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Despite hopes to the contrary, Federal estate
tax provisions of the Internal Revenue Code--
specifically the "special use valuation" and
deferred and installment payment provisions--
have not helped stem the decline of the small
family farm. Special use valuation, in fact,
may have added to the difficulties that al-
ready beset small farmers. The provisions
are difficult for farmers and their heirs
to understand and for the Internal Revenue
Service to administer. The provisions risk
inciting nonfarmers to purchase farmland,
driving up its price and aggravating the very
tendencies that the provisions were intended
to alleviate. The tax savings are unevenly
distributed among regions of the country and
among farmers in different financial brackets.
The complexity of the provisions tends to re-
strict their use to wealthier farmers since
the complexity leads to higher estate admin-
istrative costs and risks of audit. Small
farms continue to go out of operation despite
the tax savings that the two provisions offer.
In response to widespread complaints that
the Federal estate tax unfairly burdened and
forced sales of small farm estates, special
use valuation (section 2032A) and deferred
and installment payment provisions (section
6166, as enacted) were included in the Tax
Reform Act of 1976. A portion of the Federal
estate tax is now forgiven through section

The Economic Recovery Tax Act of 1981 (ERTA)
will have lessened the need for the two special
estate tax provisions because it increases the
unified credit to $600,000 over a period of
6 years and provides for an unlimited marital

If couples use proper estate plan-
ning, they will be able to leave tax-free
estates worth $1.2 million to heirs by the
mid-1980s. The larger amounts that can be left
at death and not have Federal tax paid will
result in many small farm estates not having
to elect special use valuation and achieving
the additional tax benefits from reduced farmland
valuation. The new act also consolidates the

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PAD-81-68 SEPTEMBER 30, 1981

more liberal provisions for deferred payment of estate tax owed that existed separately in the Tax Reform Act of 1976. However, small familyowned farms will still face the operating problems discussed in this report.


This study was undertaken to evaluate the effects of sections 2032A and 6166 that are intended to benefit family farms. By examining the justifications presented to the Congress on behalf of these provisions, analyzing their actual effects, and determining whether they need to be modified to improve their effectiveness, the General Accounting Office intends to point out the complications entailed in trying to aid a particular group of people through tax policy measures, especially those using the estate and gift taxes. By favoring farm estates over other estates, the two provisions induce nonfarmers to invest in farmland beyond that which now occurs. Further, the benefits of the two provisions do not reach the intended beneficiaries. Relatively large farms are deriving greater benefits (in terms of tax savings) than smaller farms, and regional differences in farmland rental practices are affecting the distribution of benefits.

GAO analyzed almost 600 Federal estate tax returns filed between 1977 and 1979 containing valid elections of section 2032A. of these returns, 175 were randomly selected from all returns filed with reported elections of section 2032A. The remaining returns were examined during GAO's survey of target agricultural States (see appendix II). The GAO also interviewed farmers now operating farms; recent inheritors of farm estates (including several who did not use the section 2032A election); attorneys, accountants, and bank trust officers involved in farm estate probate proceedings; and IRS and Treasury Department officials. (Tax return data on elections of deferred and installment payments, section 6166, were limited, preventing detailed analysis of this provision. Chapter 2 and appendix II discuss these limitations.

The GAO did compare the use of a revised section 6166 with section 2032A as an alternative for solving the farm estate's liquidity problems and ease of administration. See pp. 2-3.)


Special use valuation and deferred and installment payment were enacted in response to two major complaints concerning the estate tax treatment of farm estates. First, advocates of these provisions argued that farm estates were unfairly taxed since they were inherently less liquid than other classes of estates. Second, advocates argued that the sale of family farms to meet estate taxes is contrary to an overriding public goal of encouraging family farms. (See pp. 11-12.)

Little reliable evidence supports the view that
farm estates shoulder an unfair estate tax burden.
Any class of asset is liable to a sale forced
by estate taxes. of all farm sales, 15 percent
are estate executors' and administrators' sales.
This share has remained stable over the last
decade, despite the increasing illiquidity of
farm estates as farmland increased in value com-
pared to a relatively unchanging level of
readily marketable or liquid assets. Farm
economics seem much more responsible for the
failures of small family farms than does the
Federal estate tax. Even if farms do not bear
a unique estate tax burden, the forced sale
of any small family farm is contrary to a
long-held policy of fostering family farming.
Throughout American history, the family farm
has held a valued position as a social model
and economic force. This policy provides a
stronger foundation for special treatment of
farm estates than the fairness argument does.
(See pp. 16-18.)


Special use valuation, which is a potential
source of sizable tax savings for qualifying
estates, is a highly complex provision. By
lowering the value of an estate below its fair
market value, the provision lowers the tax
owed by the estate. (See pp. 21 and 33.)

To elect special use valuation a farm estate
executor must establish that the decedent-
owner maintained a "material participation" in
the farm operation before his or her death. ΝΟ
absolute test of material participation exists,

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however, so this requirement can create unforeseeable difficulties. Material participation by the inheritors must continue beyond the decedent's death. A full discussion of the provision is in chapter 2.

Section 2032A specifies a preferred rent cap-
italization formula for valuing an estate,
but differences among regions in the country
in typical rental arrangements have caused
regional differences in the provision's use.
ERTA now permits comparable crop-share rentals
to be used to calculate the section 2032A value
when cash rentals do not exist. (See pp. 25-26
and appendix III.)

Deferred installment payments of estate taxes provide an easy way for an inheritor of farm property (or a closely-held business) to postpone the tax for 5 years and then to pay the tax in 10 years.

The tax bill is subject to a belowmarket interest rate of 4 percent. This provision's qualification requirements are more easily met than those for special use valuation. Furthermore, the provision and its election are not affected by regional differences in farmland markets or rental practices. The deferred and installment payment provision should be much easier to elect and to administer. (See pp. 37-38.)


Electing special use valuation can reduce an estate's tax substantially. Reductions in property value typically are 40 to 70 percent of the fair market value of an estate. GAO found that on average each estate electing section 2032A saved $59,000 in estate taxes. The share of each estate that was consumed in payment of the Federal estate tax (i.e., the effective tax rate) was cut almost in half. Not all farm estates, however, save as much from special use valuation. Large farms generally save more than small farms. As a fraction of the initial tax liability, however, the tax saving becomes relatively less important for large estates, apparently because of the limit on the deduction attributable to special use valuation. (See pp. 28-32.)

Even at this early stage of experience with special use valuation, questions have arisen concerning its ultimate effect on agriculture. All observers agree that special use valuation

creates a substantial tax saving when elected.
GAO's review bears this out. In addition to the
direct effect of a tax saving, though, the pro-
vision may have indirect effects that would not
encourage small family farms to continue. Farm-
land may have become more attractive as an estate
tax shelter, increasing existing incentives for
non farmers to invest in farmland and become "tax
farmers." Farm owners who already own land have
a greater incentive to expand their landholdings.
These investment purchases will increase the price
of farmland and increase the barriers confronting
tenant and newly starting farmers who do not own
land. Land ownership, which has become increas-
ingly concentrated in recent years, may become
even more so under special use valuation. (See
pp. 24-26.)


The Congress should consider alternatives to the current provision. While alternatives probably cannot avoid all the problems of special use valuation, they can make it easier for inheritors to benefit and less costly for IRS to administer. (See chapter 7.)

GAO recommends that the Congress give an
estate tax preference to farmers only through
the tax deferral provision, with or without
installment payment privileges, and repeal
special use valuation. This would greatly
simplify the assistance given to farm estates
that incur an estate tax liability.

(See pp.

Since the Congress retained special use valua-
tion in ERTA, GAO recommends, as an alternative,
that the section and its administration be
simplified by substituting a simple exclusion
of a fixed fraction of the farm estate. This
would eliminate many of the problems of estab-
lishing a section 2032A value. It would also
extend the benefits of special use valuation
to farm estates that are composed mostly of
equipment and machinery rather than farmland.
(See pp. 54-55.)


GAO provided the Department of Agriculture,
the Department of the Treasury, and the Internal
Revenue Service copies of the draft report.
The draft report was provided, and the comments

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