June 1, 2021

American Families Plan Farm Example

The USDA issued a press release yesterday titled “The American Families Plan Honors America’s Family Farms”.  In the press release, they strived to indicate that the transfer tax proposed in the American Families Plan will not affect 98% of farm estates.  However, the details are lacking and most farm families that keep the farm in the family may not owe any transfer tax, but they will owe a lot more income tax under the proposal.

In their last example showing a married couple with $3 million of farm gains and $250,000 of non-farm housing gains would not owe any transfer tax as long as the children keep the family farm.  This likely does not mean the family simply owns the farm, the family must both own AND operate the farm.  If they end up selling the farm, the transfer tax will be owed and likely with interest from the year of death.

But let’s review the impact on income taxes of the farm operation being transferred to the next generation.

Bill and Mary Farmer own a farm operation and file as a Schedule F.  They are located in Iowa and farm 4,000 acres of which they own 1,000 acres worth $10 million with no debt.  Bill and Mary are tragically killed in a car wreck on December 31.  The farm had the following assets at the time of death:

  • Grain in the bin not sold $4 million (650,000 bushels of corn and 50,000 bushels of beans),
  • Farm equipment worth $1.5 million,
  • Prepaid fertilizer, seed and other inputs for next year’s crops worth $1 million.
  • 1 million grain facility worth $1.5 million,
  • Shop worth $500,000,
  • Other farm buildings worth $250,000, and
  • Land worth $10 million.

Bill and Mary had also invested money in the stock market and had unrealized gains of $250,000 on stocks and bonds.

On their final income tax return, Bill and Mary must report all of these items on the return.  The land had a cost basis of $3 million, therefore, the final amount of gains being reported is $16 million (total value of $18,750,000 minus land value of $3 million plus the $250,000 of stock sales).  The gain on the stock may be owed on the final return, but let’s assume the heirs continue to farm and no transfer tax is owed.

Under current tax rules, the heirs are allowed to fully deduct the grain and prepaid farm inputs.  This is a $5 million deduction.  The farm equipment, grain facility and buildings can now be depreciated over a 7-20 year period.  That allows a deduction of another $3,750,000.  Farm land cannot be depreciated so no extra deduction until sold.

The family is allowed to get a step-up of $2 million, therefore, the net deduction lost under the proposal is about $6.75 million either immediately or over time.  Assuming a combined federal and state tax rate of 35%, this will cost the heirs about $2,362,500.  

However, let’s assume the heirs finally stop farming after 20 years.  At that time, the heirs may owe the transfer tax on about $14 million of income and let’s assume that is at the top tax rate of 43.4% plus 6.6% state tax rate.  The tax owed at that time will be $7 million plus interest over 20 years which may double the amount owed to $14 million.  The heirs have not sold the farm, they have simply stopped farming.  Effectively they will have to sell the farm to pay the tax or borrow the money from either Uncle Sam or a bank.

Also, will the family be allowed to then offset this gain with the “step-up” allowed on the grain and other assets that could have been deducted by the heirs.  Additionally, if the deceased couple owes estate tax will they be able to deduct the deferred transfer tax against the estate value.  We don’t know and will not know until we see the details on the American Family Plan.

We will keep you posted.  This is a very complicated proposal and if passed in the current form, almost all farmers will be affected (not 2% as the press release indicates).

Paul Neiffer

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