Much has been made about the President's FY2016 budget and its proposed cuts to the risk management tools on which farmers depend.
In fact, leaders of the House and Senate Agriculture Committees have been critical of the budget for its attack on crop insurance, and lawmakers recently received a pointed letter on the subject from farm groups, equipment manufacturers, and the banking industry.
But Paul Neiffer, a certified public accountant with CliftonLarsonAllen LLP from Yakima, Wash., who specializes in taxation and accounting for farmers, says there's another component of the budget that should worry the agricultural community, too.
"The White House has proposed the closure of what they call a ‘trust-fund loophole' on a provision known as stepped-up basis at death," said Neiffer. "This would greatly complicate inheritance for farmers who tend to be land rich but cash poor."
Under the President's budget, heirs would face capital gains taxes on their inheritance – even if the property is not sold – in addition to estate taxes that they may have to pay under current law. The budget would also increase the top capital gains rate to 28%.
One example detailed by Neiffer comes from Washington, where land that had appreciated by millions of dollars over a 50 year period would have as much as 70% of the inheritance flowing to government coffers and just 30% to the children of the deceased.
This example is a worst-case scenario of highly profitable acreage in Washington and is more extreme than what most farmers would face, but the President's proposal would hit most farmers in the Midwest too, says Neiffer.
Take a tract of land purchased for $100,000 in the ‘60s that is now worth $1,000,000. Under the proposal, a capital gains tax would be owed on $900,000 when the property is gifted, even though the farmer has not received any cash from the gift.
Neiffer sees problems with this setup, including the bureaucratic paperwork.
"A similar proposal to alter stepped-up language was tried many years back and the administrative issues were going to be immense," he explained. "For example, if the only person who knows the income tax basis of the asset has passed away, how easy is it to pin down the original tax basis of the property?"
The provision came under attack in a recent congressional hearing where farm state lawmakers didn't pull any punches.
Calling the proposal another "Death Tax," South Dakota Republican John Thune explained how it would hit his constituents during a Senate Finance Committee hearing on Feb. 5:
[The administration's] proposal, if enacted, would have a devastating impact on family farms and small businesses in my state of South Dakota. I want to give you an example... if you take a typical family farm that bought...640 acres back in 2000 for $640,000, which...in South Dakota that would be considered a small farm. Today that same farmland is probably worth somewhere between $3.5 million and $4.5 million, depending on where it's located.
So under the current estate tax law, which excludes assets up to $5.43 million, the family farm isn't taxed when it passes from one generation to the next. Now under the administration's proposal, this family farm would be hit with a significant tax when the family farm is transferred to the next generation of family members. ...so in that example this South Dakota family would suddenly find themselves facing a tax bill of $1 million or more.
With so much opposition on Capitol Hill, it is highly unlikely that this proposal will ever see the light of day. Neiffer, however, thinks farmers should still pay attention.
"It is always wise to know when a branch of the U.S. government believes you are a trust fund loophole," he said.