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Do Farmers Really Want to Eliminate the Estate Tax? Farm Business Management Update, April/May 2004

By Daniel Osborne

One of the hot topics in the political arena for farmers is the debate over the elimination of the so called "Death Taxes." The phrase certainly makes for a horrible combination of two things humans would like to avoid, but can't - death and taxes. Is it possible that it would be advantageous for farmers not to eliminate the estate tax if given the chance? To give the question proper consideration, I think it is important to bring to light some information that is often overlooked. That information is the impact on income taxes that would result from the elimination of the federal estate tax. You must realize that there are both a federal estate tax and a Virginia estate tax. It is the federal estate tax that could have a significant impact on income taxes and, therefore, is the focus of this article.

By having the federal estate tax, beneficiaries of an estate are able to take advantage of a very important tax break called a "step-up in basis." This step-up in basis allows the beneficiary of an estate to claim a basis in the property inherited equal to the fair market value of that property at the time of the decedent's death. Suppose for example that John Farmer purchased a piece of property for $100,000. Several years later John died and left the property to Junior. At the time of John's death, his tax basis in the property was still $100,000, but the value of the property was $500,000. A step-up in basis would allow Junior to claim his tax basis in the property to be $500,000. If the estate tax is eliminated, no step-up in basis will be allowed. Without the step-up in basis, the beneficiary's basis in inherited property would be the decedent's cost basis or zero if the cost basis could not be proven. So, in the example, Junior's tax basis would be $100,000 if there was no step-up in basis.

There are two possible advantages to getting a step-up in basis. First, depreciable property can be deducted on income taxes through depreciation. The second and probably most important advantage occurs in the event the property is sold. A step-up in basis allows more to be deducted from the sales price of the property and thereby reduces the taxable gain on the sale. If Junior sells the inherited property for $700,000, a step-up in basis would allow him to recognize a $200,000 gain ($700,000 minus $500,000) on his income taxes. However, without the step-up in basis, Junior would have to recognize a $600,000 gain ($700,000 minus $100,000). A step-up in basis would save Junior as much as $160,000 in income taxes.

A $160,000 reduction in income taxes is really nice. But the income tax savings would not count for much if it meant that he had to pay $245,000 in estate taxes to get those income tax savings. Is there a way for Junior to have his cake and eat it too? The answer is YES! So long as there is a federal estate tax and the decedent's taxable estate does not exceed the estate tax exemption amount, estate taxes can be avoided and beneficiaries can get a step-up in basis.

Currently, the federal estate tax exemption amount is $1.5 million. According to the 1997 Census of Agriculture, less than 8% of Virginia farms were valued over $1 million. Therefore, an exemption amount of $1.5 million should exclude over 90% of farmers from the federal estate tax. An alternative to eliminating the estate tax would be to increase the exemption amount to something like $5 million or $10 million, so that only a handful of farmers would have to pay federal estate taxes. One thing is for sure, having the federal estate tax affects a small percentage of farmers, but elimination of the federal estate tax would affect every farm in the country.

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