This responds to your request for comments on your draft report entitled, "The Effects of Special Estate Tax Provisions on Family Owned Farms." We are generally in agreement with your findings concerning the complexity of the special use valuation provisions from the standpoint of comprehensibility and administrability. The continuing decline in the number of family owned farms is not conclusive evidence, however, that the special estate tax provisions have not worked. Even though their numbers continue to diminish, the success of these provisions should be measured by whether the estate tax ceases to be a contributing factor to sales of family owned farms or, otherwise, an onerous burden on farm estates.

In reviewing the draft report, we identified several technical or administrative matters upon which we have the following comments:

On page 4-8, both the text and the footnote indicate that the “at risk” requirement is part of the material participation test. This statement is not correct. "At risk" is part of the qualified use requirement.

The statement in the first paragraph on page 4-10 is
misleading since, in fact, estates in regions where it is not
common for farms to be rented for cash can still elect a special
use valuation, even though they cannot take advantage of the
cash rental provision.

The discussion on pages 6-15 and 6-16 concerns the cost of
administering the special estate tax provisions and the effect
on workload and grade structure of Service personnel. While we
agree that some cases containing IRC section 2032A issues may
take longer to examine than cases not containing such issues,
we estimate that the overall Service cost in administering
these provisions does not exceed $500,000 annually. Averaged

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Mr. William J. Anderson

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over all estate tax cases in districts where such issues are
most common, the limited time this adds per case has been
incorporated into our examination planning and would not serve
to reduce the number of returns for which examinations have
been planned. Furthermore, we do not plan to create a higher
grade structure in any district office to handle such cases.

On page 6-19, there is a recommendation that the multiple
five factor for valuation should be eliminated, except for
the first factor which capitalizes income over a reasonable
period of time. However, it is not apparent from the report
what advantages would be gained by ignoring fair market value

as a measure.

Because of the problems encountered in the field regarding
the application of section 2032A before the final regulations
were issued, a directive was sent to the field on May 9, 1978,
to the effect that all section 2032A cases were to be suspended
until publication of the substantive and procedural provisions
of the regulations. Subsequently, on August 15, 1979, the
field was advised that they could close section 2032A cases
based on proposed section 2032A regulations.

While it is not appropriate for us to comment on the legislative recommendations in the draft report, we do appreciate this opportunity to comment on the administrative aspects addressed in your draft report.

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GAO response

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The Internal Revenue Service agreed with our findings but felt that the continuing decline in the number of family owned farms is inconclusive evidence that special estate tax provisions have not worked.

We believe that the Federal estate tax burden on farm estates is not the main reason why many small farmers go out of business. Other problems, such as operating problems encountered by farmers, changes in agriculture, or the heirs' desire to sell the estate and realize the capital gains are much more likely to prompt the sale of farms when the owner dies.

In commenting on the inequities due to regional differences in the use of special use valuation, IRS said that in regions where it is not common for farms to be rented for cash, estates can still elect special use valuation, even though they cannot take advantage of the cash rental provision. We agree that when an estate is not able to elect special use valuation using the more favorable cash rent method the estate may elect any of the methods under the section 2032A(e)(8) multiple factor method. Our fieldwork demonstrated, however, that estates in these regions face obstacles to electing special use valuation that other estates do not and thus are less often able to take advantage of section 2032A in practice.

The IRS points out that it is not apparent what advantage would be gained by ignoring fair market value as a measure to be used for valuation, as a result of GAO's recommendation to eliminate the multiple factor method, except for the income capitalization approach. Eliminating the multiple factor method would not ignore fair market value. In the absence of a section 2032A election, the fair market value of an estate determines its taxable basis, along with allowable deductions and exclusions. Thus, we believe it is confusing to rely on "fair market value" to determine "special use value," since the Congress intended "special use value" to be lower than "fair market value."

We state that the "at risk" requirement is part of the material participation test. The IRS said that this statement is not correct because "at risk" is part of qualified use. We have added material to chapter 4 explaining that "financial risk" is needed to establish that a farm estate was used for a "qualified use." Essentially, this means that the decedent was "at risk" in operating the farm (i.e., the decedent owned the farm). We should note, however, that the "assumption of financial responsibility" to which we refer in the text is indeed one test of the decedent's "material participation" in the farm operation.

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In commenting on the cost of administering the special estate tax provisons and their effects on workload and personnel, IRS said that some cases may take longer to examine when they contain IRC Section 2032A issues and that overall cost in administration does not exceed $500,000 annually. The time it adds to a case is limited and has been incorporated into their examination planning and would not serve to reduce the number of returns for which examinations have been planned.

We found that IRS officials in the field contend that a shift of audit priorites has resulted because of 2032A issues. Estate tax cases that were previously examined would be set aside or not as closely audited. The major cost of 2032A will be the additional expense now being incurred by farmers and ranchers for proper professional advice from attorneys and accountants on preparation of elaborate documentation and the restructuring to the farm business for the purpose of how to avoid the estate taxes by qualifying for special estate tax provisions.

U. S. GOVERNMENT PRINTING OFFICE: 1981 341-843/784

(972250)