Policy Issues in Rural Development

Economic Research Service/USDA

he current Federal estate tax

was enacted in 1916.

Throughout much of its history,

the tax has not raised a significant

portion of Federal tax revenue or,

with the exception of a short period

during the early 1970s, subjected

more than 1 or 2 percent of all

estates to tax. While only about 2

percent of all estates are currently

taxable, the number of estates subject to tax more than doubled from

1987 to 1997, when 42,901 estates

owed Federal estate tax. This

increase in the number of taxable

estates and the increasing budget

surplus were the primary factors contributing to a reduction in Federal

estate and gift tax burdens in 1997,

especially for farmers and other small

business owners. While many of the

provisions enacted in 1997 are still

being phased in, Congress, as part of

the Economic Growth and Tax Relief

Reconciliation Act of 2001, made

additional changes to Federal estate

and gift taxes. These changes will be

phased in over the next decade.

Farmers and owners of other small

businesses hold significant amounts

of wealth in the form of business

assets and are thus more likely than

other taxpayers to be subject to

Federal estate taxes. Providing relief

to farmers and other small business

owners was the primary impetus for

the 1997 changes to Federal estate

and gift tax policies and a major

objective of the 2001 phaseout and

eventual repeal of the Federal

estate tax.

Overview of Current Law

The current Federal estate and gift

tax system applies a unified tax rate

structure and a cumulative lifetime

credit to gifts and transfers of money

and other property at death. Under

the system, individuals can transfer a

specified amount ($1 million in

2002) in cash and other property

without Federal estate or gift tax liability as a result of the unified lifetime credit. Although every estate

with more than $1 million in gross

assets must file an estate tax return,

the taxable amount is reduced by

deductions for funeral expenses,

administrative expenses, debts, charitable contributions, and transfers to

the decedent’s spouse. As a result,

less than half of all estates required

to file a return are actually taxable.

Gifts of up to $11,000 annually to an

unlimited number of individuals are

not subject to tax and do not count

against the amount exempted from

tax by the unified credit. Transfers

in excess of the exempt amount are

taxed at a graduated rate that

begins at an effective rate of 41 percent, rising to a maximum rate of 50

percent on taxable estates above

$2.5 million.

Estate and gift tax receipts have

historically accounted for a relatively

small share of total Federal revenues,

accounting for a little over 1 percent

of total revenue in 1998. However,

while the aggregate importance of

estate and gift taxes is small relative

to other Federal Government revenue

sources, the potential impact of these

taxes on an individual or group of

individuals, such as farmers and

other small business owners, can

be substantial. 

Special Farm Provisions

The appreciation in land values, the

increase in average farm size, and

the rising investment in farm machinery and equipment have increased

farm estate values and taxes. Over

the years, congressional concern

that the farm sector’s increasing

estate and gift tax liability might

How Will the Phaseout of

Federal Estate Taxes Affect

Farmers?

Ron Durst, James Monke, and Douglas Maxwell

POLICY ISSUES IN RURAL DEVELOPMENT

United States

Department of

Agriculture

Economic

Research

Service

Agriculture 

Information 

Bulletin No. 751-02

February 2002

Concern among policymakers that the Federal estate tax might force the liquidation of some family farms has resulted in the enactment of a variety of special provisions over the years. Providing relief to farmers and other small business owners was the primary impetus for the 1997 changes to Federal estate

and gift tax policies and a major objective of the 2001 law that will phase out

and eventually repeal the Federal estate tax. While only about 4 percent of all

farm estates owe Federal estate taxes, a much larger percentage of farm

estates must file an estate tax return, make use of special farm provisions,

alter their business practices, or engage in costly estate planning in order to

reduce the impact of the estate tax on their farm business. Thus, the phaseout and repeal of the Federal estate tax will affect a much broader group of

farmers than just those who owe tax.

T
cause the breakup of some family

farms and other small businesses led

to the enactment of a number of targeted provisions to provide tax relief

to farmers and other small business

owners. Targeted provisions include

the special-use valuation of farmland, the installment payment of

estate taxes, and a new deduction

for family-owned business interests.

Special-Use Value

In general, the value of property for

estate tax purposes is the fair market value at the date of death.

However, if certain conditions are

satisfied, the estate’s real property

devoted to farming (or other closely

held business) use may be valued at

its use value as a farm (or other

closely held business) rather than at

its fair market value. To qualify for this

use value, the property must be

transferred to a qualified heir, must

have been used as a farm for 5 years

during the 8-year period ending with

the decedent’s death, the decedent

or a member of the decedent’s family must have participated in the farm

business, the value of the qualified

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 gross estate. 

The method used to value farmland

for use-value purposes is to divide

the 5-year average annual gross cash

or share rental for comparable land

in the area, minus State and local

real estate taxes, by an average of

the annual effective interest rate for

all new Federal Land Bank (FLB)

loans for the year of death. For most

farms, the use-valuation law can

reduce the value of the real property

portion of qualifying estates by 40 to

70 percent, with the largest reductions occurring for farmland which

has residential or commercial development potential. The maximum

reduction in value for 2001 is

$800,000 ($820,000 for 2002). All

or a portion of the estate tax benefits obtained under the special-use

valuation provision are recaptured if

the property is sold to a nonfamily

member or if the property ceases to

be used for farming or other closely

held business purpose within 10

years of the decedent’s death.

Installment Payment of 

Estate Tax for Closely Held

Businesses 

A second special provision for farmers and other small business owners

is aimed at the liquidity problem that

these businesses can face as a result

of having a large portion of the

estate in land and other relatively

illiquid business assets. Federal

estate and gift taxes generally must

be paid within 9 months of the date

of death. However, when at least 35

percent of an estate’s value is a farm

or closely held business, estate taxes

may be paid over an additional 14-

year period with only interest due for

the first 5 years. Beginning in 1998,

the interest rate on the first $1 million in taxable value (above amounts

exempted by the unified credit) of

the farm or other closely held business was reduced to 2 percent, with

the interest rate on amounts above

$1 million equal to 45 percent of the

normal rate applicable to tax underpayments. The amount of estate tax

eligible for the 2-percent interest rate

is scheduled to increase from

$153,000 in 1997 to $435,000 for

2002. This provision, combined with

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

has greatly reduced the liquidity

problem that some farm heirs might

otherwise experience as a result of

Federal estate taxes. 

Deduction for Qualified

Family-Owned Businesses

Beginning in 1998, a new deduction

for the first $675,000 of value in

qualified family-owned business

interests was enacted. The deduction

is in addition to any benefits from

special-use valuation and the unified

credit. The total amount excludable

from the combination of this provision and the unified credit is limited

to $1.3 million. Thus, as the amount

exempted by the unified credit

increases (as scheduled under current law), the additional amount of

farm and closely held business property that can be transferred free of

tax declines.

A qualified family-owned business

interest is any stake in a business

with its principal place of business

in the United States in which one

family owns at least 50 percent of

the business, two families own at

least 70 percent, or three families

own at least 90 percent, as long as

the decedent’s family owns at least

30 percent. To be eligible for the

exclusion, such interests must comprise more than 50 percent of a

decedent’s estate and the decedent,

the decedent’s heirs, or a member

of their family must satisfy certain

pre- and post-death ownership and

participation requirements. The benefits from the exclusion are recaptured

if the qualified heir fails to meet the

material participation requirements,

disposes of the business interest

other than to a family member or

through a qualified conservation contribution, loses U.S. citizenship, or

moves the principal place of business

outside the United States.

The deduction for farms and other

family-owned businesses, combined

with the increased unified credit, is

expected to significantly reduce both

the number of taxable farm estates

and total taxes paid. Nevertheless,

the targeting provisions associated

with the deduction are extremely

complex and contain a number of

pitfalls for the uninformed.

Qualifying for the deduction requires

careful planning, further increasing

the administrative burden and

expense associated with the Federal

estate tax. 

Exclusion for Land Subject to

Conservation Easement

In addition to the targeted provisions, farmers and other landowners will be the primary beneficiaries

of a new exclusion for land subject

to a conservation easement. Since

1981, a deduction has been

allowed for Federal income and

estate and gift tax purposes for a

contribution of a qualified real

property interest to a charity or

other qualifying organization exclusively for conservation purposes. A

“qualifying real property interest”

means a perpetual restriction or

easement on the use of real property. A “conservation purpose” is

defined as (1) the preservation of

land for the general public’s outdoor recreation or education, (2)

the preservation of a natural habitat, (3) the preservation of open

space for the scenic enjoyment of

2

Policy Issues in Rural Development

Economic Research Service/USDA
the general public or in furtherance

of a governmental conservation

policy, or (4) the preservation of

historically important land or certified historic structures. 

Beginning in 1998, in addition to the

reduction in value for the conservation easement, up to 40 percent of

the value of the land in an estate

subject to a qualified conservation

easement and located within 25

miles of a metropolitan area, a

national park, or wilderness area, or

within 10 miles of an Urban National

Forest can be excluded for Federal

estate tax purposes. The land must

have been owned by the decedent or

a member of the decedent’s family

for at least 3 years prior to the date

of death, and the donation must

have been made by the decedent or

his family. The exclusion is based on

the value of the property after the

conservation easement is placed,

but does not include any retained

development rights to use the land

for any commercial purpose except

farming. If the value of the conservation easement is less than 30 percent of the value of the land for purposes of the exclusion then the

exclusion percentage is reduced 2

percentage points for each percentage point below 30 percent. The

maximum exclusion was $400,000

in 2001 but increased to $500,000

in 2002 and thereafter. 

The exclusion provides an additional

incentive to donate a conservation

easement within the designated

areas. The new exclusion is especially attractive for farmers who own

land near urban areas where the difference between the value of land

for farm purposes and for development purposes can be significant.

However, given the increased unified

credit, the availability of special-use

valuation, and the new deduction for

family-owned business interests, the

number of landowners subject to the

Federal estate tax who would benefit

from the additional exclusion is relatively small. Geographic targeting of

conservation easements has also

limited the pool of potential donors.

Impact of Federal Estate

Taxes on Farmers

The changes enacted in 1997

reduced the number of farm estates

subject to tax primarily by increasing

the favored treatment of farm and

other business assets over other

types of assets for estate tax purposes. Despite this favorable treatment,

farm estates are twice as likely as

nonfarm estates to be subject to the

estate tax. Based on simulations

using 1998 farm-level survey data,

an estimated 4 percent of all farm

estates owed Federal estate and gift

taxes, versus just about 2 percent of

all estates. Of the 31,161 estimated

farm estates for 1998, 5,394 (17

percent) had assets in excess of

$625,000 and would be required to

file an estate tax return (fig. 1). After

deductions, special-use value, and

the family business deduction, only

1,219 of these estates would be taxable. The total amount of Federal

estate taxes owed by farmers was

estimated at $735 million. The average tax due was about $602,000 on

an average net worth of $2,832,000

for an average tax rate of 21 percent. 

The Federal estate tax burden for

farmers can be further analyzed by

the size and type of farm (table 1).

Using Agricultural Resource

Management Survey (ARMS) data and

the new ERS farm typology (see

America’s Diverse Family Farms, AIB769, May 2001, http://www.ers.usda.

gov/publications/aib769), the

Federal estate tax appears to be of

little concern to most small farms

(farms with sales under $250,000).

Only about 3.5 percent of all small

farms owed any Federal estate taxes

in 1998 (fig. 2). Within the smallfarm category, no limited-resource

farmers owed any estate tax because

of the low level of assets associated

with this group. Of the remaining

farm types within the small-farm

typology, the only farm type with

more than 4 percent of farm estates

owing taxes were primary occupation

farms with sales less than $100,000.

An estimated 5 percent of these

farms owed taxes. Compared with

small farms, the share of large and

very large farms that owe taxes is

significantly greater—10 percent and

17 percent, respectively. In most

instances, the tax owed is also

greater, with the very large farms on

average owing over $1 million in

Federal estate taxes. 

Without the special provisions, the

Federal estate tax would impose a

much greater burden on farmers

(see example below). The potential

for savings from these provisions is

highlighted by the fact that the special-use valuation and the family

business deduction reduced both

the number of taxable estates and

total Federal estate taxes for all farm

estates by about half (fig. 3). The

largest percentage reductions

occurred for primary occupation

farms with sales between $100,000

and $250,000. Federal estate taxes

for this category of farms were cut

by nearly 75 percent. Reductions for

retirement farms were substantially

less, with such farms experiencing

only about a one-third reduction in

taxes. This reflects the inability of

many retirement farms to qualify for

the family business deduction due

to the relative value of nonfarm

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Policy Issues in Rural Development

Economic Research Service/USDA

Example of farm and nonfarm-nonbusiness estate tax liability, 1998 

Farm estate1 Other estate 

Gross estate $2,000,000 $2,000,000

Reduced by—special-use value2 -$750,000 NA

Family business deduction -$675,000 NA

Taxable estate $575,000 $2,000,000

Tentative tax $183,550 $780,800

Reduced by—unified credit -$202,050 -$202,050

Estate tax owed 0 $578,750

NA= not applicable.

1Assumes that 80 percent of estate is composed of farm assets (75 percent farmland) and

that all other ownership and participation requirements are satisfied for special-use valuation and the family business deduction.

2In this example, special-use valuation results in a reduction in the farmland portion of the

estate by 50 percent of fair market value.
assets in the estate. For retirement

farms, average nonfarm net worth

exceeds the average value of farm

assets other than land and buildings.

This may reflect the disposition of

farm assets in anticipation of or during retirement. Reductions as a percentage of tax were also smaller for

very large farms. This can be attributed to the $750,000 cap (in 1998)

on the reduction in value under the

special-use value provision and the

maximum $675,000 exemption

from the new deduction for familyowned business interests. 

The installment payment provision

further reduced the estate tax burden

by providing for below-market interest

rates on installment payments over

an extended repayment period.

Nearly 60 percent of all taxable farm

estates were eligible for installment

payment. These estates owed much

higher taxes on average and accounted for over 87 percent of total

Federal estate taxes paid by farmers.

The present value of Federal estate

tax payments for these farm estates

was reduced by about a third.

New Law

The Economic Growth and Tax Relief

Reconciliation Act of 2001 provides

for the phaseout and eventual repeal

of the Federal estate tax. Beginning

in 2002, the unified credit is

increased to $1 million and the top

tax rate is reduced from 55 percent

to 50 percent. Additional increases

in the unified credit and reductions

in tax rates will be phased in

through 2009 before the estate tax

is completely repealed in 2010

(table 2). The gift tax will remain in

effect but with a $1 million exemption amount and a tax rate equal to

the top individual income tax rate

(35 percent) under the new law. 

In 2004, the deduction for qualified

family-owned business interests will

be repealed once the exemption

from the unified credit reaches $1.5

million, exceeding the $1.3 million

4

Policy Issues in Rural Development

Economic Research Service/USDA

Table 1—Average net assets and estate taxes by type of farm, 1998

Small family farms Large Very

family large

Farming occupation farms farms

Limited Residential/ Farm sales ($1000)

resource Retirement lifestyle <$100 $100-250 $250-500 >$500

Number

All farmers 150,268 290,938 834,321 422,205 171,469 91,939 61,273

Percent

Share across farm types 7 14 41 21 8 5 3

Number

Taxable estates 0 365 178 448 68 78 82

Percent

Share across farm types 0 30 15 37 5 6 7

Thousand dollars

Average net assets for taxable estates

Total 0 2,534 1,657 3,335 2,303 2,921 4,330

Farm 0 2,027 921 2,895 1,916 2,602 4,037

Nonfarm 0 507 736 440 387 319 293

Thousand dollars

Federal estate tax paid

Total 0 208,470 44,645 333,599 17,850 35,735 94,584

Percent

Share across farm types 0 28 6 45 3 5 13

Thousand dollars

Average 0 571 250 745 262 458 1,156

Source: Estimated by USDA-ERS from ARMS data.

Figure 1

Share of farm estates with returns and taxes, 1998

4%

13%

Returns with taxes

Based on a total of

31,161 farm estates

Paid total of $735 million

Average tax due was 

$602,000

Source: USDA-ERS, estimates based on ARMS data.

83%

No returns

Returns/

no taxes
currently allowed under the family

business deduction and unified

credit. The act also expands the

availability of qualified conservation

easements by eliminating the

requirement that the land be located

within a certain distance of a metropolitan area, national park, wilderness area, or Urban National Forest.

Thus, a qualified conservation easement can now be claimed on all

land located in the United States. 

The entire 2001 Act is scheduled to

terminate on December 31, 2010.

Unless the sunset provision is

repealed, the Federal estate and gift

tax will revert to the law in effect

prior to the 2001 Act. Under this law,

the applicable exclusion amount

from the unified credit for both the

Federal estate and gift tax would be

$1 million with a maximum tax rate

of 55 percent. 

Who Would Benefit from

Phaseout and Repeal?

While only about 4 percent of all

farm estates owe Federal estate tax,

a much larger number are required

to file, utilize special farm provisions, alter business practices, or

engage in estate planning to reduce

the impact of the tax on their business. Thus, the phaseout and repeal

of the Federal estate tax will affect a

much broader group of farmers than

just those who owe tax. 

Prior to the 2001 Act, about 1 out of

every 6 farm estates were required

to file an estate tax return. As a

result of the phaseout and repeal of

the tax, this group of farm heirs will

be relieved of the administrative burden of filing. Also, those required to

file but who owe no tax due to special provisions, including special-use

valuation and the deduction for family-held business interests, currently

may be subject to the recapture of

estate tax benefits and may face

increased income tax liability.1 The

number of farm estates that must

file but owe no tax due to these special provisions is estimated at nearly

double the number of estates that

actually owe Federal estate taxes.

Under repeal, these individuals

would realize income tax savings and

could avoid potential estate tax

recapture liability. Finally, farmers

with assets near the filing threshold

would no longer need to alter their

business plans or engage in other

estate planning techniques to avoid

the estate tax. 

The significant increase in the unified credit will greatly reduce the

number of estates that are required

to file but owe no tax. In fact, while

the number of estates that owe tax

is projected to be cut in half by

2006, the number required to file

will decline from 17 to 10 percent of

all farm estates in 2002 and to only

4 percent by 2006 (fig. 4).

5

Policy Issues in Rural Development

Economic Research Service/USDA

Figure 3

Tax and tax reductions from special farm provisions, 1998

Installment

payment

Tax 

(present value)

Source: USDA-ERS, based on 1998 ARMS data.

Family business

deduction

Special-use

value

Percent of tax before special provisions

0

20

40

60

80

100

Limited 

resource

(No tax)

Retirement Residential/

lifestyle

Large Very 

large

Farm type

Farming

occupation:

Low sales

Farming

occupation:

High sales

Figure 2

Farm estate returns and taxes by farm type, 1998

Source: USDA-ERS, based on 1998 ARMS data.

Tax returns Owe taxes

No tax

or returns

Limited

resource

Retirement Residential/

lifestyle

Farming

occupation:

Low sales

Farming

occupation:

High sales

Large Very large

Farm type

0

10

20

30

40

50

60

70

80

Percent

1The election of special-use value reduces

the value of qualified farm property for

estate tax purpose. This special-use value

rather than fair market value then also

becomes the value used to determine

gain for income tax purposes. Thus, electing special-use value can increase future

gain and income tax liability upon sale of

the special-use value property.
While phaseout and repeal of the

estate tax may benefit as many as a

third of all farm estates, the bulk of

the benefits will accrue to the 4 percent of farm estates that owe taxes.

Under the new law, taxes are gradually cut in half before final repeal in

2010. On average, taxable farm

estates will save over $600,000 as a

result of the repeal of the estate tax,

but the benefits would vary significantly with farm size. Taxable estates

with net worth under $1 million

would save about $68,000 on average beginning in 2002. The primary

beneficiaries of repeal would be

farm estates with net assets in

excess of $5 million; such farm

estates currently account for an estimated two-thirds of all Federal estate

taxes paid by farmers. 

Impact of Repeal

Repeal of the Federal estate tax

could influence farm efficiency and

various structural aspects of farming, including farm size and the

ownership and control of farmland.

However, given the relatively small

number of farms affected each year,

the impact may be less important

than the effects of other government policies or other factors on

the agricultural sector. 

For 2001, the gap between the

amount of farmland and other business assets versus other property

that can be transferred tax free was

at least $1,425,000 but could be

much higher if both the husband

and wife took advantage of the special provisions. The combination of

the high marginal estate tax rates

and the preferential treatment

accorded farm business assets,

especially farmland, encourages

older farmers to retain ownership of

these assets while providing a substantial incentive for nonfarmers to

invest in farmland to shelter assets

from the Federal estate tax. At the

same time, the ownership and participation requirements associated

with the preferred treatment tend to

reduce the supply of farmland,

especially since heirs must hold

property for several years to avoid

the recapture of tax benefits. 

The value of this preferential treatment for farm business assets will

decline as the unified credit is

increased, marginal tax rates are

reduced, and the family-owned business deduction is repealed. Thus,

the phaseout and repeal of the

estate tax will reduce and eventually

eliminate the effects of this preferential treatment on farmland markets by reducing the incentive to

purchase and hold such assets and

by removing the obstacles associated with the heirs’ post-death holding

requirements. With heirs free to dispose of property without concern for

income taxes or recapture of estate

taxes, the supply of farmland

offered for sale by heirs should

increase. However, to the extent that

heirs have been forced to sell farmland and other farm assets to pay

estate taxes, a partially offsetting

effect would occur, since repeal

would also eliminate the need to sell

such assets, especially for the

largest estates.

Limiting Step-up of Basis 

at Death

Due to concerns regarding the cost

of eliminating the estate tax, repeal

is phased in over several years and

also involves some limitations on the

step-up in basis rules that currently

apply to inherited property. Under

current rules, the basis (value) of

property received from a decedent’s

estate is generally adjusted to the

6

Policy Issues in Rural Development

Economic Research Service/USDA

Figure 4

Share of farm estates with returns and taxes, 1998-2010

Source: USDA-ERS, based on 1998 ARMS data.

Percent

0

5

10

15

20

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Returns

(2001 Act)

Unified

credit to

$1.0 M

Unified

credit to

$1.5 M

Unified

credit to

$2.0 M

Unified

credit to

$3.5 M

Returns

(old law)

Owe taxes 

(old law)

Owe taxes 

(2001 Act)

Table 2—Estate tax exemption amount and tax rates, 1998-2010

Calendar Estate tax Highest estate and

year exemption amount gift tax rates

1998 $625,000 55%

1999 $650,000 55%

2000 $675,000 55%

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 35% gift tax rate

2011* $1,000,000 55%

*Under current law, the 2001 Act sunsets on December 31, 2010, resulting in a reversion to the law applicable prior to the 2001 Act.
property’s fair market value on the

date of the decedent’s death, rather

than its original cost. This step-up in

basis eliminates any Federal income

taxes on the appreciated value of

property that occurred prior to the

death of the individual from whom

the property was inherited. 

A complete elimination of the current step-up in basis rules could

result in heirs’ becoming liable for an

estimated $1.3 billion in unrealized

capital gains taxes each year. Almost

every estate would have some unrealized capital gains tax liability that

would be owed upon the sale of the

property. To reduce the impact of a

carryover basis for inherited property, the new law provides an exemption amount of $1.3 million with an

additional $3 million for transfers to

a surviving spouse. This amount is

added to the existing basis of the

assets transferred. Determining this

existing basis imposes a significant

record-keeping burden on property

owners, especially those who have

held their property for long periods

of time and those whose property

value exceeds the exemption

amount.

Allowing the basis of estate assets to

be stepped up to fair market value

by the $1.3 million exemption

amount ($4.3 million with a surviving spouse) will reduce the number

of estates with potential capital gains

taxes to just over 1 percent of all

estates and will reduce the tax liability to an estimated $88 million, or

about 12 percent of current Federal

estate tax liability. Few estates with

assets under $2.5 million would be

liable for any tax on unrealized gains

(fig. 5). In addition, while estate tax

liability is currently triggered by

death, the capital gains tax on inherited property is due only if the property is sold. Thus, the carryover basis

provisions would not impose a current income tax obligation on farm

heirs who continue to use the inherited assets in the farm business.

Estates that currently owe Federal

estate taxes are not necessarily

identical to those that will have

unrealized capital gains taxes under

the new-basis-at-death rules. For

estate tax purposes, net worth is the

primary determining factor. Thus,

debt reduces the potential for owing

estate taxes. However, for capital

gains tax purposes the amount of

gain is not reduced by debt. Also,

farms that currently benefit from

special-use valuation and the new

family business deduction will not

receive similar benefits under the

new basis rules. Thus, while the

repeal of the estate tax, combined

with a step-up in basis of $1.3 million (with an additional $3 million

for transfers to a surviving spouse),

will reduce the number of farm

estates that owe tax and the amount

of tax owed, a small number of farm

estates may actually experience a

tax increase or owe capital gains

taxes even though they would not

have been subject to Federal estate

or capital gains taxes under prior

law. 

Summary and Conclusions

The impact of Federal estate and gift

taxes on the ability to transfer the

farm business to the next generation

has been a major issue for farmers.

Concern among policymakers that

the Federal estate tax might force

the liquidation of some family farms

has resulted in the enactment of a

variety of special provisions over the

years. These provisions include the

special-use valuation of farmland,

the family-business deduction, and

the installment payment of estate

taxes. These provisions, combined

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Policy Issues in Rural Development

Economic Research Service/USDA

Estimating Procedures

Estimates in the report are based

on simulations using data from

the 1998 USDA Agricultural

Resource Management Survey

(ARMS). The age of the operator

was used to estimate the probability that the operator would die.

Estate values for future years

were estimated based on the

USDA baseline.

The ARMS survey is a stratified

sample of farms with detailed

financial information, including

nonfarm assets. Since the ARMS

does not include questions about

previous or planned future operation of the farm, the analysis is

based on the relative amounts of

farm real estate, other farm property, and the gross estate to

determine eligibility for specialuse valuation and the family business deduction. Since some farmers may not meet the participation

requirements or elect special-use

valuation or the family business

deduction, the benefits shown

here represent the maximum benefits available for the special provisions. However, the analysis

also does not attempt to account

for estate planning strategies

such as annual gifts, etc.

Figure 5

Number of farm estates with unrealized capital gains taxes 

exceeding step-up allowance, by size of estate, 2001

0

100

200

300

Under 

$1,000,000

$1,000,000 - 

$2,500,000

$2,500,000 -

$5,000,000

Over 

$5,000,000

Gross assets

Number of estates

0

10

20

30

40

50

Taxes (Million dollars)

Estates Taxes 
with the increase in the unified credit,

have greatly reduced both the number of taxable estates and the total

Federal estate and gift tax burden.

Based on an analysis of 1998 data,

less than 4 percent of all small farm

estates owe any Federal estate

taxes. In comparison, 12 percent of

large and very large farm estates

owe Federal estate taxes. 

While only about 4 percent of all

farm estates have owed Federal

estate tax, a much larger percentage

of farm estates have been required

to file an estate tax return, utilize

special farm provisions, alter their

business practices, or engage in

estate planning to reduce the impact

of the estate tax on their farm business. Thus, the phaseout and repeal

of the Federal estate tax will affect a

much broader group of farmers than

those who owe tax. In fact, during

the phaseout period, the significant

increase in the unified credit will

substantially reduce the share of

estates that are required to file but

that owe no tax. However, the primary beneficiaries of complete

repeal are farm estates with assets in

excess of $5 million; such estates

currently account for an estimated

two-thirds of all Federal estate taxes

paid by farm estates.

Placing limits on the amount of property eligible for step-up in basis to

fair market value at death with an

exemption amount of at least $1.3

million and an additional $3 million

for a surviving spouse will affect a

relatively small number of farmers.

Furthermore, since capital gains tax

rates are lower than estate tax rates

and the taxes are due only when the

property is sold or otherwise triggered, such a change should not

impose a significant burden on

estates with property above the

exempt amount, especially those

who want to continue farming.

However, the change, combined with

the uncertainty caused by the

extended phase-in and sunset provision, will impose a record-keeping

and planning burden, especially for

the largest farm estates. 

Identifying the effects of repeal on

farm structure and opportunities to

enter farming is more difficult than

identifying who benefits from the

reduction in taxes and the reduced

administrative burden associated

with the Federal estate tax. The current preferred status of farmland and

other business assets for Federal

estate tax purposes clearly increases

the demand for such assets. At the

same time, the ownership and participation requirements associated with

the preferred treatment tend to

reduce the supply of farmland, especially since heirs are required to hold

property for several years to avoid

the recapture of tax benefits. The

elimination of the deduction for family-held business interests and the

eventual repeal of Federal estate

taxes will eliminate these effects on

farmland markets. However, repeal

will also eliminate the need to sell

farmland to pay Federal estate taxes,

especially for the largest estates.

Thus, the net effect on farm structure and on opportunities for beginning farmers who do not inherit

farmland or other farm property is

not clear but may be relatively small.

8

Policy Issues in Rural Development

Economic Research Service/USDA

Contacting the Authors

Ron Durst

(202) 694-5347

e-mail: RDURST@ERS.USDA.GOV

James Monke

(202) 694-5358

e-mail: JMONKE@ERS.USDA.GOV

Douglas Maxwell

(202) 694-5371

e-mail:

DMAXWELL@ERS.USDA.GOV

National Agricultural Library

Cataloging Record

Durst, Ron

How will the phaseout of Federal

estate taxes affect farmers?

(Agriculture information bulletin;

no. 751-02)

(Policy issues in rural development)

1. Farms--Taxation-Law and 

legislation-United States.

2. Inheritance and transfer 

tax--United States. 3. Tax remission--United States. 4. Family

farms--Taxation-United States.

I. Monke, James. II. Maxwell,

Douglas. III. Title, HD 1443.U6

Further Reading

Durst, R., and J. Monke. Effects of

Federal Tax Policy on Agriculture,

AER-800. U.S. Department of

Agriculture, Economic Research

Service. April 2001.

Also see the discussions on the

ERS website http://www.ers.usda.

gov/briefing/Federaltaxes/

Policy Issues in Rural

Development

The Food and Rural Economics

Division of ERS/USDA designed this

series of policy-oriented, timely publications to provide background and

analysis for decisionmakers and

others.

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