United States 

Department 

of Agriculture

Economic 

Research 

Service

Economic 

Information

Bulletin

Number 54

May 2009

Federal Tax Policies 

and Farm Households

Ron Durst
www.ers.usda.gov

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Durst, Ron

 Federal tax policies and farm households.

 (Economic information bulletin ; no. 54)

 1. Fiscal policy—United States. 2. Farm income—Taxation—United 

States.

 3. Inheritance and transfer tax—United States.

 4. Taxation—United States—Rates and tables.

 I. United States. Dept. of Agriculture. Economic Research Service. II. 

Title.

HD1443.U6

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www.ers.usda.gov

Recommended format for citation: Durst, Ron. Federal Tax Policies and Farm 

Households, EIB-54, U.S. Dept. of Agri., Econ. Res. Serv., May 2009.
United States

Department

of Agriculture

www.ers.usda.gov

A Report from the Economic Research Service

Ron Durst, rdurst@ers.usda.gov

Federal Tax Policies

and Farm Households 

Economic

Information

Bulletin

Number 54

May 2009

Abstract

Signifi cant changes in Federal individual income and estate tax policies have occurred 

over the last 10 years. Analysis suggests that changes in Federal tax provisions affecting 

both individual and business income taxes have reduced average tax rates for all farm 

households, resulting in the lowest tax burden on farm income and investment in a 

decade. Similarly, an analysis of the changes to Federal estate tax policies suggests that 

increases in the value of property that can be transferred to the next generation free of 

the estate tax, combined with special provisions for farmers and other small businesses, 

have greatly reduced the number of farm estates subject to the tax and the amount owed. 

While nearly 10 percent of commercial farm estates could owe tax in 2009, only 1 to 2 

percent of all farm estates are estimated to be subject to the Federal estate tax this year. 

Keywords: income tax, estate tax, tax rates, estate, Federal tax policy, farm losses, 

commercial farms

Acknowledgments

The author thanks James Williamson and Pat Sullivan of USDA’s Economic Research 

Service (ERS), Jim Monke of the Congressional Research Service, Jim Hrubovcak of 

USDA’s Offi ce of the Chief Economist, Brent Gloy of Cornell University, and Gary 

Hoff of the University of Illinois for their helpful comments and suggestions. The author 

also thanks John Weber for his help editing and preparing the report for publication and 

Curtia Taylor for the design and layout of the report.
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Contents

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

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

Federal Individual Income and Business Taxes Reduced . . . . . . . . . . . . . . . 3

Most Federal Income Tax for Farm 

 Households Is Paid on Off-Farm Income . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Reduced Capital Gains Taxes Increase 

 Return on Farm Business Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Capital Cost Recovery System Allows Most 

 Investment To Be Expensed in Year of Purchase . . . . . . . . . . . . . . . . . . . . 8

Manufacturer’s Deduction Provides Substantial 

 Benefi ts for Commercial Farmers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Self-Employed Health Insurance Deduction 

 Reduces Cost of Health Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Income Averaging Provides Reduced Tax Rates 

 for Farmers With Variable Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Estate Taxes Reduced, But a Relatively Larger Share 

 of Farmers Still Owe Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Special Provisions Benefi t Farmers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Current Law Provides for Repeal and Uncertainty . . . . . . . . . . . . . . . . . . . 18

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
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Summary

Signifi cant changes in Federal individual income and estate tax policies 

have occurred over the last 10 years. Since the Federal individual income 

tax affects a broad group of farmers and the Federal estate tax can affect 

the ability to transfer the Nation’s farm businesses to the next generation, these changes are of considerable importance to the farm community. 

Modifi cations to Federal income and estate tax policies affect not only the 

fi nancial well-being of farm households but also the number and size of 

farms, their organizational structure, and their use of land, labor, and capital 

inputs. 

What is the issue?

A number of changes to Federal income and estate tax policies are scheduled 

to expire in 2010. As the expiration date approaches, the debate regarding 

the future of these policies is likely to intensify, especially in light of the 

increasingly challenging Federal budget environment. This report evaluates 

the impact of Federal income and estate tax policies on the tax burdens and 

fi nancial well-being of farm households.

What did the study fi nd?

Over the last decade, Federal income tax changes affecting both individual 

and business income taxes have reduced average tax rates for all farm 

households. While nearly all farm households have benefi ted from the 

changes, commercial farm (annual sales greater than $250,000) households 

are the primary benefi ciaries of many of the business tax provisions, 

including increased expensing of capital purchases, reduced tax rates on 

business assets, and a new deduction for manufacturers, which is defi ned to 

include farmers. 

The cumulative effect of these changes to Federal tax policy has resulted in 

the lowest Federal tax burden on farm income and investment in a decade. 

The average tax rate for farm sole proprietors was reduced from 17.1 percent 

in 1994 (and 17.8 percent in 2000) to about 14.8 percent in 2004. Federal 

income taxes paid by farm sole proprietors dropped from $24.9 billion in 

2000 to $21 billion in 2004, a reduction of nearly 16 percent. Current average 

tax rates are estimated to be at or below the 2004 levels.

Changes to Federal estate tax policies have increased the value of property 

that can be transferred to the next generation free of the estate tax and have 

reduced tax rates on estates still subject to the tax. Special tax provisions 

targeted to farmers and other small business owners have provided additional 

benefi ts. Those changes have reduced the number of farm estates required 

to fi le an estate tax return as well as the number required to pay tax and the 

amount of Federal estate taxes owed. Based on simulations using farm-level 

survey data, about 2.9 percent of the 38,234 projected farm estates in 2009 

are estimated to have enough assets to necessitate fi ling an estate tax return. 

After deductions, only about half of those farm estates will be taxable. The 

total amount of Federal estate taxes owed by farm estates in 2009 is estimated 

at $683 million.
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The estate tax is scheduled to be repealed completely in 2010 before 

reverting to 2001 law in 2011. If allowed to go into effect, the reversion to 

2001 law would increase the share of farm estates that owe Federal estate tax 

and total Federal estate tax revenues. As many as 1 of every 10 farm estates 

would owe estate tax in 2011, with total Federal estate taxes rising to about 

$2.55 billion, an increase of nearly three times the amount estimated to be 

owed in 2009.

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 and estate tax policies. It also uses farm-level data from USDA’s 

Agricultural Resource Management Survey (ARMS) to estimate the effects 

of various policies on Federal income and estate tax liabilities. ARMS was 

also used to estimate the number of farm estates, the number of estates that 

would owe taxes, and total Federal estate taxes for the estates of farm operator households.
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Introduction 

Signifi cant changes in Federal individual income and estate tax policies 

have occurred over the last decade. Since the Federal individual income 

tax affects a broad group of farmers and the Federal estate tax can affect the 

ability to transfer the farm business to the next generation, changes in these 

two taxes are of considerable importance to the Nation’s farm community. 

Modifi cations to tax policies can affect not only the fi nancial well-being of 

farm households but also the number and size of farms, their organizational 

structure, and their use of land, labor, and capital inputs. 

Federal tax changes affecting both individual and business income taxes 

have reduced average tax rates for all farm households. While nearly all 

farm households have benefi ted from the changes to individual tax rates and 

other nonbusiness deductions and credits, commercial farm (annual sales 

greater than $250,000) households are the primary benefi ciaries of many 

of the business tax provisions, including increased expensing of capital 

purchases, reduced tax rates on business assets, and a new deduction for 

manufacturers. 

Changes to Federal estate tax policies have increased the value of property that can be transferred to the next generation free of the estate tax and 

reduced tax rates. Special tax provisions targeted to farmers and other small 

business owners have provided additional benefi ts. This has reduced the 

number of farm estates required to fi le an estate tax return and pay tax and 

the amount of Federal estate taxes owed. 

While Federal tax policies have undergone signifi cant change in the last 

several years, several factors suggest that additional changes are likely over 

the next couple of years:

• In both the income and estate tax area, a number of the changes 

enacted since 2000 are scheduled to expire in 2010. As the expiration 

date approaches, these policies are likely to be reexamined. Decisions 

regarding expiring tax provisions could affect both the tax burden and 

the fi nancial well-being of farm households.

• The tax code has been increasingly viewed as a suitable vehicle to 

achieve a variety of social policy objectives. The fi rst-time home buyer’s 

tax credit is a recent example. In farming, the use of tax incentives as 

an alternative to cash payments for participation in various conservation 

programs, such as tax benefi ts for conservation easements, has expanded 

the use of the tax code to achieve conservation policy objectives. 

• Tax reductions and incentives have been the focus of Federal tax 

policy over the last several years. However, the Federal budget defi cit 

continues to increase at a rapid rate. In the near future, this deteriorating 

budget situation will likely lead to a review of the various Federal tax 

expenditures as potential revenue-raising options to reduce the Federal 

budget defi cit.
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All of these factors, as well as the inclusion of a tax title in the 2008 Farm 

Act, have raised awareness of the importance of Federal tax policies for the 

farm sector. 

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

Internal Revenue Service (IRS) to provide an overview of the current income 

tax situation for farm households and to evaluate the importance of various 

Federal income and estate tax provisions. It also uses farm-level data from 

USDA’s Agricultural Resource Management Survey (ARMS) to estimate the 

effects of various policies on Federal income and estate tax liabilities of farm 

households. 
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Federal Individual Income and Business 

Taxes Reduced

Since most U.S. farms are operated as sole proprietors, partnerships, or 

small business corporations, most farm income is taxed under the individual 

income tax rather than the corporate income tax. In fact, based on 2007 

ARMS data, over 99 percent of all farmers are taxed under the individual 

rather than the corporate income tax. As a result, farmers and many other 

small businesses are major benefi ciaries of recent changes to Federal individual income and business tax provisions.

Tax relief measures enacted since 2000 have signifi cantly reduced Federal 

income taxes for both individual and business taxpayers. For individual 

taxpayers, legislation has reduced marginal income tax rates, increased standard deduction and exemption allowances, lowered tax rates on capital gains 

and dividends, increased savings incentives, and raised child and earned 

income credit amounts. Federal tax policies affecting businesses have also 

been modifi ed, including reduced tax rates on business investment and manufacturing income.

As of 2008, the cumulative effect of these tax policy changes has resulted in 

the lowest Federal tax rate on farm income and investment in over a decade. 

Federal income taxes paid by farm sole proprietors dropped from $24.9 

billion in 2000 to $21 billion in 2004, a reduction of nearly 16 percent. The 

average tax rate dropped from 17.1 percent in 1994 and 17.8 percent in 2000 

to about 14.8 percent in 2004. While published data are not available for 

more recent years, the current average tax rate is estimated to be at or below 

the 2004 rate. In addition, since the average tax rate is based on adjusted 

gross income, it understates the actual reduction in tax rates to the extent that 

various changes, such as capital expensing and the deduction for manufacturers, which is defi ned to include farmers, have lowered the adjusted gross 

income base. 

Like all households, about one of every three farm households now owe no 

Federal income tax, with some receiving a refundable child or earned income 

credit. Nearly all farm households have realized some tax savings as a result 

of the Federal tax policy environment that has existed over the last decade.
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Most Federal Income Tax for Farm 

Households Is Paid on Off-Farm Income

Since the household is the typical unit of taxation, farm and nonfarm income 

are combined when computing Federal income taxes for farm households. In 

fact, most Federal income tax paid by farm households can be attributed to 

nonfarm income. Since 1980, farm sole proprietors have reported negative 

aggregate net farm income for tax purposes. Over the years, 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 2004, the most recent year for which detailed tax data are available, an 

estimated 1.4 million, or about 70 percent, of farm sole proprietors reported a 

net farm loss for tax purposes. The average loss was $14,380, while average 

adjusted gross income was $73,440. Thus, income from off-farm sources 

averaged $87,820. These farmers paid about $16 billion in Federal income 

taxes. In that same year, an estimated 589,000 farm sole proprietors reported 

a farm profi t. The average profi t reported was $12,520. This accounted for 

only about 20 percent of their average adjusted gross income of $62,670. 

These farmers paid about $5 billion in Federal income taxes.

In 2006, based on IRS data, nearly three of every four farm sole proprietors 

reported a farm loss. The average loss reported was $16,366, for a total of 

just over $23 billion. The increased reporting of losses coincided with an 

increase in the amount of capital investment that can be expensed in the fi rst 

year and may partially explain the trend.

Figure 1

Net farm income/loss on Schedule F 

-30

-15

0

15

30

1998 1999 2000 2001 2002 2003 2004 2005 2006

Billion $

Profits Losses Net profit/loss

Source: USDA, Economic Research Service using Internal Revenue 

Service Federal income tax data.
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Examining losses by size of business receipts provides additional insight 

into the reporting of farm losses for tax purposes. Based on IRS data, farms 

with business receipts less than $50,000 reported an aggregate net farm loss 

of $13.5 billion in 2004 (table 1). Only those farms with sales in excess 

of $100,000 reported a small aggregate net farm profi t, for a total of $1.1 

billion. While accounting for only about 12 percent of farmers, these farms 

accounted for about 80 percent of total business receipts.

Many of those reporting farm losses are individuals whose primary occupation is something other than farming. ERS classifi es farms as rural residence 

farms (lifestyle, retirement, and limited-resource farms), intermediate farms 

(annual sales less than $250,000 and primary occupation is farming), and 

commercial farms (annual sales greater than $250,000). While rural residence farms report relatively high levels of adjusted gross income, three of 

four typically report a farm loss, and these farms account for over half of all 

losses reported. 

The fact that many small rural residence and intermediate farms report losses 

should not suggest that changes in tax policies affecting farm income and 

investment are unimportant. In fact, the $20.6 billion in losses reported in 

2004 is estimated to have reduced Federal income taxes on the off-farm 

income earned by farm households by over $3 billion. This return to farming 

through the tax code may partially explain the continued existence of many 

small farm operations despite the persistence of farm losses.

While there are limits on the ability to use such losses to offset income from 

other sources, in most instances, losses from farming are fully used to reduce 

taxes on other income. The 2008 Farm Act does impose an additional limitation: the amount of farm losses an individual can use to offset nonfarm 

income is limited to the greater of $300,000 or the total amount of net farm 

income the individual has reported over the last 5 years. This limitation only 

applies to those farmers receiving direct, counter-cyclical, or Commodity 

Table 1

Farm profi ts and losses by size of gross farm income, 2004

 Size of annual gross farm income

 Under $50,000 $100,000 All

 $50,000 < $100,000 or more farmers

Number

Farmers 1,660,865 114,635 246,798 2,022,298

Percent

Share of total 82.1 5.7 12.2 100.0

Billion dollars

Schedule F income:

 Profi ts 1.198 .809 5.363 7.371

 Losses -14.725 -1.601 -4.284 -20.610

 Net (profi ts less losses) -13.527 -.792 1.079 -13.239

Source: USDA, Economic Research Service using Internal Revenue Service 2004 Federal 

income tax data.
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Credit Corporation (CCC) loans. Losses that are beyond the limit can be 

carried forward to subsequent years. The annual revenue gain from this 

change is estimated by the Joint Committee on Taxation at less than $100 

million. This suggests that most farm losses can continue to be used to offset 

income from other sources. 

Since rural residence and many intermediate farm households derive most 

of their income from nonfarm sources, these farm households are primarily 

affected by the changes in individual marginal income tax rates, standard 

deduction, and other exemption amounts and those policies affecting the tax 

treatment of income from nonfarm sources. In contrast, commercial farms 

account for a disproportionate share of total U.S. farm sales and investment 

and report most of the farm profi t. Thus, these farms are the primary benefi -

ciaries of the tax changes affecting farm business income and investment. 

The most signifi cant changes over the last decade include reduced capital 

gains tax rates, increased capital expensing and bonus depreciation, and the 

new manufacturer’s deduction. The increased deduction for self-employed 

health insurance and the availability of income averaging are also important 

changes to tax policy that affect farmers.
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Reduced Capital Gains Taxes Increase 

Return on Farm Business Assets 

The Federal income tax system has historically taxed gains on the sale of 

assets held for investment purposes at rates that are lower than tax rates on 

other sources of income. The current tax rate on capital gains is 15 percent 

(0 percent for taxpayers in the 15-percent-or-lower income tax brackets). 

This reduced rate is especially signifi cant for farmers because some assets 

used in farming are eligible for capital gains treatment and the amount of 

capital gains is increased by the ability to currently deduct certain costs, 

especially for livestock. Due to the combination of current expensing and the 

tax rate differential, as long as the losses can be used to offset other income, 

a breakeven or losing investment on a before-tax basis can be converted into 

an after-tax profi t. As a result, capital gains are a key component of income 

for many farmers. 

According to the IRS, 40 percent of all farmers report some capital gains, 

nearly double the share for all taxpayers. The average amount of capital gain 

reported by farmers is also about 50 percent higher than the average capital 

gain reported by other taxpayers. In 2004, the last year for which complete 

data are available, farmers reported net capital gains of $28.7 billion. This 

amount represented about 20 percent of total adjusted gross income reported 

by farm households. The average amount for those reporting gains was 

$35,900. On average, about one-third of reported gains is attributed to 

the sale of assets used in farming. Over 60 percent of commercial farmers 

reported capital gain income, accounting for 25 percent of all capital gains 

reported by farmers. Farmers with adjusted gross income over $250,000 

also report a large amount of capital gain income. In 2004, capital gains 

accounted for one-third of the total income for this group. These high-income 

farmers accounted for nearly 70 percent of all capital gains reported by 

farmers and reported average capital gains of $387,000. 

The lower tax rates for capital gains are scheduled to expire in 2010. At that 

time, barring further legislation, they will revert to pre-2003 rates of 10 and 

20 percent. This would result in an increase in Federal income taxes owed by 

farmers. A large share of the increase would fall on commercial farmers and 

those with adjusted gross income over $250,000. 
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Capital Cost Recovery System Allows 

Most Investment To Be Expensed in Year 

of Purchase 

Farming requires large investments in machinery, equipment, and other 

capital. The tax treatment of these investments is of considerable importance 

to the farm sector, especially commercial farmers. Prior to the Economic 

Growth and Taxpayer Relief Reconciliation Act of 2001 (2001 Act), capital 

purchases were eligible for an immediate expensing of up to $25,000 per 

year. Investments above this amount were depreciated over a specifi ed 

recovery period, generally 7 years (5 years in 2009) for most farm machinery 

and equipment. 

The 2001 Act added a temporary 30-percent fi rst-year allowance. The Jobs 

and Growth Tax Relief Reconciliation Act of 2003 increased the bonus fi rstyear depreciation from 30 to 50 percent of eligible investment and, more 

importantly, raised the annual amount of investment that can be expensed 

from $25,000 to $100,000 (table 2). The temporary fi rst-year bonus depreciation allowance expired, but the expensing provision was extended through 

2007. The 2008 stimulus legislation increased the capital expensing amount 

to $250,000 per year and restored the 50-percent bonus fi rst-year depreciation 

allowance for 2008. The 2009 stimulus legislation has extended the $250,000 

expensing amount and the 50-percent bonus depreciation through the end of 

2009. Less than 1 percent of farmers annually invest more than the $250,000 

expensing amount. Since investments above this amount are eligible for the 

bonus fi rst-year depreciation, nearly all capital investment by farmers can be 

written off in the current year. This increased capital expensing allowance 

reduces the effective tax rate on farm capital and simplifi es the recordkeeping 

burden associated with the depreciation of capital purchases, with commercial farmers the primary benefi ciaries. 

Unless the increased expensing amount and fi rst-year bonus depreciation are 

extended beyond 2009, the expensing amount will drop to $125,000 in 2010 

Table 2

Amount of capital investment that can be expensed has increased

Tax year Expensing amount

Dollars

2000 20,000

2001-02 24,000

2003 100,000

2004 102,000

2005 105,000

2006 108,000

2007 125,000

2008 250,000

2009 250,000

20101 125,000

2011 25,000

1The expensing amount for 2010 will be adjusted for infl ation. 

Source: USDA, Economic Research Service using Internal Revenue Code Section 179.
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and revert to the pre-2003 amount of $25,000 per year after 2010. Less than 

10 percent of residential and intermediate farms invest more than $25,000. 

However, over 40 percent of commercial farms invest more than $25,000. 

Thus, investment by commercial farmers will be affected the most by a 

substantially lower expensing amount. This could lead to reduced capital 

investment by these farmers.
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Manufacturer’s Deduction Provides Substantial Benefi ts for Commercial Farmers

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 allowed U.S. exporters to exclude a portion 

of their foreign sales income from taxation, with a new deduction for U.S. 

manufacturers, which is defi ned to include 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.

While few farm households directly benefi ted from the prior exclusion, 

about one in fi ve farm households directly benefi t from the new deduction. 

The deduction is equal to 6 percent of qualifying production income in 2009 

and 9 percent in 2010 and later. The deduction is limited to no more than 50 

percent of wages paid to hired labor. While this limitation will reduce the 

deduction for many smaller farms that hire little or no labor, farm households are expected to be eligible to deduct nearly $1.9 billion in 2009 and 

nearly $2.6 billion in 2010 when the deduction is increased to 9 percent. 

Commercial farm households are the primary benefi ciaries, with about 

two-thirds expected to benefi t, compared with about 14 percent for all other 

farms. While commercial farms account for only about 8 percent of all farms, 

they will receive about 75 percent of all the farm sector’s benefi ts from the 

manufacturers’ deduction. The average deduction for eligible commercial 

farm households is estimated at $13,300 for 2009.
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Self-Employed Health Insurance Deduction 

Reduces Cost of Health Insurance

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.

About one of eight farmers use the self-employed health insurance deduction in any given year. In 2004, these farmers deducted an average of $4,600 

for a total of $1.24 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.

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 these households are more likely 

to receive health insurance from a nonfarm job or may not qualify for the 

deduction given the likelihood of 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 employersponsored plans.
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Income Averaging Provides Reduced Tax 

Rates for Farmers With Variable Income

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

taxpayers with similar yet more stable income. Farm income is more variable 

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

farm household income far exceeds that of all U.S. households, mostly due 

to variability in income from farming. 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 farm income, and 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. Since 1998, farmers have been eligible for income averaging. Under 

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

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

year. The current income 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, an estimated 

50,800 farmers saved an average of $4,434 with income averaging. The tax 

savings 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 saved an average of $264,000, 

for a total savings of $82.6 million, or about 37 percent of total tax savings 

from the income averaging provision. 
13

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Estate Taxes Reduced, But a Relatively 

Larger Share of Farmers Still Owe Taxes 

The Federal estate tax has applied to the transfer of property at death since 

1916. While the tax has been amended many times, the estate tax and the 

companion gift tax imposed upon transfers prior to a property owner’s 

death have never directly affected a large percentage of taxpayers. Under 

the current Federal estate tax system, individuals can transfer up to a specifi ed amount in money and other property without incurring Federal estate 

tax liability. The estate of a decedent who, at death, owns assets in excess of 

the estate tax exemption amount ($3.5 million in 2009) must fi le a Federal 

estate tax return. However, only those returns that have a taxable estate 

above the exempt amount after deductions for expenses, debts, and bequests 

to a surviving spouse or charity are subject to tax at a graduated rate, up to a 

current maximum of 45 percent. 

In 2009, total Federal estate and gift tax revenues are estimated at about 

$26 billion, accounting for about 1 percent of total Federal tax revenue. 

While the aggregate importance of the Federal estate tax is small relative to 

other Federal Government revenue sources, the potential effect of the tax 

on farmers and other small business owners has been a major concern. Over 

the years, a number of targeted provisions have been enacted to reduce the 

burden of the estate tax on these groups. These include a special provision 

that allows farm real estate to be valued at its farm use value rather than at 

its fair market value, an installment payment provision, and a special deduction for family-owned business interests. A provision aimed at encouraging 

farmers and other landowners to donate an easement or other restriction on 

development has provided additional estate tax savings. These provisions 

have reduced the potential impact of estate taxes on the transfer of a farm or 

other small business to the next generation. 

Providing tax relief to farmers and other small business owners was a 

primary impetus for the 2001 Act. The Act reduced Federal estate tax rates 

and substantially increased the amount of property that can be transferred 

to the next generation free of Federal estate tax, culminating in the tax’s 

complete repeal in 2010. However, like many other provisions in the 2001 

Act, the estate tax changes will sunset (expire) at the end of 2010. 

Since passage of the legislation, the amount exempted from the estate tax 

has gradually increased from $675,000 in 2001 to $3.5 million in 2009 (table 

3). As a result, both the number of estates required to fi le a tax return and 

the number of taxable returns have dropped dramatically. Only about 9,600 

estates (0.4 percent of all estates) are expected to owe Federal estate tax in 

2009, down from 51,766 in 2001. During this same period, Federal estate 

tax revenues have declined, but only by about 25 percent. This illustrates the 

fact that most of the Federal estate tax is paid by the largest estates, which 

continue to be taxable even at the higher exemption levels. In 2005, estates 

with a gross value over $5 million represented only about 14 percent of all 

the estates required to fi le a return, but they accounted for over 60 percent of 

Federal estate tax revenue.
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The estates of small business owners are about twice as likely as the typical 

estate to owe tax, and farm estates are even more likely to owe tax. The 

median wealth of farm households is about fi ve times that of all U.S. households.1 As a result, a larger share of farm estates owes Federal estate tax, 

largely due to appreciation in land values, increases in the average size of 

commercial farms, and rising investment in farm machinery and equipment. 

Based on simulations using farm-level survey data (see box, “Estate Tax 

Estimating Procedures”), about 2.9 percent of the 38,234 farm estates 

projected for 2009 are estimated to have assets in excess of $3.5 million 

and would be required to fi le an estate tax return (fi g. 2). After deductions, 

slightly more than half of these farm estates are likely to owe tax. These 

taxable farm estates have an average net worth of $7.0 million, with about 85 

percent of the value attributable to farm business assets, primarily farm real 

estate. The total amount of Federal estate taxes due from farm estates in 2009 

is estimated at $683 million, with the average taxable estate owing about 

$1.1 million. 

The impact of the Federal estate tax varies by farm type. A relatively larger 

share of commercial farms are projected to owe Federal estate taxes in 2009. 

The average value of farm assets for commercial farms was roughly $2.9 

million in 2007, based on the most recent data available from ARMS. Thus, 

despite estate tax relief targeted to farmland (special-use valuation), an estimated 10 percent of all commercial farm estates are likely to owe Federal 

estate taxes in 2009 (fi g. 3). Commercial farms are 10 times more likely to 

owe Federal estate taxes than other farms. While representing only about 6 

percent of all farm estates, commercial farms account for nearly 40 percent 

of all Federal estate taxes paid by farm estates (fi g. 4). In contrast, rural residence farms account for nearly three-fourths of all farm estates but only about 

one-third of Federal estate taxes. These estates also tend to have a larger 

share of their net worth in nonfarm assets than commercial farm estates.

1www.ers.usda.gov/briefi ng/wellbeing/

farmnetworth.htm

Table 3

Estate tax exemption amount has increased while graduated 

tax rates have declined 

 Estate tax Highest marginal

Year exemption amount estate tax rate

 Dollars Percent

2001 675,000 55

2002 1,000,000 50

2003 1,000,000 49

2004 1,500,000 48

2005 1,500,000 47

2006 2,000,000 46

2007 2,000,000 45

2008 2.000,000 45

2009 3,500,000 45

2010 Estate tax repealed Estate tax repealed

2011 1,000,000* 55

*

Before being superseded by the 2001 Act, the estate tax exemption was scheduled to increase 

to $1 million by 2006. 

Source: USDA, Economic Research Service using Internal Revenue Code Section 2010.

Estate Tax Estimating Procedures 

Estate tax estimates in the report 

are based on simulations using data 

from USDA’s Agricultural Resource 

Management Survey (ARMS) for 

2000-07. The ARMS survey is a stratifi ed sample of farms with information 

on farm operators and their households, including detailed fi nancial information for both farm and nonfarm 

assets and debts. The number of estates was estimated based on the age 

of the operator and mortality rates from 

the Social Security Administration. 

The estimates are for farm operator 

households only and do not include 

potential estate taxes on the transfer 

of farm assets by landlords and others. Estate values for future years are 

estimated based on ERS forecasts for 

the value of assets and debts.
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Figure 2

Share of farm operator estates with returns and taxes, 2009

Source: USDA, Economic Research Service estimates based on USDA’s

Agricultural Resource Management Survey, 2007.

Returns with taxes

1.6%

Returns/No taxes

1.3%

No returns

97.1%

Figure 4

Distribution of farm estates, estate returns, taxable returns, and taxes, by farm type, 2009

Note: Rural residence farms have annual sales under $250,000 and operators whose primary occupation is other than farming; 

intermediate farms have annual sales under $250,000 and operators whose primary occupation is farming; commercial farms 

have annual sales over $250,000.

Source: USDA, Economic Research Service estimates based on USDA’s Agricultural Resource Management Survey, 2007.

73.1%

20.9%

6.0%

36.9%

23.5%

36.3% 39.7%

27.7%

36.3%

32.5% 27.8%

39.2%

Rural residence farms Intermediate farms Commercial farms

Estates Tax returns Estates with tax Estate taxes

3.3%

19.2%

9.7%

2.9% 2.1% 1.6%

Intermediate farms Commercial farms All farms

Figure 3

Share of farm estates required to file a tax return and pay estate taxes, by farm type, 2009

1.5% 0.8%

Rural residence farms

Tax returns Estate taxes

Note: Rural residence farms have annual sales under $250,000 and operators whose primary occupation is other than farming; 

intermediate farms have annual sales under $250,000 and operators whose primary occupation is farming; commercial farms 

have annual sales over $250,000.

Source: USDA, Economic Research Service estimates using data from the Agricultural Resource Management Survey, 2007.
16

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Special Provisions Benefi t Farmers 

Concerns that Federal estate taxes might cause the breakup of some familyowned farms and small businesses led to the enactment of two special provisions in the Tax Reform Act of 1976. At that time, the exemption amount 

was only $120,000 and the top tax rate was 70 percent. These targeted 

provisions—the special-use valuation and the installment payment of estate 

taxes—reduce the impact of Federal estate taxes on farms with estates valued 

above the basic exemption amount. 

Special-Use Valuation. The value of property for Federal estate tax 

purposes is generally the fair market value on the date of the property 

owner’s death. However, if certain conditions are satisfi ed, the estate’s real 

property that is used solely for farming or other closely held business may 

be valued at the property’s value as a farm or business rather than at its fair 

market value. For the property to qualify for the special-use valuation, farmland must be transferred to a qualifi ed heir, the land must have been used as 

a farm for 5 years during the 8-year period ending with the decedent’s death, 

and the decedent or a member of the decedent’s family must have participated in the farm business. In addition, the value of the qualifi ed real property must equal at least 25 percent of the estate and the combined value of the 

real and other business property must be at least 50 percent of the total gross 

value of the estate. 

For qualifying farms, special-use valuation can reduce the value of the real 

property portion of estates by 40 to 70 percent, with the largest reductions 

occurring for farmland having residential or commercial development potential. Based on information published by the IRS, the average reduction in 

value for qualifying estates in 2001 was 50 percent. The maximum reduction 

in value for estates of those dying in 2009 is $1 million. At current Federal 

estate tax rates, the potential estate tax savings available under special-use 

value could be as much as $450,000. However, all or a portion of the estate 

tax benefi ts obtained under the special-use valuation provision must be repaid 

if the property is sold to a nonfamily member or if the property ceases to be 

used for farming within 10 years of the decedent’s death. 

Installment Payment of Estate Taxes. Federal estate taxes generally must be 

paid within 9 months of the date of the property owner’s death. The installment payment provision was enacted out of concern that the heirs of family 

farmers and small business owners might have diffi culty paying taxes on land 

and other relatively illiquid business assets. Under the provision, if at least 

35 percent of an estate’s value is a farm or closely held business, estate taxes 

may be paid over 14 years and 9 months, with interest due only for the fi rst 

5 years. In 2009, the interest rate on the fi rst $1.33 million in taxable value 

(above the basic exemption and other exclusions) of farm or other closely 

held business assets is 2 percent, with slightly higher rates owed on amounts 

above $1.33 million. This installment payment provision, combined with the 

increase in the amount of property that can be transferred tax free, greatly 

reduces the liquidity problem that some farm heirs might otherwise experience as a result of Federal estate taxes. In 2005, only 382 estates elected to 

defer taxes. However, the estates that made the election held a much larger 
17

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share of their estate in real estate or farm or other closely held business 

interests. 

The Taxpayer Relief Act of 1997 provided two additional provisions that 

have helped to reduce the impact of the estate tax on farmers. These include 

an estate tax exclusion for land subject to a conservation easement and a 

deduction for family-owned businesses.

Exclusion for Land Subject to Conservation Easement. Under this provision, farmers and other landowners can exclude up to 40 percent of the value 

of land subject to a qualifi ed conservation easement for estate tax purposes. 

To qualify for the exclusion, the decedent or a member of his or her family 

must have owned the land for at least 3 years prior to the decedent’s date of 

death. They also must have made a qualifi ed conservation contribution, such 

as a perpetual restriction or easement on the use of real property for conservation purposes, to a charity or other qualifying organization. A conservation 

purpose is defi ned as the preservation of (1) land for the general public’s 

outdoor recreation or education; (2) a natural habitat; or (3) open space for 

the scenic enjoyment of the general public or in furtherance of a governmental conservation policy. 

The maximum estate tax exclusion for qualifi ed landowners under this provision is $500,000. This is in addition to the reduction in the land’s value 

resulting from the easement itself. Thus, if the value of the easement represents a large share of the land’s market value, the total reduction in value 

for estate tax purposes can be signifi cantly higher than $500,000. Donating 

a conservation easement may be an especially attractive option for farmers 

near urban areas who want to keep their land in farming. In 2005, landowners made 2,307 charitable donations of conservation easements. While 

the estate tax benefi ts from these contributions is unclear, their total value 

was $1.8 billion. 

Deduction for Qualifi ed Family-Owned Businesses. The 1997 Act also 

included a special deduction for farmers and other small business owners. 

This provision allowed a deduction for the fi rst $675,000 of value for qualifi ed family-owned business interests. The deduction is in addition to the 

basic exemption and any benefi ts from special-use valuation. However, the 

total amount excludable under this provision and the basic exemption is 

limited to $1.3 million. Since the basic exemption was raised to $1.5 million 

in 2004, the special deduction was repealed that year. If the estate tax provisions are allowed to expire and revert to pre-2001 law, the family business 

deduction will once again apply. However, since the basic exempt amount 

would be $1 million, the maximum benefi t of the family business deduction 

would be $300,000.
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Figure 5

The share of farm estates required to file a return and pay Federal estate tax

could rise sharply in 2011

0

5

10

15

20

25

30

35

2001 2002 2003 2004 2005 2006 2007 2008 2009f 2010f 2011f

Percent

0.0

0.5

1.0

1.5

2.0

2.5

Billion dollars

Total taxes ($1)

Returns filed (%)

Taxable estates (%)

If pre-2001 law 

goes into effect

f=forecast based on 2007 data.

Source: USDA, Economic Research Service estimates using data from 2000-07 Agricultural Resource Management Survey.

Current Law Provides for Repeal 

and Uncertainty

Under the 2001 Act, the Federal estate tax is repealed completely in 2010. 

However, since the 2001 estate tax changes are scheduled to expire at the end 

of 2010, this repeal is only temporary. The resurrected tax in 2011 reverts to 

the law in place prior to the 2001 changes. As a result, the exempt amount 

would return to $1 million and the top tax rate would revert to 55 percent. 

This situation not only creates uncertainty, but it also raises equity concerns 

regarding the fairness of providing such disparate treatment for similar 

estates depending upon the date of death, especially when they may be only 

days apart. 

If it occurs, the reversion to pre-2001 law will increase the share of estates 

that owe Federal estate tax and will result in signifi cantly higher Federal 

estate tax revenues. The share of estates that would owe tax under a reversion 

to pre-2001 law is estimated to increase to about 2.5 percent of all estates, 

with total tax liability more than doubling to over $50 billion. 

The impact on farm estates is expected to be even larger. Since 2000, farm 

equity has more than doubled, primarily due to the increased value of farm 

real estate. Farmland values have increased by an average of 14 percent 

annually since 2004. As a result, under current law, it is estimated that as 

many as 1 of every 10 farm estates would owe estate tax in 2011 (fi g. 5). 

Total estate taxes that year could increase to about $2.55 billion—nearly 300 

percent more than the estimated amount owed by farm estates in 2009. 

In addition to repealing the estate tax, the 2001 Act changed the treatment 

of unrealized gains at death, effective with estate tax repeal. Under current 

law, the basis (which is the value used to determine gain or loss) of assets 

acquired from a decedent is stepped up to the fair market value at the 
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date of death. This “step-up in basis rule” essentially eliminates the recognition of income on the appreciation of the property that occurred prior to the 

property owner’s death. This change can be especially important for assets, 

such as farmland, that are typically held for long periods and have appreciated considerably. 

Upon repeal of the estate tax in 2010, the step-up in basis rule is replaced 

with a carryover of the decedent’s basis with an added amount of up to $1.3 

million (plus an additional $3 million for transfers to a surviving spouse). 

This change will add to compliance burdens because it will be necessary to 

determine the cost or other basis of inherited assets. In farming, these assets 

may have been held for several decades with limited documentation on their 

original cost or the method in which they were acquired. The heirs of some 

farm estates that would owe no Federal estate tax or capital gains tax under 

current law would be faced with this compliance burden and could owe taxes 

upon the sale of the inherited assets. The number of estates with unrealized 

gain above the step-up amount is estimated to exceed the number of estates 

that currently owe estate taxes. While most of these gains would be taxed at 

capital gains rates that are substantially lower than estate tax rates, the tax 

would be triggered only upon the sale of the inherited assets, so some heirs 

would be discouraged from selling inherited assets, creating a lock-in effect.

With repeal and resurrection of the estate tax approaching, support is 

growing for a substantial permanent increase in the exempt amount combined 

with the retention of the stepped-up basis at death treatment for inherited 

assets. The 2010 President’s Budget would make the current $3.5 million 

exemption amount and tax rates permanent and retain the stepped-up basis 

treatment for inherited assets. This would limit the share of estates subject 

to tax to less than one-half of 1 percent of all estates and to between 1 and 

2 percent for the estates of farmers. It would also reduce some of the uncertainty and inequity created by the temporary repeal and sunset provisions 

applicable under current law. 
20

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References

Durst, Ron L., and James Monke. The Effects of Federal Tax Policy on 

Agriculture, Agricultural Economics Report 800, U.S. Department of 

Agriculture, Economic Research Service, April 2001, www.ers.usda.gov/

publications/aer800/

Gangi, Martha Eller, and Brian G. Raub. Utilization of Special Estate Tax 

Provisions for Family-Owned Farms and Closely-Held Businesses, Statistics 

of Income Bulletin, Internal Revenue Service, Summer 2006, pp. 128-144.

Herman, Tom. “Estate Tax Repeal May Hurt Some,” Wall Street Journal, 

May 11, 2005.

Jacobson, Darien B., Brian G. Raub, and Barry Johnson. The Estate Tax: 

Ninety Years and Counting,” Statistics of Income Bulletin, Internal Revenue 

Service, Summer 2007.

Joint Committee on Taxation. History, Present Law and Analysis of the 

Federal Wealth Transfer System, JCX-108-07, November 13, 2007. 

Mishra, Ashok K., Hisham S. El-Osta, Mitchell J. Morehart, James D. 

Johnson, and Jeffrey W. Hopkins. Income, Wealth, and the Economic 

Well-Being of Farm Households, Agricultural Economics Report 812, U.S. 

Department of Agriculture, Economic Research Service, July 2002, 

www.ers.usda.gov/publications/aer812/

Pierce, Kevin, and Mary E. Jezek. Farm Sole Proprietorship Returns, 1998-

2004, Statistics of Income Bulletin, Internal Revenue Service, Spring 2007, 

pp. 122-159.