax exemption. 

Some of the most widely used deductions—for mortgage interest and real 

estate taxes—are related to the value of property and real property tax rates, 

which are generally lower in rural areas. Although rural households have 

higher rates of home ownership, they are less likely to have a mortgage. 

Thus, the typical rural homeowner may even benefi t if the current mortgage 

interest deduction was replaced with a refundable credit for mortgage interest 

because the credit does not require taxpayers to itemize to receive the benefi t 

or even have a tax liability at all. 

While rural households would be less affected than other households by 

the elimination of itemized deductions, the restructuring of refundable tax 

credits could signifi cantly lower the after-tax income of low-income rural 

households. Any reform that reduces the value of refundable credits—especially the Earned Income Tax Credit (EITC) and Child Tax Credit (CTC)—is 

likely to reduce the well-being of low-income rural households. Overall, 
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one out of every three rural taxpayers receives benefi ts from the EITC or 

the CTC. In 2008, 21.6 percent of rural taxpayers received EITC benefi ts, 

compared with 16.9 percent of urban taxpayers. The earned income and child 

tax credits provided a total benefi t of $20.6 billion to rural taxpayers in 2008. 

How Was the Study Conducted?

This report uses both published and special tabulation data obtained from the 

Internal Revenue Service to provide an overview of the current tax situation 

for U.S. farm households and to evaluate the importance of various Federal 

income tax policies. It also uses farm-level data from USDA’s Agricultural 

Resource Management Survey to estimate the effects of various policies on 

Federal income tax liabilities of farmers. The American Housing Survey is 

also analyzed to evaluate the relative importance of various tax provisions for 

rural households.
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Introduction

Tax reform has once again become a topic of discussion among policymakers 

and the general public. Proposals calling for fundamental reform of the 

Federal income tax system have raised awareness of features of the system 

that many regard as overly complex, ineffi cient, or inequitable. Proponents of 

reform argue that the system, with its patchwork of tax preferences, is needlessly complicated and expensive to administer. Proponents also see this as an 

opportune time for a comprehensive overhaul of the tax system because major 

features of the system are set to change, although some features were recently 

made permanent by the American Taxpayer Relief Act of 2012. 

Legislation enacted in the Economic Growth and Tax Relief Reconciliation 

Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation 

Act of 2003 (JGTRRA) expired at the end of 2012. However, the American 

Taxpayer Relief Act of 2012 made permanent or extended many of the 

provisions in those acts important to farm businesses and rural households.2

Under current law, the marginal tax rates on ordinary income under $400,000 

($450,000 for couples) remain at the current rates, as does the rate on capital 

gains and dividends; certain preferential accelerated capital cost recovery 

provisions also remain. 

This report examines recommendations put forth in a report by the co-chairs 

of the National Commission on Fiscal Responsibility and Reform (NCFRR) 

for addressing the Federal tax system. The Commission was a bipartisan 

reform panel created by the President in February 2010 to address the 

fi scal stability of the United States. This report represents common reform 

themes expressed by stakeholders and policymakers that will likely serve 

as a blueprint for future tax reform.3 The elements of reform discussed 

in this report—eliminating or restructuring tax preferences such as mortgage interest deductions, restructuring capital gains and dividend tax rates, 

lowering marginal tax rates, and reducing the number of tax brackets—could 

have a signifi cant impact on the after-tax income and well-being of farm 

businesses and rural households. We use tax return data from the Internal 

Revenue Service (IRS), income and balance sheet data from USDA’s 2010 

Agricultural Resource Management Survey (ARMS), and house ownership and mortgage data from the American Housing Survey to examine the 

size and scope of farm business and rural household activities that currently 

benefi t from provisions identifi ed as targets for reform (For additional information on data sources and defi nitions, see box). 

2Rural is defi ned as nonmetropolitan, 

which is any area that is not part of a 

Metropolitan Statistical Area (MSA).

3As provided by its bylaws, the 

Commission was required to vote on 

the approval of a fi nal report. On Dec. 

3, 2010, a vote was held on a plan 

forwarded by the panel’s 2 chairs, Alan 

Simpson and Erskine Bowles; however, 

it fell short of the supermajority of 14 

needed to send a proposal to Congress. 

This analysis examines the proposals of 

the Commission’s co-chairs (National 

Commission on Fiscal Responsibility 

and Reform, 2010).
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Data Sources and Defi nitions

Internal Revenue Service Income Tax Data 

The Internal Revenue Service annually collects and publishes information on the operation of the Internal Revenue laws. This report uses both 

published and special tabulation data obtained directly from the Internal 

Revenue Service to evaluate the effect of various tax policies on farmers 

and rural America by level of adjusted gross income. Adjusted gross 

income is income from all sources, including net farm income/loss, minus 

certain adjustments to income. For tax purposes, a farm is defi ned as a 

taxpayer who has farm income or expense and fi les a schedule F Federal 

income tax return.

http://www.irs.gov/uac/Tax-Stats-2

Agricultural Resource Management Survey Data 

The annual Agricultural Resource Management Survey (ARMS) is 

USDA’s primary source of information on the fi nancial condition, 

production practices, and resource use of America’s farm businesses 

and the economic well-being of America’s farm households. The report 

uses income and balance sheet information from the survey to evaluate 

various policies and to differentiate the impact by farm size based on 

gross sales. For purposes of the survey, a farm is defi ned as any place 

from which $1,000 or more of agricultural products were produced and 

sold, or normally would have been sold, during the year.

http://www.ers.usda.gov/data-products/arms-farm-fi nancial-and-cropproduction-practices.aspx

American Housing Survey Data 

The American Housing Survey is the most comprehensive national 

housing survey in the United States. It provides current information on 

a wide range of housing subjects. The survey is used in this report to 

obtain information on home ownership and mortgage amounts.

http://www.census.gov/housing/ahs/
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Objectives of Fundamental Tax Reform

The impetus to reform the tax system is the nearly universal desire to make 

the tax system simpler to administer and comply with, to improve its effi -

ciency, and to ensure equitable treatment. To accomplish such goals, reform 

proponents often refer to “broadening the tax base,” or amending the Internal 

Revenue Code (IRC) to include more income as taxable by eliminating 

tax expenditures or preferences.4 Tax expenditures, the top ten by expense 

shown in table 1, are defi ned as Federal revenue losses attributable to special 

tax exclusions, exemptions, and deductions, as well as preferential tax rates, 

credits, and deferrals of tax liability (OMB, 2012). Broadening the tax base 

by eliminating tax expenditures can reduce complexity and computational 

burden, and perhaps increase effi ciency and equity.

Maintaining the progressive nature of the current tax system is also a stated 

goal of reform. Generally, progressivity is measured as a function of taxes 

paid relative to income. If the average tax rate increases with income, the 

system is said to be progressive. Progressivity can also be measured by the 

system’s impact on the change in the relative after-tax income shares across 

the population of taxpaying households. A progressive system will reduce the 

after-tax income of taxpayers relative to their pre-tax incomes as taxpayers’ 

incomes increase.

4Tax expenditures are sometimes 

known as “tax preferences,” evoking an 

image that the benefi ts accrue to a small 

group or a narrowly defi ned activity. 

However, in some cases, an individual 

tax expenditure benefi ts a large proportion of taxpayers. The exclusion from 

income allowed for the employer 

contribution toward health insurance is 

one example.

Table 1

Top ten individual tax expenditures, 2011

Expenditures

Estimates 

($ billion)

Exclusion of employer contributions for health care, health 

insurance premiums, and long-term care insurance premiums 109.3

Reduced tax rates on dividends and long-term capital gains 90.5

Deduction for mortgage interest on owner-occupied residences 77.6

Earned Income Tax Credit 59.5

Child Tax Credit 56.4

Exclusion of pension contribution and earnings to defi ned 

contribution plans 48.4

Exclusion of pension contribution and earnings to defi ned benefi t 

plans 42.7

Deduction of non-business State and local government income 

taxes, sales taxes, and personal property taxes 42.4

Exclusion of capital gains at death 38.0

Exclusion of untaxed social security and railroad retirement 

benefi ts 31.0

Exclusion of untaxed benefi ts provided under cafeteria plans* 31.0

Total 626.8

*A “cafeteria plan” is a type of employer-provided benefi t plan that allows employees to receive 

certain benefi ts—for example, accident and health benefi ts, adoption assistance, or dependent care assistance—on a pretax basis, . 

Source: Joint Committee on Taxation, January 2012, Estimates of Federal Tax Expenditures 

for Fiscal Years 2011-2015, JCS-1-12, table 1.
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Simplifying the Tax System

Complying with the tax code can be time consuming and costly if help with 

preparation is needed. More than three out of fi ve U.S. taxpayers paid for tax 

preparation in 2006 (GAO, 2007). The need for assistance is not limited to 

taxpayers who would traditionally have complex tax fi lings, like individuals 

who receive income through partnerships or other pass-through entities, 

including a majority of farmers. Many tax credits are targeted to low-income 

families with children, and on average, a family receives multiple credits. 

Further, each credit may require a complex series of calculations, carried out 

through multiple forms, and guided by different eligibility rules. Filers may 

not be aware of the tax benefi ts available to them because of the labyrinth of 

rules, and accessing the benefi ts may require paying for preparation assistance. This complexity may also result in taxpayers’ failure to report income 

or fi le appropriately, and in some cases failure to fi le altogether. The IRS 

estimated the tax gap—the difference between taxes owed and taxes paid—

was $345 billion in 2001 (GAO, 2011).

Improving Effi ciency

Taxes affect decisions about resource allocation, including the decision 

to participate in an activity and the level of effort of the activity for those 

who participate. The labor force participation decision is often cited as an 

example. Tax rates infl uence a person’s decision to participate in the labor 

force, as well as how many hours to work, by altering the after-tax rate of 

pay. Proponents also suggest that the tax preferences in the current system 

distort such economic decisions by changing relative prices of economic 

activities. From the perspective of societal well-being, preferential tax treatment can cause distortions to arise when relative price differentials encourage 

taxpayers to consume, save, and invest differently than they would without 

such distortions. By removing preferential tax treatment, many of the taxinduced economic distortions can be lessened or eliminated.

Many proponents of tax reform argue that current tax rates—seven brackets 

ranging from a rate of 10 to 39.6 percent—are too high and discourage work 

and investment, leading to ineffi ciency. On the other hand, higher tax rates 

may encourage more work if taxpayers choose to maintain their current standard of living rather than trade consumption for leisure. Further, the preferential treatment of gains from capital income may encourage an ineffi cient 

allocation of resources to unearned income; in particular, higher income 

individuals have the ability to substitute their remuneration between ordinary income and capital income. However, the extent to which a taxpayer’s 

labor-supply decisions are infl uenced by the after-tax value of earnings is an 

empirical question.5 Further, many of the provisions in the IRC, such as the 

Earned Income Tax Credit (EITC) and Child Tax Credit (CTC), are subject 

to phaseout once a taxpayer’s income reaches a certain level. When the 

graduated tax brackets combine with the credit phaseout rates, taxpayers face 

even greater effective tax rates, which could lead some to work less in order 

to avoid the phaseout.6

5The effect of taxes on labor supply varies by demographic; the labor 

supply of prime-age (ages 25-54) men 

is estimated to be very insensitive to 

taxes (Hausman, 1981; MaCurdy et 

al., 1990), while the labor supply of 

women, particularly married women 

and women with children, is estimated 

to be more sensitive (Hausman. 1981; 

Dickert et al., 1995).

6Eissa and Williamson-Hoynes 

(2004) fi nd that married women in the 

phaseout range of the EITC are less 

likely to work.
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Equity Concerns

The Federal tax system has been criticized for violating the concepts of 

vertical and horizontal equity. Simplifying the tax code by eliminating 

deductions may address some equity concerns. The principle of vertical 

equity requires that taxpayers across the income distribution are taxed in 

proportion to their ability to pay, and proponents of reform note that the 

system of deductions violates this principle because higher income individuals benefi t more from deductions due to their higher marginal tax rates. 

From the standpoint of vertical equity, credits offer an advantage over itemized deductions because the tax value of each dollar of credit is equal for all 

taxpayers, no matter the taxpayer’s marginal tax rate. 

On the other hand, in many cases, the system treats similarly situated taxpayers 

differently—or treats taxpayers with the same income differently—violating 

the principle of horizontal equity. The different tax treatment of earnings and 

capital gains is a notable example. Under current law, a taxpayer with $50,000 

of earned income from salaries, wages, or business endeavors will face a significantly higher tax burden than a taxpayer whose income consists of $50,000 of 

unearned income from dividends or capital gains.
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Reform Proposals

The bipartisan National Commission on Fiscal Responsibility and Reform 

was created in February 2010 by the President to “[identify] policies to 

improve the fi scal situation in the medium term and to achieve fi scal sustainability over the long run.”7 The Commission’s co-chairs released a report in 

December 2010 entitled “The Moment of Truth,” offering multiple variations of tax reform scenarios that rely on eliminating itemized deductions 

and restructuring or creating new credits, as well as lowering the statutory 

marginal rates. 

Itemized deductions are targeted for reform because they add complexity to 

the tax system and reduce equity and progressivity. Proponents of reform 

argue that itemized deductions complicate the Federal tax system and create 

differences in tax liability between taxpayers with similar incomes and fi ling 

status—a violation of the principle of horizontal equity. Further, itemized 

deductions reduce the progressivity of the tax system because their value 

depends on the taxpayer’s marginal tax rate, generally reducing tax liability 

more for a high-income taxpayer than for a low-income taxpayer. Thus, the 

impact of reducing or eliminating itemized deductions would be more keenly 

felt by high-income taxpayers. This is true, for example, with respect to the 

mortgage interest deduction, which is typically one of the largest itemized 

deductions for most taxpayers.

To start, the Commission’s proposal would eliminate all special tax preferences and use revenue from the savings to lower tax rates and add back 

“small and more targeted” provisions that accomplish policy goals, such as 

promoting the labor force participation of low-income households, homeownership, health, charity, and retirement saving. Under the co-chairs’ 

illustrative plan, the widely used deduction for mortgage interest would be 

replaced with a 12-percent nonrefundable credit applied to the annual interest 

on a mortgage worth no more than $500,000 in original value.8

The deduction for charitable donations would also be eliminated and 

replaced with a 12-percent nonrefundable credit with a 2-percent adjusted 

gross income (AGI) fl oor—that is, the credit would only apply to donations 

to the extent that they exceed 2 percent of a taxpayer’s AGI. The NCFRR 

co-chairs’ plan would simplify retirement saving by consolidating retirement 

accounts and limit the aggregate annual amount that could be contributed to 

the lesser of $20,000 or 20 percent of income.

Under current law, the interest income received from State and municipal 

bonds is not taxable and has been treated as such for nearly a century. The 

co-chairs’ proposal would tax the interest income on all newly issued State 

and municipal bonds, including “Aggie Bonds” issued by States, which 

provide loans to beginning farmers with low equity.

7Created by Executive Order 13531.

8A nonrefundable credit is applied up 

to only the amount of a taxpayer’s tax 

liability. If the value of a nonrefundable credit is more than the 

amount of tax, the taxpayer’s tax liability is reduced to zero. In contrast, 

a refundable credit may entitle the 

individual to receive a refund for the 

amount in excess of tax liability.
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The co-chairs’ plan also calls for a limit or “cap” on the tax treatment of 

employer-sponsored health care insurance. Under current law, 100 percent 

of the cost of an employer’s contribution for health insurance is excluded 

from taxation, and this represents the largest tax expenditure in terms of 

cost—over $109 billion a year (see table 1)—covering close to 150 million 

individuals in America (Kaiser Foundation, 2011). The proposal calls for the 

exclusion to be reduced to the 75th percentile of premium values in 2014 and 

kept at this level through 2018, effectively reducing the value of the exclusion, though only for benefi ciaries whose plans exceed the imposed cap. By 

2038, however, the proposal would completely phase out the exclusion, and 

tax the full extent of employers’ contribution to health insurance.

The NCFRR report also proposes to reduce the statutory marginal tax rates 

and condense them to three brackets—the lowest rate could be as low as 8 

percent and the maximum rate no higher than 29 percent.9 Capital gains and 

dividends would be taxed at these new lower ordinary rates.

Two other notable tax reform plans have also been released recently (see 

appendix table A1). In August 2010, The President’s Economic Recovery 

Advisory Board—an advisory panel tasked by the President with assembling options to reform the tax system—released a report with options to 

simplify the IRC for individual taxpayers, increase taxpayer compliance, and 

reform the corporate tax system. The Bipartisan Policy Center also issued a 

proposal by their Debt Reduction Task Force10 entitled “Restoring America’s 

Future.” Both of these proposals share common features with the NCFRR 

co-chairs’ report, such as lowering marginal rates on ordinary income, equalizing capital gains and ordinary income tax rates, reducing tax expenditures, 

reducing itemized deductions, consolidating credits, and streamlining the taxfi ling process. The Bipartisan Policy Center plan proposes a national sales 

tax as well.

9The current maximum rate is 39.6 

percent.

10Senator Pete Domenici and Dr. 

Alice Rivlin, co-chairs.
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Taxation of Farm Income Under Proposed Reform

The Federal income tax is a progressive tax imposed on net income. It is 

collected annually and accounts for a substantial portion of total Federal tax 

revenues. Reform of the Federal income tax could have a signifi cant effect on 

investment, management, and production decisions in the agricultural sector. 

The individual income tax is signifi cantly more important than the corporate 

income tax for understanding how taxes affect most farmers. Sole proprietorships, partnerships, and subchapter S corporations are all taxed at the 

individual level. The most common form of farm organization is the sole 

proprietorship which, according to the 2007 Census of Agriculture (USDA, 

National Agricultural Statistics Service), accounted for 86.5 percent of all 

farms and 50 percent of total sales. Partnerships comprise 7.9 percent of 

farms and 20 percent of sales. Income from farm partnerships and corporations taxed under subchapter S of the IRC (known as S Corporations) is 

also passed through to the individual partners or shareholders for taxation 

at the individual shareholder or partner level. Corporate farms, including 

C-corporations and S-corporations, in total represent 4.4 percent of U.S. 

farms and account for about 30 percent of sales. While census data do not 

separate S-corporations from other corporations, family-held corporations 

account for about 90 percent of all corporations, and many of these familyheld corporations are S-corporations. The remaining 1.3 percent of farms 

includes cooperatives, estates, trusts, and institutional farms. Some of the 

income from these farms is also taxed under the individual tax rate structure. 

Therefore, more than 96 percent of all farms and over 75 percent of farm 

sales are taxed under the provisions of the individual income tax.

Although most family income and a large share of farm income is taxed 

under the individual tax structure, this does not mean that reform of the 

corporate tax structure would have no impact on agriculture.11 The NCFRR 

co-chairs recommended replacing the graduated corporate tax rate structure with one rate; they suggested a 28-percent tax rate, depending upon the 

number of corporate tax expenditures that are eliminated. Since most farm 

corporations are relatively small, with income taxed at less than the top 

rate, eliminating the graduated rate structure could shift the tax burden from 

larger to smaller corporations.12 For instance, the current tax rate on the fi rst 

$50,000 of taxable income is 15 percent. Thus, smaller farm corporations 

could not only lose deductions as tax expenditures are eliminated but face 

higher tax rates on their expanded income tax base if the current rate structure is replaced with a single rate. 

Corporate tax reform could also affect capital cost recovery and the domestic 

production activities deduction. Changes to these business tax provisions as 

part of corporate tax reform could also have a signifi cant impact on the farm 

business income and tax liability of sole proprietors, partners, and other farm 

businesses taxed under the individual tax structure.

11Corporate taxes are levied on the 

net income of the corporation; individual taxes are based on the adjusted 

gross income of the individual.

122008 Internal Revenue Service 

(IRS) data indicate that as many as 

64 percent of corporate farms have 

business receipts of less than $250,000 

(IRS, SOI Tax Stats, Table 5: Returns of 

Active Corporations 2008).
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Most Federal Income Tax for Farm Households 

Is Paid on Off-Farm Income

Farm households receive income from both farm and off-farm activities, and 

for many, off-farm income accounts for a large share of the household’s total 

income. In 2011, the average farm household income reported in the ARMS 

survey was $87,289, and off-farm sources accounted for a majority of the 

income (84.3 percent). In fact, since 1980, farm sole proprietors as a group 

have reported negative aggregate net farm income for tax purposes, and over 

the last decade, both the share of farmers reporting losses and the amount of 

losses reported have increased (fi g. 1). About half of all farm partnerships 

and small business corporations also report losses. 

In 2010, based on IRS data, nearly three of every four farm sole proprietors reported a farm loss. For those who reported a loss, the average loss 

was $18,079 for a total of $24 billion. This increased reporting of losses 

has coincided with an increase in the amount of capital investment that can 

be expensed in the fi rst year; that and other tax law changes may partially 

explain the trend of increasing reported farm losses.

Because the family is the typical unit of taxation for a farm business, farm 

and nonfarm income are combined when computing Federal income taxes 

for farm households. Most Federal income tax paid by farm households can 

be attributed to nonfarm income. With only about 30 percent of farm sole 

proprietors reporting a profi t and with just 60 percent of those reporting a 

farm profi t owing any Federal income taxes, only about 19 percent of farm 

sole proprietors paid any Federal income tax on their schedule F farm income 

in 2010. 

Table 2 provides information on average income, farm profi t/loss, and taxes 

by level of adjusted gross income for farm sole proprietors in 2010. While 

farm sole proprietors reported average adjusted gross income and taxes of 

Figure 1

Total taxable net farm income/loss for farm sole proprietors reported on Form 1040 Schedule F, 1998-2010 

Billion $

-30

-20

-10

0

10

20

1998 99 2000 01 02 03 04 05 06 07 08 09 10

Taxable profits Taxable losses Taxable net

Source: USDA, Economic Research Service; tax data are compiled from the Internal Revenue Service.
10

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$85,021 and $12,664, respectively, they also reported a net farm loss of 

$6,064, on average. Because taxes on farm income are paid at the individual 

level, under the proposed changes to the individual income tax system, farm 

households could experience significant changes to their after-tax incomes. 

Proposed changes to the system of deductions and credits will expand the 

taxpayer’s tax base, and proposed changes to tax rates on dividends and 

capital gains, in particular, will raise current tax rates for some farmers, even 

if the plan is designed to be revenue neutral.

Farmers Realize a Greater Share of Their Income 

From Capital Gains Than the Average Taxpayer

Reform would likely alter the tax treatment of capital gains. The Federal 

income tax system has historically taxed gains on the sale of assets held for 

investment purposes at lower rates than on other sources of income. The 

current tax rate on capital gains is 15 percent for taxpayers below the 39.6-

percent income tax bracket and 20 percent for those in the 39.6-percent 

bracket (0 percent for taxpayers in the 10- or 15-percent income tax brackets; 

in addition, certain high-income taxpayers are assessed a 3.8 percent 

surtax). These reduced rates are especially significant for farmers because 

some assets used in farming or ranching are eligible for capital gains treatment and the amount of capital gains is increased by the ability to currently 

deduct certain costs (e.g., maintenance or depreciation). A primary source of 

such gains (or losses) is the sale of cattle used for breeding, dairy, draft, or 

sporting purposes; and certain other livestock.13 Under current tax law, the 

IRC allows for proceeds from the disposition of such business property to be 

treated as a capital gain (or loss).

13[C]attle and horses, regardless of 

age, held by the taxpayer for draft, 

breeding, dairy, or sporting purposes, 

and held by him for 24 months or more 

from the date of acquisition, and (B) 

other livestock, regardless of age, held 

by the taxpayer for draft, breeding, dairy, 

or sporting purposes, and held by him 

for 12 months or more from the date of 

acquisition. Such term does not include 

poultry (IRC Section 1231(b)(3)).

Table 2

Average farm profit/loss, income tax liability, and tax rate for farm sole 

proprietors by level of adjusted gross income, 2010

Level of adjusted 

gross income

Number of 

returns

Average 

adjusted 

gross 

income

Average 

farm profit/

loss

Average 

Federal 

income 

tax 

Average 

effective 

income 

tax rate 

Dollars Dollars Dollars Percent

No adjusted gross 

income 152,600 (115,827) (27,746) 106 -

$1 to $10,000 155,440 5,051 (5,092) 8 .2

$10,001 to $25,000 242,271 17,285 (6,457) 116 .7

$25,001 to $50,000 413,386 37,148 (5,025) 1,067 2.9

$50,001 to $100,000 554,953 72,088 (3,181) 4,858 6.7

$100,001 to $250,000 339,874 141,398 (800) 17,376 12.3

Over $250,000 76,206 944,714 (13,488) 203,773 21.6

All 1,934,731 85,021 (6,064) 12,664 15.1

Source: USDA, Economic Research Service, based on special tabulations from 2010 

Internal Revenue Service (IRS) tax data.
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Under the reform proposals, the preferential tax rate for capital gains would 

be eliminated and replaced with a rate that is equal to the rate on ordinary 

income. According to the IRS, in 2010 about 38 percent of all farmers 

reported some capital gains—more than three times the share for all other 

taxpayers. The average amount of capital gain reported by farmers was also 

more double the average capital gain reported by other taxpayers. In 2010, 

the last year for which complete IRS data are available, farmers reported 

capital gains of $28.4 billion.14 This amount represented about 21.5 percent 

of total taxable income reported by farm households. The average amount for 

those reporting capital gains or losses was $38,921. 

A large amount of this capital gain income was reported by high-income 

farmers with adjusted gross income over $250,000. Capital gains accounted 

for one-third of the taxable income for this group. Although high-income 

farmers comprised less than 4 percent of sole proprietorships filing returns, 

they accounted for 74.2 percent of all capital gains reported by farmers and 

reported average capital gains of $362,200 (table 3). On average, nearly onethird of reported gains by farm sole proprietors are attributed to the sale of 

assets used in farming. 

The share of farms reporting capital gains income also increases with farm 

size. Over 60 percent of commercial farmers reported capital gains income, 

accounting for 25 percent of all capital gains reported by farmers. However, 

14Internal Revenue Service, Statistics of Income, Special Tabulations for 

Farm Proprietorships, 2010:

Table 3

Share of returns and average capital gain and income from the sale of 

business assets for farm sole proprietors by level of adjusted gross 

income, 2010

Level of 

adjusted 

gross income

Total 

number of 

returns

Share 

reporting 

capital 

gain/loss

Average 

capital 

gain

Share 

reporting sale 

of business 

assets

Average 

gain on 

business 

assets

Business 

asset 

share of 

total capital gain

Percent Dollars Percent Dollars Percent

No adjusted 

gross income 152,600 47.0 21,090 28.8 10,952 31.8

$1 to $10,000 155,440 25.4 3,159 16.0 2,762 55.0

$10,001 to 

$25,000 242,271 27.0 3,122 16.3 3,881 75.1

$25,001 to 

$50,000 413,386 33.9 4,476 16.3 6,429 68.9

$50,001 to 

$100,000 554,953 33.6 13,518 18.7 7,985 46.0

$100,001 to 

$250,000 339,874 49.4 15,792 17.6 22,434 50.7

Over $250,000 76,206 77.9 362,200 31.9 204,003 23.1

All 1,934,731 37.8 38,921 18.8 22,748 29.1

Source: USDA, Economic Research Service, based on special tabulations from 2010 

Internal Revenue Service tax data.
12

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most of the capital gain is from the sale of nonfarm assets, especially for residential/lifestyle farmers (Durst and Monke, 2001).15

A 2007 IRS Sales of Capital Assets study reported that net gains from the 

sale of livestock were $2.2 billion, while gains from the sale of farmland 

were $4.6 billion. The data include farmers and nonfarmers who held the 

assets (many nonfarmers hold investments in agriculture but do not materially participate in farming) and demonstrate the high value that the assets 

generate upon their sale.

Limits on Accelerated Capital Cost Recovery Could 

Affect Farmers’ Capital Purchase Decisions

Farming requires large investments in machinery, equipment, and other 

depreciable capital. Under the current tax system, such costs may be treated 

as a current expense or capitalized and depreciated over time. In either case, 

this reduces the income subject to tax. The amount that can be expensed is 

subject to a limit, and the investment amount above the limit must be depreciated over a specifi ed recovery period, generally 7 years for farm machinery 

and equipment. 

Based on 2010 ARMS data, U.S. farmers reported a total of $29 billion in 

capital purchases, and those making investments made $32,000, on average, 

in annual capital purchases. 

The tax treatment of these investments is of considerable importance to the 

farm sector, especially to commercial farmers (farm sales above $250,000). 

Over the last decade, the amount that a farmer could immediately expense 

has changed. Beginning with the Economic Growth and Taxpayer Relief 

Reconciliation Act of 2001 (2001 Act), which set the expensing amount at 

$25,000, the amount of capital purchases eligible for immediate expensing 

has steadily increased (table 4). The amount was raised from $25,000 to 

$100,000 in 2003, and then again in 2008 to $250,000 through stimulus 

legislation. The Small Business Jobs Act of 2010 doubled the expensing 

amount to $500,000 for property placed in service in 2010 and 2011.16 The 

Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act 

of 2010 extended the modifi ed expensing amount, but the amount was 

lowered to $139,000 for property placed in service in tax year 2012. The 

American Taxpayer Relief Act of 2012 temporarily increases the amount to 

$500,000 for 2012 and 2013.

The ability to take an additional fi rst-year depreciation deduction also benefi ts farmers making capital purchases. Combined with the expensing amount, 

the ability to accelerate depreciation has meant that much of the capital 

purchases made during the past decade have been completely deducted in the 

fi rst year (table 4). For tax years 2012 and 2013, the fi rst-year depreciation 

allowance is 50 percent.

In 2010, 43 percent of U.S. farms made a capital investment, but the 

percentage varies by farm size. In general, the greater the sales revenue of 

the operation, the more likely it is to make a capital investment in a given 

year. Based on 2010 ARMS data, 83 percent of very large commercial 

farms—farms with at least $500,000 in annual sales—reported they made 

15See appendix table A2 for typologies of farms.

16The amount is reduced (but not 

below zero) by the amount by which 

the investment exceeds $2,000,000.
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such an investment in 2010, while only 36 percent of farms classifi ed as rural 

residences (less than $250,000 in sales and a reported occupation other than 

farming) made a capital investment.

The impact of tax reform on U.S. agricultural investment will depend on how 

the expensing and depreciation provisions change. Currently, fewer than 18 

percent of farmers annually invest more than the prior 2012 expensing limit 

of $139,000 while only a little over 1 percent invest more than the revised 

2012 and 2013 limit of $500,000. Investments above this amount are eligible 

for the 50-percent additional fi rst-year depreciation, so nearly all capital 

investment by farmers can be written off in the current year. The capital 

expensing allowance reduces the effective tax rate on income from farm 

capital and simplifi es the recordkeeping burden associated with the depreciation of capital purchases, with commercial farmers the primary benefi ciaries.

Eliminating or lowering the expensing amount would raise the cost of capital 

purchases for some farms. Currently, few farms exceed the limits on the 

expensing provision, and as the amounts decrease, it is the farms with the 

largest business receipts that are constrained by the expensing amount. Under 

present law, the maximum expensing amount will become $25,000 in 2014. 

While 2010 ARMS data indicate that fewer than 20 percent of residential and 

intermediate farms (farms with less than $250,000 of gross sales) invest more 

than $25,000, nearly 54 percent of all commercial farms (farms with at least 

$250,000 of gross sales) invest more than that amount (fi g. 2). Thus, investment by commercial farms will be affected the most by a substantially lower 

expensing amount. This could lead to increased taxable income and reduced 

capital investment by these farms.

Table 4

Expensing amount limits and additional fi rst-year depreciation, 

2000-2014

Tax year Expensing amount Additional fi rst-year depreciation

Dollars Percent

2000 20,000 0

2001-02 24,000 30

2003 100,000 50

2004 102,000 50

2005 105,000 50

2006 108,000 0

2007 125,000 0

2008 250,000 50

2009 250,000 50

2010 500,000 1001

2011 500,000 100

2012 139,0002 50

2013 500,000 50

2014 25,000 0

1Property acquired and placed in service after September 8, 2010.

2Indexed for infl ation; Source: Revenue Procedure 2011-52. Retroactively increased to 

$500,000 by the American Taxpayer Relief Act of 2012.

Source: Internal Revenue Code Sections 165 and 179.
14

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As well as raising the cost of capital investment, lowering or eliminating 

expensing and additional fi rst-year depreciation could increase the farm’s tax 

base, potentially increasing its taxable income. On average, farmers reported 

depreciation expenses of $21,259 in 2010. Farms with $500,000 or more of 

annual sales had an average depreciation expense of $94,000. Farmers that 

had previously been able to write off most or all of their capital investment in 

the fi rst year due to the expensing and fi rst-year depreciation provisions will 

fi nd that their taxable incomes are higher with the scaling back or elimination 

of these provisions, whether they adjust their investment levels or not, and 

this could result in higher tax burdens.

Income Averaging

Under a progressive tax rate system, taxpayers whose annual income fl uctuates widely may pay higher total taxes over a multiyear period (due to 

bouncing among tax brackets from year to year) than other taxpayers with 

similar yet more stable income. Farm business income is more variable 

than many other sources of income, such as wages and salaries. Mishra et 

al. (2002) estimate that farm business income accounts for 46.5 percent of 

the annual variation in farm household total income, while off-farm wages 

account for 23.2 percent. Farm business income is susceptible to commodity 

price volatility, which embodies the risks of weather and natural phenomena. 

As such, variability of farm household income generally exceeds that of all 

U.S. households. 

Variability in farm income across time is attributed to fl uctuations in farm 

output, commodity prices, and business cycles. Farmers are allowed to 

use various income tax provisions to manage their tax liabilities. Cash 

accounting, which recognizes income and expenses when received or paid, 

can reduce taxable income through prepaid business expenses or deferred 

Figure 2

Farms with agricultural investments exceeding the expensing limit, by gross farm sales, 2010

Percent

* Retroactively increased to $500,000 by the American Taxpayer Relief Act of 2012.

Source: USDA, Economic Research Service, Agricultural Resource Management Survey, 2010.

0

10

20

30

40

50

60

70

< 20 20 to < 40 40 to < 100 100 to < 250 250 to < 500 500 and over

Sales class ($1,000)

Exceeds 2010-2013 limit ($500,000) Exceeds 2012 limit ($139,000)* Exceeds 2014 limit ($25,000)
15

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farm income, and, as discussed above, well-timed capital purchases can 

reduce taxable income through depreciation deductions or capital expensing. 

While these provisions are useful in reducing income variability, they are 

limited by the ability of a farmer to defer sales or accelerate expenditures. 

Income averaging can reduce the effect of a progressive tax rate system on 

taxpayers with variable income by allowing them to smooth their tax burdens 

over time through tax accounting methods that consider multiyear income. 

U.S. farmers have been eligible for income averaging since 1998. Under 

the current income averaging provision, a farmer can elect to shift a specifi ed amount of farm income, including gains on the sale of farm assets other 

than land, to the preceding 3 years and to pay taxes at the rate applicable to 

each year. Income that is shifted back is spread equally among the 3 years. 

If the marginal tax rate was lower during 1 or more of the preceding years, a 

farmer may pay less tax than he or she would without the option of income 

averaging. The provision, however, does not allow income from previous 

years to be brought forward. Furthermore, although the provision is designed 

to reduce the effect of farm income variability, as long as some farm income 

is available to be shifted, the source of income variability does not need to be 

farm income for income averaging to be benefi cial. 

In 2004, according to IRS tax data, 50,800 farmers—or about 2.5 percent 

of farms—reduced their tax liability on average by $4,434 with income 

averaging. The reduced liability totaled $225.3 million and amounted to a 

23-percent reduction in Federal income taxes for those taking advantage of 

the provision, compared with the amount that they would have owed without 

income averaging. A large share of the total tax reduction was realized by 

farmers with adjusted gross income over $1 million. These farmers reduced 

their liability by an average of $264,000, for a total of $82.6 million. 

While more recent data are not available, since farm income has trended 

higher in recent years the income averaging provision is likely to be of equal 

or greater benefi t to farmers with substantial income growth. While a reduction in the number and level of marginal tax rates would reduce the savings 

under a new system, some farmers would still face higher tax rates due to 

income variability if the income averaging provision is eliminated.

Domestic Production Activities Deduction

One of the most important business changes in the American Jobs Creation 

Act of 2004 was the replacement of the foreign sales corporation/extraterritorial income provisions, which had allowed U.S. exporters to exclude a 

portion of their foreign sales income from taxation, with a new deduction for 

U.S. manufacturers, which includes farmers. The foreign sales corporation 

provision had been declared a prohibited export subsidy by the World Trade 

Organization, and its replacement was required to avoid retaliatory tariffs.

A domestic production activity includes an activity that involves the lease, 

rental, license, sale, exchange, or other disposition of tangible personal property that was manufactured, produced, grown, or extracted in whole or in 

signifi cant part within the United States. It is not limited to exported goods.17

Thus, while very few farm households directly benefi ted from the export 

provision, according to IRS tax data about 7 percent of farm households 

17Domestic production activities 

income is the excess of domestic production gross receipts for the tax year 

minus the sum of the cost of goods sold 

and other expenses, losses, or deductions 

(other than the domestic production 

activities deduction) allocable to such 

receipts (IRC Section 199). 
16

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directly benefi t from the new deduction. The deduction is limited to the lesser 

of 9 percent of adjusted gross income or domestic production activities 

income or 50 percent of wages paid to produce such income. While the 

wages-paid limitation reduces the deduction for many smaller farms that hire 

little or no labor, farm sole proprietors deducted nearly $1.25 billion in 2010. 

The average deduction for eligible farm households was $8,926. Among 

farms, commercial farm households are the primary benefi ciaries since they 

are more likely to report positive farm income and wages paid to hired labor. 

Reducing or eliminating this deduction would result in a signifi cant increase 

in taxable income for the benefi ciaries of this deduction.

Self-Employed Health Insurance Deduction

The self-employed health insurance deduction was created in 1988 to give 

small business owners, including many farmers, tax benefi ts similar to those 

of employees who receive employer-deductible health insurance. This deduction is especially important for self-employed individuals who must purchase 

health insurance on their own.

Since 2003, farmers and other self-employed taxpayers have been allowed to 

deduct 100 percent of the cost of providing health insurance for themselves and 

their families as long as they are not eligible for any employer-sponsored plan. 

The self-employed health insurance deduction is limited to the amount of the 

taxpayer’s income from self-employment. This limitation eliminates the deduction for farmers with net farm losses and no other self-employment income.

While IRS tax data indicate that only about 2.6 percent of all taxpayers 

utilize the self-employed health insurance deduction, about one out of 

seven farmers use the deduction in any given year. In 2010, these farmers 

deducted an average of $6,173 for a total of $1.684 billion in health insurance premiums. Over 50 percent of farm households obtain their insurance 

through off-farm employment of the operator or spouse, which helps account 

for the low number of farmers claiming the deduction. Many other farmers 

are over age 65 and are covered by Medicare or other Government programs 

(Jones et al., 2009).

Intermediate and commercial farmers are more likely than rural residence 

farmers to use the deduction. Only about 8 percent of rural residence farmers 

claim the deduction, primarily because greater proportions of these households receive health insurance from a nonfarm job or do not qualify for the 

deduction due to reporting a farm loss. The self-employed health insurance 

deduction allows farmers to save a portion of their premiums equal to their 

marginal tax rate, helping make health insurance more affordable and making 

the tax treatment more comparable to employer-sponsored plans. 
17

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Taxation of Rural Households Under 

Proposed Reform

Tax reform would affect rural nonfarm households differently than farm 

and urban households. Rural nonfarm households have lower incomes, are 

older, and have higher poverty rates than urban households. In 2008, the 

average rural taxpayer reported an adjusted gross income (AGI) of $43,616, 

compared with $60,841 for the average urban taxpayer (Durst and Farrigan, 

2011). Given their lower income, rural nonfarm households are less likely 

to benefi t from tax deductions, exemptions, exclusions, or deferrals because 

they either lack eligible expenses to exceed the standard deduction or otherwise do not qualify for the tax benefi ts.18 For example, some of the most 

widely used deductions—the deduction for mortgage interest and real estate 

taxes—are related to the value of property and real property tax rates, which 

are generally lower in rural areas (average annual rural real property taxes 

in 2009 were $1,639 for rural homeowners versus $3,393 for nonrural).19

However, rural households are more likely to own homes and pay property 

taxes than urban households (table 5).

The age distribution of rural America also affects the impact of tax reform. 

Approximately 16.4 percent of the rural population is over the age of 65 

(12.9 percent of the urban population is over the age of 65) (2012 Current 

Population Survey), and older adults generally have lower incomes, particularly from earned income, due to lower rates of labor force participation. 

Older adults also are less likely to use the tax system to receive tax benefi ts 

targeted to wage earners and families with children. Therefore, they are less 

likely to be required to fi le a tax return or to apply for a refundable credit.20

Because rural households are less likely to benefi t from itemized deductions 

compared to urban households, proposals to eliminate deductions will have 

less effect on their well-being. On the other hand, rural nonfarm households are 

more likely than others to benefi t from tax credits, particularly the refundable 

credits such as the Earned Income Tax Credit and the Child Tax Credit. The 

NCFRR co-chairs’ report proposes to keep the current EITC and CTC intact; 

however, other reform plans seek to consolidate credits along the lines of work 

and family (appendix table A1). How rural nonfarm residents will fare under 

tax reform will depend in large part on how the credit system is changed.

Rural Homeowners Are Less Likely To Benefi t From 

the Mortgage Interest Deduction

Itemized deductions are allowed for certain medical expenses, State and local 

taxes paid, mortgage interest paid, investment interest, charitable contributions, and a variety of miscellaneous expenses (see table 1).

The mortgage interest deduction is one of the largest tax expenditures in the 

Federal income tax system, and it is the largest Federal tax benefi t for owneroccupied housing. This deduction allows taxpayers who own a home, have a 

mortgage, and itemize on their tax returns to deduct interest paid on up to 

$1.1 million of home mortgage debt.21 The mortgage interest deduction 

primarily benefi ts homeowners in the top fi fth of the income distribution 

(defi ned as household income of at least $98,000) because they are the 

18Standard deduction for married 

couples fi ling jointly in 2011 was 

$11,900.

19Authors’ calculations from the 2009 

American Housing Survey, Department 

of Commerce, Bureau of the Census.

20Social Security benefi ts are not 

taxed if a taxpayer’s modifi ed adjusted 

gross income plus one-half of their 

Social Security benefi ts are below a 

certain amount ($32,000 for married 

couples fi ling jointly in 2011); however, 

if a benefi ciary’s “provisional” income 

exceeds that amount, part of the Social 

Security benefi t may be taxed

21The provision allows for $1 million 

for mortgage debt plus $100,000 of 

home equity debt.
18

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taxpayers who are most likely to itemize. Thus, eliminating or scaling back 

the mortgage interest deduction would have a larger negative impact on highincome homeowners than on low- to middle-income homeowners.

Toder et al. (2010) estimated that eliminating the mortgage interest deduction without replacing it with another tax preference would raise taxes, while 

reducing the after-tax income of all taxpayers by less than 1 percent, on 

average. In fact, if the tax expenditures for the mortgage interest deduction 

and property tax were eliminated, the after-tax income of the lowest quintile 

in the income distribution would be essentially unchanged. However, these 

effects would vary greatly across income groups: 1 to 20 percent of taxpayers 

in the bottom to middle income quintiles would likely experience some 

increase in tax liability, compared to about 70 percent in the top income quintile. The latter group is more likely to own homes, to itemize deductions, and 

to face higher marginal tax rates that tend to make deductions more valuable 

to them than to lower income taxpayers.

Various mortgage interest deduction reform options have been considered. 

Under the proposal by the co-chairs of the NCFRR, the mortgage interest 

deduction would be eliminated and replaced with a nonrefundable mortgage 

interest credit that would be available to both itemizers and non-itemizers. 

The Debt Reduction Task Force also proposed to eliminate the mortgage 

interest deduction, but replace it with a refundable credit, which would 

benefi t taxpayers with mortgages who do not itemize or who do not have a 

tax liability—generally, taxpayers in the bottom three income quintiles. On 

Table 5

Homeowners with a mortgage by income group, share by residence, 

2009

Housing and mortgage statistics

Household income quintile

Rurala

$0-

$19,299

$19,300-

36,465

$36,466-

59,999

$60,000-

97,999

$98,000 

and 

above

All 

income 

groups

Own (%) 62 72.8 82.1 89.7 95.0 62.1

Mortgage (%) 14.7 27.8 46.0 58.7 64.6 30.8

% population 6 5 5 4 3 22

Mortgage 

value ($)b 83,799 79,657 91,859 113,979 180,483 112,464

Urban

Own (%) 43.5 55.6 66.2 78.2 90.1 59.5

Mortgage (%) 15.6 26.5 42.4 58.7 72.0 38.8

% population 14 15 15 15 17 78

Mortgage 

value ($)b 119,905 124,536 140,754 167,274 260,771 187,244

Notes: Own is the percentage who own their residence; Mortgage is the percentage who have 

a mortgage on their owned residence; % population is the percentage of the U.S. population. aRural is defi ned as living outside of a Metropolitan Statistical Area.

bMean value of original mortgage or mortgages. 

Source: Authors’ calculations using data from the American Housing Survey, 2009. 
19

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the other hand, taxpayers in the fourth quintile would gain the most from a 

nonrefundable (NCFRR) credit because they are more likely to have a positive tax liability to be offset with the credit. With either a refundable or a 

nonrefundable credit, those in the top quintile would likely experience a 

signifi cant increase in the amount of income subject to tax and, depending 

upon the tax rate structure, could face higher taxes.

In general, based on their incomes, less than a third of rural households 

itemize their deductions. Urban taxpayers are more likely to benefi t from the 

mortgage interest deduction and are more likely to face reductions to aftertax income if the mortgage interest deduction is eliminated; in fact, only 3 

percent of the population resides in a rural area and has income that puts 

them in the top fi fth of the income distribution (table 5). The average mortgage value (including up to four mortgages) in 2009 was $112,464 for rural 

homeowners and $187,244 for urban homeowners. 

On average, taxpayers in urban areas have higher incomes than their rural 

counterparts, and though they have lower rates of home ownership (table 

5), they are more likely to have a mortgage, especially the urban residents 

in the top quintile of the income distribution. Further, high-income rural 

homeowners are less likely than high-income urban homeowners to have a 

mortgage, and their mortgages are of lower value. Thus, rural homeowners, 

especially in the lower three quintiles of the income distribution, currently 

receive little or no benefi t from the mortgage interest deduction and may 

even benefi t by replacing it with a refundable credit for mortgage interest.

Low-Income Rural Families Rely Heavily on 

Refundable Tax Credits 

The major tax reform proposals each offer plans to create credits in lieu of 

deductions or to restructure the current credits. Although low-income families 

generally do not benefi t from itemized deductions, they are primary benefi ciaries of refundable tax credits, and how the system of credits is changed could 

have a substantial impact on their after-tax income. A tax credit, whether 

refundable or not, is applied after an individual’s tax is computed.

Tax credits are an alternative to direct spending programs to accomplish 

specifi c policy objectives, and they have increasingly been used as a means 

to provide income support to low-income workers and families with children. 

Since 1980, the total cost of all tax expenditures or preferences has increased 

by over 250 percent and currently exceeds $1 trillion a year (The White 

House, 2010). Two of the most signifi cant tax credits—the earned income tax 

credit (EITC) and child tax credit (CTC), which are refundable—accounted 

for $116 billion in tax expenditures in 2011 (table 1). In fact, the EITC has 

increasingly become one of the largest sources of cash assistance for lowincome families. The refundable CTC also provides a signifi cant amount of 

support. These two credits have signifi cantly reduced the share of taxpayers 

who owe Federal income tax. For many low-income families, tax credit 

refunds represent a large share of their disposable income.

Both the EITC and CTC encourage work and help families with children 

meet basic needs. Since the EITC and CTC phase in with earnings, they 

encourage labor force participation among low-income single parents, to 
20

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whom the tax credits are most valuable. While a phaseout of the EITC could 

arguably discourage a current recipient from working, research suggests 

that, overall, the EITC encourages work among recipient households.22 A 

growing number of families (25.7 million in 2009) receive these benefi ts (fi g. 

3). In 2010, these two refundable tax credits represented nearly 15 percent of 

income for low-income families and approximately 25 percent of income for 

low-income families with children.23

Rural households have historically had lower incomes and higher poverty rates 

than urban households. Given the income differential and the prevalence of 

low-wage jobs, it is not surprising that rural taxpayers benefi t disproportionately from tax programs targeting low-income workers, especially the EITC. 

In 2008, 21.6 percent of rural taxpayers received EITC benefi ts, compared 

with 16.9 percent of urban taxpayers. The share of rural taxpayers who 

received the refundable portion of the child tax credit was also slightly 

higher, at 13.9 percent versus 12.6 percent for urban taxpayers. The earned 

income and child tax credits provided a total benefi t of $20.6 billion to rural 

taxpayers in 2008. Overall, one out of every three rural taxpayers received 

benefi ts from the EITC or the CTC. 

The refundable portion of the EITC and the CTC provides a signifi cant 

boost ($13.7 billion in 2008) in income to rural taxpayers (table 6). For rural 

taxpayers with AGI under $10,000, these refundable credits were nearly onethird of AGI and averaged $1,276 in 2008. For those with income between 

$10,000 and $20,000, these refundable credits were nearly one-fourth of AGI 

and were $3,474, on average. Overall, EITC and CTC refunded tax credits 

provided a 13-percent increase in income to rural taxpayers receiving one or 

both of the credits in 2008. 

22For example, while Eissa and Williamson-Hoynes (2004) fi nd evidence 

that married women reduced their labor 

force participation in response to an 

expansion of the EITC, others such as a 

Meyer and Rosenbaum (2001) fi nd that 

single mothers work more in response 

to the EITC.

23Estimates based on 2011 Current 

Population Survey, tax model data for 

2010.

Figure 3

Number of EITC recipient families, total amount of credit, and refunded amount of total (2009 dollars), 

1975-2009

Source: USDA, Economic Research Service using data from the Internal Revenue Service.

0

10,000

20,000

30,000

40,000

50,000

60,000

Number of recipient families

(thousand)

Total amount of credit 

($ million)

Refunded amount of credit 

($ million)

Average credit per family ($)

1975 79 83 87 91 95 99 2003 07
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Refundable tax credits, especially the EITC, have lifted a signifi cant number 

of households above the poverty line. While the offi cial measure of poverty 

does not include the EITC as a form of income, the Census Bureau publishes 

information on poverty under various alternative defi nitions. Comparing 

the poverty rate under the defi nition of income that includes various support 

programs and the EITC with the offi cial poverty estimates for 2008 suggests 

a reduction in the rural poverty rate from 15.1 percent to 11.1 percent. The 

EITC alone was responsible for a reduction of 1.7 percentage points in the 

rural poverty rate. This suggests that in 2006 the EITC lifted an estimated 

800,000 rural residents above the poverty line. Given expansions in the EITC 

that have occurred since 2006 as well as the expanded refundability of the 

child tax credit, the current impact on rural poverty of these tax-based policies is likely to be even greater. 

The value of these credits suggests that their elimination or reduction would 

have a signifi cant effect on low-income families, and rural families in particular, unless new programs were created to provide cash assistance. Most tax 

reform proposals would not eliminate these credits, but would consolidate them 

into new family and worker credits. The various options under consideration 

would reduce the number of credits and deductions and standardize eligibility 

rules. While it is suggested that this would eliminate much of the complexity, 

computational burden, taxpayer confusion, and diffi culties with enforcement 

that are commonly cited by critics of the tax system, the changes could have a 

signifi cant impact on the after-tax income of some rural households.

Table 6

Refundable credits and adjusted gross income for rural taxpayers by level of adjusted gross 

income, 2008

Rural taxpayers

Refundable earned 

income and child 

tax credits

Adjusted gross 

income

Credits as share 

of adjusted gross 

income

Adjusted gross income Thousand $ Million $ Million Percent

Under $10,000 5,148 2,026 6,442 31

$10,000 to $20,000 4,756 6,025 25,620 24

$20,001 to $25,000 1,965 2,383 16,148 15

$25,001 to $50,000 6,278 2,968 45,730 6

$50,001 to $100,000 5,352 273 12,472 2

Over $100,000 1,895 2 220 1

All 25,395 13,680 106,633 13

Source: USDA, Economic Research Service, based on special tabulations from 2008 Internal Revenue Service tax data.
22

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Conclusion

The primary goals of tax reform are to simplify the tax system, making it 

easier to comply with, and to reduce economic distortions induced by the 

system while preserving its progressive nature. While reform may improve 

societal welfare, the current tax system contains features that provide 

substantial benefi t to farm businesses, and reform could reduce the aftertax income of many farm households. In particular, reducing or eliminating 

deductions for capital purchases and raising capital gains taxes could increase 

the farmers’ tax base and raise the tax rate paid on a signifi cant portion of 

their income. These effects will vary by farm size and type. Offsetting these 

effects, though, is the proposed reform of the marginal tax rate structure. 

A reduced number of brackets and lower rates will mitigate the effect of a 

potentially larger tax base for U.S. farm households.

Nonfarm rural households also have a major stake in tax reform. On average, 

rural households have lower incomes than the average U.S. household and 

receive signifi cant benefi ts from the tax system’s credits. Any reform that 

reduces the value of refundable credits, especially the Earned Income Tax 

Credit and Child Tax Credit, is likely to reduce the well-being of rural households. On the other hand, rural households are less likely to benefi t from 

deductions and other adjustments to gross income. Therefore, eliminating or 

limiting these deductions will not have a large effect on most rural households. As with farmers, the net effect on Federal income tax liability and 

after-tax income will depend upon the specifi c details of tax base broadening 

and the restructuring of tax rates.
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References

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the Economy, Cutting Spending and Debt, and Creating a Simple, 

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The Potential Impact of Tax Reform on Farm Businesses and Rural Households / EIB-107

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Appendix table A1

Major reform proposal provisions

Current law NCFRR PERAB BPC

Tax rates for individuals

Ordinary income 10, 15, 25, 28, 33, 

35, 39.6 %

Three brackets with 

a target of 12, 22, 

29%

N.A. Two brackets: 15, 27%

Capital gains and 

dividends

0, 15, 18.8, 20,

23.8%

Tax at ordinary rates Tax at ordinary 

rates with an 

exclusion for 50% 

of gains

Tax at ordinary rates (not greater 

than 27%), with an exclusion for fi rst 

$1,000 of gain or loss

Standard deduction $6,100 single

$12,200 married

No change Increase value Eliminate

Itemized deductions Limits on itemized 

deductions for 

those with adjusted 

gross income over 

$250,000 ($300,000 

joint return)

Eliminate Reduce the value 

of itemizing by limiting cost of expenses (<100%)

Eliminate and replace many of the 

deductions with a tax credit; allow 

deductions in excess of 5% of AGI

Credits Mix of refundable 

and non-refundable 

credits

Maintain current 

law EITC and Child 

Tax Credit; create 

non-refundable 

credits for mortgage 

interest, charitable 

giving, and retirement savings

Consolidate common credits along 

the themes of work 

and family; simplify 

the eligibility rules

Create a refundable per-child tax 

credit of $1,600; create a 21.3% 

refundable earnings credit; 15% 

refundable credits for charitable 

giving and mortgage interest; 15% 

credits for education and retirement 

savings; AGI phase-outs for some 

credits

National sales tax None N.A. N.A. 6.5% phased in over 2 years

N.A. = not applicable. 

Sources: National Commission on Fiscal Responsibility and Reform (NCFRR), December 2010, “Moment of Truth”; President’s Economic 

Recovery Advisory Board (PERAB), August 2010, “The Report on Tax Reform Options: Simplifi cation, Compliance and Corporate Taxation”; 

Bipartisan Policy Center (BPC), November 2010, “Restoring American’s Future: Reviving the Economy, Cutting Spending and Debt, and 

Creating a Simple, Pro-growth Tax System.”

Appendix table A2

Farm Typology

Farm Types

Small family farms

(gross sales less than $250,000) 

Large-scale family farms

(gross sales of $250,000 or more)

Rural-residence family farms: 

Retirement farms. Small farms whose operators report 

they are retired.

Residential/lifestyle farms. Small farms whose operators 

report a major occupation other than farming.

Intermediate family farms:

Farming-occupation farms. Small family farms whose 

operators report farming as their major occupation.

• Low-sales farms. Gross sales less than $100,000.

• High-sales farms. Gross sales between $100,000 

and $249,999.

Commercial family farms:

Large family farms. Gross sales between $250,000 and 

$499,999.

Very large family farms. Gross sales of $500,000 or more

Nonfamily farms

Any farm not classifi ed as a family farm, that is, any farm for 

which the majority of the farm business is not owned by 

individuals related by blood, marriage, or adoption.