CHAPTER 7 CONCLUSIONS AND RECOMMENDATIONS As it now exists, special use valuation and the deferral and installment payment provisions have not helped slow the decline of small family farming. One reason why they have not is that the Federal estate tax has had little to do with the changes that are transforming American agriculture. While inheritors of family farms benefit from the estate tax savings, no evidence clearly demonstrates that they would have been forced to sell the farm estate if these tax preferences had not been available. The demise in recent years of many small farms, most of which were family operations, appears to be due not to the burdens placed on them by the Federal estate tax but rather to a constellation of economic and technical forces that have affected all farmers, not only those who inherit their farms. Small operators are generally less able to exploit technological advances than large operators, and many have been forced out of business. Farmers also differ considerably in their managerial skills. Since the best farm managers have incentives to expand their farms, the farm failures attributable to inadequate managerial skills are concentrated among small farms. We believe that these estate tax provisions should be viewed as instruments for delivering Federal assistance to American farmers--as aid programs embedded in the Federal estate tax--and evaluated by the same criteria that are used to evaluate direct Federal spending programs. Like so many other Federal programs that aid American agriculture, these provisions, particularly special use valuation, reflect the special importance attached to farming, particularly small family farming, in American social and economic life. Today farmers are eligible for a wide assortment of Federal assistance programs, including subsidized loans, federally sponsored research and information services, and preferential treatment under the Federal income and estate tax systems. These farm programs are designed to promote certain objectives-maintaining a diversity of farm ownership is one of them--and should continually be scrutinized to ensure that they are effective. Although we were unable to find evidence that special use valuation has helped keep any small family farms in existence, the provision undoubtedly does ease estate tax burdens on some farm families and is a source of financial assistance to the farm sector. However, special use valuation has proved to be complex in practice. (Chapters 2 and 6 discuss the sources of its complexity and ambiguity.) As a result of this complexity, the provision is costly to comply with and to administer. simpler alternative would make it easier for farmers to receive assistance and would relieve the IRS of some of the burden of administering this program. A A more serious worry prior to ERTA, however, was that special use valuation may have actually accelerated the decline of family farming rather than assisting and encouraging its continuation. Because this complicated provision is costly to use, larger farms were the major beneficiaries. Many small family farmers lack the sophistication or the access to the skilled, professional services that would be required to plan for its use. In addition, even when small farms used the provision, we found that the dollar amount of benefits that large farms received were typically greater than the amount that small farms receive. Because of changes enacted in ERTA, it appears likely that there will be fewer small farm estates electing section 2032A, special use valuation. A direct result will be a decrease in the administrative burden on IRS in handling estates that have made this election. Many small farms will be able to avoid paying Federal estate tax because of the increase in the unified credit and an unlimited marital deduction. The wealthier farm estates will still have to resort to using the special estate tax provisions with their inherent complexities. Much of the complexity of special use valuation stems from the restrictions that were incorporated in the statute to limit benefits to a certain group of farm estates, that is, the estates of persons who were actively engaged in farming until their death and whose family heirs wish to continue farming the same property. These restrictions are contained in the material participation requirements of section 2032A. The Congress' decision to limit the benefits of the program in this manner is essentially a policy decision and we therefore make no recommendation to the Congress to consider relaxing or tightening these restrictions. 1/ A tradeoff obviously exists between the cost and complexity that these restrictions add and the desire of the Congress to focus the benefits of the program on a particular group in the population in order to increase its effectiveness without adding to its cost in foregone tax revenues. It is important to realize, however, that at least some restrictions are necessary not only to keep costs down but also because in the absence of restrictions nonfarm investors would be attracted by the tax savings. Their demand for farmland would drive its price up, encourage farmers to sell their property and leave agriculture, and make it more difficult for successful family farmers to expand their operations by purchasing more land. In that case the program might actually disserve the goal of encouraging smaller family farms to continue in operation and accelerate their decline. In preparing the following recommendation, we assume that the basic structure of the Federal estate tax would remain much as it is today. Enactment of the Economic Recovery Tax Act of 1981 has resulted in several major changes in the transfer tax structure 1/ERTA contains a number of changes that ease material participation requirements for special use valuation. and has lessened the need for the two special estate tax provisions. The Act would phase in over 6 years an increase in the unified credit and at the end of the phase-in there would be no tax on estates under $600,000. The marital deduction for gifts and bequests to spouses will be unlimited. No transfer tax will be imposed on transfers to a spouse, no matter how large the transfer. The use of proper estate planning techniques will allow couples to leave tax-free estates worth $1.2 million to heirs in 1987 and subsequent years. RECOMMENDATIONS TO THE CONGRESS If a tax preference for farm estates is to be preserved, we recommend that the Congress replace special use valuation with a simpler alternative. The simplest alternative would be a modified version of the current tax deferral and installment payment provisions, sections 6166 and 6166A. Postponing the payment of a tax liability and then paying by installments over an extended period, with interest charged at below-market interest rates or with no interest charged at all, amounts to receiving a "tax loan" from the Government and as such is a valuable privilege. A "tax loan" provision has the clear advantage of being easier for taxpayers to understand than special use valuation. Disputes between the taxpayer and IRS over the amount of the tax lien are less likely than under special use valuation, which provides no method for settling disputes over the fair market value of the estate. 1/ Since IRS has established procedures for collecting deferred taxes, the deferral and installment payment provisions are less complex than special use valuation. A tax deferral and installment payment provision can be made as generous or meager as the Congress desires by adjusting the length of the postponement of payment or the interest rate that the farmer is charged. Section 6166 now permits a 5-year delay before the first tax payment is due, then permits the tax to be paid in ten annual installments. Only interest is charged during the first 5 years. Thereafter interest is charged on the unpaid balance at a concessional rate of 4 percent per year. Forgiving the tax is merely the extreme case in which payment is deferred indefinitely and no interest is charged at all. No matter what is done with special use valuation, sections 6166 and 6166A should be consolidated in a single section containing features of both, but more closely resembling section 6166. 2/ If section 2032A is repealed and all the estate tax benefits for 1/Since there is no immediate tax liability, such disputes may not be settled by the courts, yet the size of the tax saving depends on the fair market value estimate. Without knowing the tax saving, IRS cannot guarantee the recapture through a tax lien, as section 2032A requires. 2/ERTA has consolidated the estate tax payment provisions, basically following section 6166. farmers are delivered through a new tax deferral provision or a consolidated deferral and installment payment provision, the Congress may wish to enlarge the assistance delivered through the new provision and make it greater than the assistance that is currently delivered through section 6166. If the assistance will be greater than that given currently, the Congress may wish to consider further restricting eligibility. Replacing special use valuation with a new tax deferral plan would alter the distribution of benefits that are delivered to farmers through the Federal estate tax system. All estates that qualified for the deferral privilege would receive a benefit equal to a fixed fraction of their estate tax liability. Under special use valuation qualifying estates receive a benefit that varies as a fraction of their tax liability. In general, smaller estates receive a larger benefit--if expressed not in dollars but as a fraction of their tax liabilities--than larger estates. Accordingly it may seem that substituting a tax deferral provision for special use valuation would skew the distribution of benefits away from small estates and toward large estates. We believe, however, that many more small farm estates will be able to take advantage of a new tax deferral provision than now take advantage of special use valuation and therefore that a larger fraction of all the assistance delivered by the program will flow to small estates than flows to them now. Since the Congress decided to retain special use valuation rather than replace section 2032A with an enlarged tax deferral plan in ERTA, we recommend that it simplify the section and its administration by substituting a simple exclusion of a fixed fraction of the farm estate. For example, 30 percent--or whatever fraction the Congress chose--of the fair market value of all farm assets could be excluded from the estate tax base. Such a change would eliminate the complexity that now attends the calculation of an agricultural use value for farmland. The most reliable method of calculating this value is based on cash rentals paid for the use of similar farmland nearby. Under ERTA, crop share rentals may be used where rental agreements are commonly expressed in crop shares rather than cash; this method of calculating a use value entails a new set of problems, as chapter 4 notes. Many of the problems of establishing the section 2032A value would be eliminated if a fixed fraction of the fair market value of farm assets were excluded from the estate tax base. This method would also make benefits available to farm estates that are composed mostly of equipment and machinery rather than farmland and that cannot now qualify for special use valuation. In general, it would tend to eliminate differences in the benefits received by estates that now depend on the fraction of the estate's assets that are in the form of land. If section 2032A were revised in this manner, small estates would continue to be eligible for a larger benefit, expressed as a fraction of their estate tax liability, than large estates, just as they are now. A larger fraction of the total program benefits might flow to small estates, however, if the simplification of the provision encouraged more of them to take advantage of it. 1/ AGENCY COMMENTS We sent copies of our draft report to the Department of Agriculture, the Department of Treasury, and the Internal Revenue Service. Their comments are included in full in appendix IV, together with our responses. The report was modified in response to certain of the agency comments. The draft reports were provided to the agencies, and their comments received, prior to passage of the Economic Recovery Tax Act of 1981. The following discussion concerns only the most significant agency comments and our evaluation of them. The Departments of Agriculture and Treasury hold different views of the Congress' intent in passing the special use valuation provision. Agriculture believes that the Congress adopted special use valuation as a means of providing tax reductions to keep land in farming. Treasury believes that the Congress was concerned with the problems created by highest and best use measurement of value, and the focus of special use value was to relieve valuation pressures on family farms. Only the Department of Agriculture commented on our recommendations. Agriculture took exception to our alternative to eliminate the special use valuation provision in favor of a modified version of the current tax deferral and installment payment provisions. Agriculture's view is that the proposal would tend to benefit the larger estates more than their smaller counterparts, and investors would structure their estates to receive the benefits. We believe that the modified deferred and installment payment provision, if adopted, would not necessarily attract investors if the eligibility requirements were structed to prevent nonfarm investors from abusing the tax loan privileges. 1/Changes in ERTA will likely result in very few small estates requiring the benefits of section 2032A by the mid-1980s, since the expanded unified credit and marital deduction will allow virtually all estates to avoid the tax entirely. |