fer to exactly "comparable" farmland, as required by section 2032A (see chapter 6 for a discussion of the comparability issue), the USDA data can be used as a standard for comparing the reliability of any comparable rents that are obtained. Since cash rent agreements normally do not require the landowners to manage the farms or to assume any financial risks, the cash rent reflects the value of the land rather than the owners' services. Provisions lock in ownership Another effect that the special provisions may have is to "lock in" some ownership of some land. Farmers who wish to sell their land and equipment and retire or heirs who would like to sell the land may now decide to keep it and thus reduce estate taxes. If the farmer/landowner continues to materially participate in the farm operation until his or her death and the inheritors do the same afterwards, the estate tax may be reduced. If the provisions discourage sales of farmland to people outside the decedent's family who would have established their own family farm, however, the provisions encourage concentration rather than family farming. THE LARGEST ESTATES MAY BENEFIT MORE Several attorneys and economists believe that the special use valuation option favors large, wealthy estates that are already able to pay the Federal estate tax, other death taxes, and estate administrative expenses or to arrange financing for these debts. For example, Professor Roland Hjorth argues that "the present economic characteristics of farmland, federal income tax law, and now the federal estate tax law all portend the emergence of a landholding elite class in America." 1/ He concludes that the provisions will not save the family farm. "Indeed, it seems more probable that section 2032A and 6166 will contribute to the decline and continuing demise of the number of family farms." 2/ Hjorth notes several reasons for believing this: (1) Both special use valuation and the deferred and in- (2) Landowners benefit, but not tenant or contract farmers. (3) Large farmers benefit more than small farmers, 1/Roland L. Hjorth, "Special Estate Tax Valuation of Farmland and the Emergence of a Landholding Elite Class, "Washington Law Review, vol. 53 (1978), p. 662. 2/Ibid., p. 612. (4) Farmers who want to sell land are persuaded not to do so but to act as landlords. 1/ In addition, Hjorth notes that the provisions open new problems in other areas: They complicate estate planning by making it more Since the concept of preferential farm use valuation is not novel, previous experience with its use for property tax purposes may indicate how effective a similar provision may be in the Federal estate tax. States have used similar provisions to prepare farm property tax assessments for years. One examination of these property tax provisions has concluded that farmers can benefit from property tax use valuation, particularly if their land is located on the fringe of an urban area. 3/ The study concluded that the provisions have little importance in determining land use since they do not alter the basic financial motivation to use land productively. This conclusion is supported by a report from the Council on Environmental Quality. 4/ The report found that differential property tax assessments are effective and politically popular methods of conveying tax savings to participating landowners. As land use planning tools, however, differential property tax assessments are "inefficient and expensive" for several reasons, among them the fact that the burden of property taxes is only one of many factors affecting a farmer's decision to sell, and a reduction in property taxes will deter few farmers from selling. 1/Ibid., pp. 612-3. 2/Ibid., p. 613. 3/Robert J. Gloudemanns, Use Value Farmland Assessments (Chicago: International Association of Assessing Officers, 1974). 4/Council on Environmental Quality, Regional Science Research Institute, Untaxing Open Space, Executive Summary (Washington: Government Printing Office, 1976), p. 6ff. SPECIAL USE VALUATION CAN SIGNIFICANTLY REDUCE Farm estates that elect special use valuation will generally enjoy substantial Federal estate tax savings, an advantage that tax advisors have been quick to point out. In 1977, for instance, it was noted in the Brigham Young University Law Review that In areas where urban development pressure on farmland prices is strong, the formula permits a drastic reduction in the value of farmland for estate tax purposes. 1/ By August 1980, over 6,000 estates had used the special use valuation. This option greatly reduced the estates' values and in turn lowered estate taxes. We estimate that the annual revenue loss from special use valuation is over $150 million since each estate in our sample saved about $59,000. 2/ The average value of the taxable estate with special use valuation was approximately $278,000, or just under 60 percent of the average fair market value of $465,000. The effective tax rate (Federal estate tax paid divided by taxable estate) was cut nearly in half, from 17.3 percent to 10.8 percent of fair market value (see table 2). Our annual revenue loss estimate does not differ greatly from the Treasury's most recent estimate of $140 million. 3/ Both estimates, however, are much larger than the annual loss of $14 million that was expected when the provision was enacted. If one assumes that these revenue loss estimates of approximately $150 million per year are accurate, the cost is about 3 percent of current estate and gift tax collections. 4/ Still, these amounts are small in comparison with direct Federal payments to farmers. In 1978, for example, such payments totaled $3,030 million in 1978, according to the Department of Agriculture. 5/ 1/"The Family Farm and Use Valuation-Section 2023A of the Internal Revenue Code," Brigham Young University Law Review, vol. 1977 (1977), p. 368. 2/Between August 1979 and August 1980, the latest period for which data are available, 3,074 estates elected special use valuation. 3/Harry L. Gutman, U.S., Congress, Senate Committee on Finance, Miscellanous Tax Bills V, hearings before the Subcommittee on Taxation and Debt Management, March 4, 1980. 4/Federal estate and gift tax receipts totaled $5,411 million in 1979, according to the Economic Report of the President, 1980. 5/U.S., Bureau of the Census, Statistical Abstract of the U.S., 1979 (Washington, D.C.: Government Printing Office, 1979), P. 696. Table 2 Profile of Estates Filing Returns a/Estimate based upon GAO or IRS calculation of estate taxes of the sample estates, if they were valued at fair market value. b/Federal estate tax divided by taxable estate value. c/"Stocks and Bonds" (Form 706 Schedule B) plus "Mortgages, Cash and Notes" (Form 706 Schedule C). d/"Insurance on Decedent's Life" included in the total gross estate value (Form 706 Schedule D). Source: Average or mean data from a sample of IRS Forms 706 containing I.R.C. Section 2032A elections. See appendix II for a description of the sample. Tax saving from section 2032A depends on estate size Forty The benefits of special use valuation are more concentrated among the larger estates in our sample. Nearly 60 percent of the benefits are received by nearly one-third of the estates. percent of the total tax saving accrued to estates valued between $500,000 and $1,000,000 although these estates were only 24 percent of all estates sampled. Thirty-four percent of the tax saving went to estates valued between $250,000 and $500,000. Table 3 shows the distribution of the tax saving among sample estates electing special use valuation. As table 3 indicates, the average tax saving increases with the value of the estates. Estates valued over $1,000,000 saved an average $152,856, while estates valued under $250,000 saved $16,152. We expected that the tax saving from special use valuation would be largest among large estates. First, many small estates incur no Federal estate tax liability, even when valued at fair market prices. Second, the saving is proportionate to an estate's marginal estate tax rate, which is higher for a larger estate. Third, large estates are more likely to take advantage of special use valuation than small estates, since they are able to bear the costs and risks of the election. 1/ A concentration of the special use valuation benefits among the richest estates parallels the concentration of farm subsidy benefits among the rich farmers. In his 1971 study of farm subsidies, Charles Schultze found that the concentration of farm production among a small share of the farm population and the vesting of subsidies in land combine to prevent small-scale farmers from obtaining a large share of the subsidies. Whatever the advantages or disadvantages of the farm 1/As estate size grows, however, the portion of the estate tax that can be avoided by "use" valuation decreases. Electing "use" valuation will eliminate the entire tax only for relatively small estates. Larger estates can achieve savings but cannot avoid the tax entirely. Further, the 1976 Act limited the decrease from fair market value to $500,000, effectively capping the tax saving for the largest estates. Their total tax bill can continue to grow with estate value, though, so the capped tax saving becomes relatively less important. |