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REPORT BY THE
SPECIAL ESTATE TAX PROVISIONS
D I G E S T
Despite hopes to the contrary, Federal estate
The Economic Recovery Tax Act of 1981 (ERTA)
If couples use proper estate plan-
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.
OBJECTIVES, SCOPE, AND METHODOLOGY
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.)
ORIGINS OF SPECIAL USE VALUATION
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
OPERATION OF THE SPECIAL
Special use valuation, which is a potential
To elect special use valuation a farm estate
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-
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.)
CONSEQUENCES OF SPECIAL USE VALUATION
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.
CONCLUSIONS AND RECOMMENDATIONS
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
Since the Congress retained special use valua-
GAO provided the Department of Agriculture,