A tax plan being considered in the U.S. House of Representatives seeks to do away with the federal estate tax levied on transfers of wealth when a person dies. Supporters of abolishing the tax, mostly Republicans, say it forces the children of recently deceased farmers to sell the family’s land to pay the tax. But Democrats and some tax experts say that claim doesn’t stand up.
Neil Harl, an emeritus professor of agriculture and economics at Iowa State University, has spent more than 50 years looking for examples of forced sales. He has found plenty of cases of heirs who sold family farms after a parent’s death, but says that was because they did not want to be family farmers.
“I’ve never yet seen a farm that had to be sold because of federal estate tax,” says Harl. “A lot of people promoting repeal of this tax are using farmers as their reasoning, and it just doesn’t wash.” Most of those that were rumored having to sell land to pay federal estate tax (including one case in Iowa) did sell some land, but only because the heirs wanted it sold. Incidentally, the estate in that case had sufficient funds on hand to more than pay the federal estate tax, he adds.
A blueprint for tax reform
Why does the truth about forced sales matter? Because it will figure in the debate over the estate tax in 2017, if Republican leaders in Congress follow through on their vows to scrap what some call “the death tax.” Their party has full control of both the White House and Congress, and they say the tax punishes people who have worked hard, saved and been successful in establishing family farms and small businesses.
The GOP tax plan has as its centerpiece a goal to cut the corporate income tax rate. But repeal of the estate tax is also in the recently introduced legislation, which will provide a blueprint for tax reforms to be hammered out with the Trump administration. President-elect Donald Trump has said the estate tax “can result in double, and potentially even triple, taxation on small businesses and family farms.”
Under the current law, for the 2017 tax year, the exemptions are $5.49 million for an individual and $10.9 million for couples. Transferred estates valued at more than those amounts are subject to a maximum tax rate of 40% on the amount of assets above those levels.
Most Democrats oppose any repeal. They say the estate tax is the only purely progressive tax the U.S. has, because it taxes the rich, thus helping in a small way toward rebalancing what they see as inequities of income distribution. They say the idea that farms are being sold against the will of the heirs is a story to disguise how abolishing the estate tax would help the families of Republicans’ multimillionaire friends and party contributors. However, there is more to the issue than that, says Harl.
Other consequences to consider
In 1976, Congress passed and the President Gerald Ford signed a new break for farmers and ranchers, called the “special-use valuation.” It permits, for deaths in 2017, up to $1.12 million to pass free of federal estate tax if the estate meets certain requirements. This $1.12 million is on top of the combined amounts for husband and wife of more than $10 million that can pass free of federal estate tax for all married taxpayers already.
The more damaging long-term consequence of repealing the federal estate tax is that the repeal would almost certainly result in the loss of a new income tax basis at death to pay for part of the revenue loss due to the repeal. That loss of the new tax basis would cause heirs to be unwilling to sell the property. “Every time this issue of repeal comes up, as it did in the 1970s and again early in this century,” says Harl, “it is quietly mentioned that the loss in funds coming to the federal government would be at least partially paid for by repealing any increase in income tax basis on property held at death.”
He gives this example: Assume a grandfather had bought 320 acres of unimproved land in 1955, paying $300 per acre, for a total purchase price of $96,000. He died in early 2017 with the land (despite a 16.7% drop since 2013) valued at $7,000 per acre for a total value for the half-section of $2.24 million. Under the current tax law, which has existed for many years, the gain of $2.144 million would be wiped off the books (date-of-death value of $2.24 million minus the original basis of $96,000). The income tax basis would become $2.24 million, and the land could be sold at that figure without the heirs paying income tax.
Loss of new basis would hit hard
“That tax effect is currently available to everyone, up and down the asset scale,” notes Harl. “It causes the repeal of federal estate tax to pale by significance to the loss of new basis at death.”
Another consequence of losing the “new basis at death” would be the unwillingness of the heirs to sell the property, essentially immobilizing the property, which is bad for economic growth. “It would take several years for this to become a significant factor, but it eventually would become a drag on economic growth,” Harl adds.
Another factor usually not discussed is that repealing the federal estate tax would take away one of the major incentives to make charitable gifts of assets like land. “That’s why most charitable organizations recoil in horror at what this could mean to charitable contributions,” says Harl.
The IRS data are not specific enough to know whether a descendant was a farmer or rancher, only that the descendent owned some farm property. That could be a billionaire who owned 50,000 acres in western Nebraska as a hobby or it could mean a farmer-owner in Iowa. With approximately 2.5 million people dying each year in the U.S., the estates of only about 5,000 people (just one in 500) have to pay the estate tax, according to an estimate from the Tax Policy Center. Of those, only about 50 are farms or other small businesses.
The current estate tax law
Legislation to permanently repeal the federal estate, gift and generation-skipping taxes was introduced in the U.S. House of Representatives in early January. Various farm groups and others support the measure, known as the “Death Tax Repeal Act,” HR 198.
The estate tax is levied on the net value, less an exemption, of an owner’s assets transferred at death to an heir or heirs. Who is affected by the law today? Neil Harl, emeritus professor of economics and ag law at Iowa State University, provides the following explanation:
• Estate tax. Until 1976 only estates worth less than $60,000 were exempt from the estate tax. Since then the exemption has gone up. In 2017 an individual can leave $5.49 million to his or her heirs and pay no estate tax. A couple could leave $10.98 million tax-free. Transferred estates valued at more than this are subject to a maximum tax rate of 40% on the amount of assets above the two thresholds.
• Gift tax. Individuals and couples who give property during their lifetimes also are subject to the top tax rate of 40% for gifts that exceed the lifetime exemption amounts. But individuals and couples for 2017 may make gifts of up to $14,000 and $28,000, respectively, without reducing their lifetime exemption amounts, which for 2017 are $5.49 million and $10.98 million. For example, an individual who in 2017 gifts $25,000 to a relative would reduce his or her lifetime exemption by $11,000 — from $5.49 million to $5.38 million.
• Generation-skipping tax. The generation-skipping tax applies to gifts and transfers in trust to, or for the benefit of, unrelated persons who are more than 37.5 years younger than the donor or to related persons more than one generation younger than the donor, such as grandchildren. The top tax rate of 40% is applied only if such gifts or transfers avoid the gift or estate taxes.
• Gifts to charity. No tax is paid on portions of an estate that are transferred to a spouse or passed to charity. Some estates give just enough to charity to bring the value of the remaining assets down to under the $5.49 million threshold, avoiding the tax entirely. Thus, charitable organizations are strong advocates for keeping the tax.
Estate tax is a political issue
In the recent U.S. presidential election, Democratic candidates campaigned to make the estate tax more punitive for wealthy individuals. Hillary Clinton adopted a proposal from her Democratic rival Bernie Sanders, who wanted a graduated rate that would start at 45% and climb to 65% for estates worth more than $500 million.
Past Democratic administrations have warned that repealing the estate tax would contribute to a rise in the U.S. national debt and do more long-term harm than many other Republican tax ideas. Republicans say there is no need to worry about losing revenue by repealing the estate tax, because the amount of revenue lost wouldn’t amount to that much.
Repealing the estate tax is not a new idea for Republicans. Former President George W. Bush signed a bill in 2001 that increased the estate tax exemption in a series of steps and eliminated the tax entirely in 2010, but it came back when legislation expired the following year.