The Tax Implications of the American Families Plan on Iowa Farmland Owners

President Biden proposed the American Families Plan (AFP) on April 28, 2021, to provide new social programs to millions of Americans. To pay for this $1.8 trillion benefits package, the AFP proposes significantly changing the way capital gain is taxed. The Administration has explained that "reforms to the taxation of capital gains and qualified dividends will reduce economic disparities among Americans and raise needed revenue." Specifically, the AFP proposes increasing the top marginal tax rate, taxing some capital gain at ordinary income tax rates, and subjecting more gain to the 3.8% Medicare tax. The AFP would thus boost the top federal rate at which some capital gain is taxed to 43.4% in 2022 and beyond. In addition to increasing tax rates, the AFP proposes taxing previously unrealized capital gain upon the transfer of appreciated property at death or by gift. This new tax-never before implemented in the United States-would generally apply to gain exceeding $1 million per person. It would supplement, not replace, the current estate and gift tax, which-because of a current exclusion of $11.7 million per person-impacts very few estates. As proposed, the AFP would generally eliminate the tax-free step up in basis for capital gain exceeding $1 million. This would apply to gain arising from investment assets such as stocks or commercial real estate, as well as gain arising from farmland or other business property. The AFP proposes applying the current $250,000 per person exclusion for capital gain on a principal residence. To determine the potential impact of these proposals on the owners of Iowa farmland, we analyze statistically representative data of farmland and landowners in Iowa, collected through the 2017 Iowa Farmland Ownership and Tenure Survey (IFOTS). We determine the basis of the farmland based upon its location and how and when it was acquired. We then calculate potential gain based upon estimated county-level fair market value (FMV) in 2021, which is assumed to be 5% higher than the average county farmland value estimates reported in the ISU Land Value Survey as of November 1, 2020. Because the AFP would treat entities differently from individuals, we exclude entity-owned farmland from our analysis and only consider acres owned by sole owners, joint tenants, tenants in common, or revocable living trusts. As such, our study examines the potential impact of the AFP on 22 million acres of Iowa farmland, which is 72% of the 31 million-acre total. Our study also considers the AFP's potential impact on 217,548 owners or 80% of the 272,906 farmland owners in Iowa, as shown in figure 1. Figure 1. Farmland acres and owners in the study. The 217,548 farmland owners and 22,044,707 acres in our study are broken down into four categories: full-time farmers, part-time farmers, retired farmers, and non-farmers (see figure 2). We review the impact of the AFP on owners in these categories throughout the report. The data show that more owners call themselves part-time farmers than full-time farmers, but full-time farmers own 29% of acres in our study, while part-time farmers own 13%. Note that some spouses of current, retired, or deceased farmers are non-farmers, as are off-farm owners of a family farming operation. Figure 2. Farmland acres and owners in study, by category. Note: FT=full-time; PT=part-time. Throughout the study, we consider spouses to be individual owners of 50% of all jointly-owned property, and we calculate gain accordingly. When determining gain realized at death or upon gift, we apply a separate $1 million exclusion for each owner/spouse. This means that our calculated tax liability estimate for an owner/spouse is roughly 50% of the tax liability that would exist for the couple if all of the couple's property is jointly owned. It also means that we calculate all estimated owner tax liability averages and medians using this one-spouse, one-owner approach. We present individual land holdings, as well as whole farm size data, which is all farmland in which the individual owner has at least a partial interest. The whole farm data allows us to compare results with other data sources, such as the USDA Census of Agriculture. All tax calculations are based upon the individual's fractional interest in the whole farm. Limiting our data to capital gain arising from the ownership of farmland only, our analysis estimates the average minimum tax liability imposed upon Iowa farmland owners by the AFP in the event of: (a) a lifetime sale; or, (b) the transfer of property at death or by gift. Most owners would have additional income or gain from non-farmland property that would increase overall tax liability beyond our estimates. We must also emphasize that our estimates are limited to the average results of hypothetical events. In other words, to determine the new AFP tax arising at the death of a farmland owner in a particular category, we calculate the average tax liability for all owners in that category as though all owners died in the same year. Lifetime Sales We first review the potential impact of proposed AFP tax rate increases upon the sale of farmland. No exclusions or potential deferrals apply to a lifetime sale. We apply the new rules of the AFP, as though they applied in 2021, and compare the new liability to that under current law. We estimate that the AFP's higher tax rates would increase the average minimum tax liability flowing from a taxable lifetime sale of an Iowa owner's farmland by 65%, from $368,092 to $607,870. Tax liability across owners varies significantly, depending upon the number of acres owned and the basis of the farmland. On average, we estimate that a full-time farmer owning 358 acres of farmland would see tax liability from a lifetime sale increase from $475,248 to $860,572 (81% increase) or from 14.5% to 26% of FMV. As shown in figure 3, active farmers see the most significant increase. We assume that a new 3.8% Medicare tax impacts gain greater than $400,000 arising from the sale of an active farmer's land. Non-farmers already pay this tax at a lower income threshold under current law. Figure 3. Lifetime sale tax under current law and proposed AFP. Example 1: In 2002, an unmarried Cerro Gordo County farmer purchased 422 acres of farmland worth $2,648/acre or $1,117,550. In 2021, the FMV of the land is $3,250,642 or $7,703/acre. The farmer sells, recognizing $2,133,092 in gain. Under current law, the farmer would owe $398,265 or 12% of the sales price in tax, assuming no additional income beyond the standard deduction. Under the AFP, the farmer would owe $686,208 or 21% of the sales price in tax, a 72% tax increase. Lifetime sale information is also relevant because the AFP proposes to limit the tax-deferred like kind exchange of real property to $500,000 per person each year. Further analysis of the impact of this restriction is beyond the scope of this report. Transfers at Death or by Gift We next review the potential impact of the AFP's imposition of a tax on unrealized gain at death or gift. When triggered, the new transfer tax would be calculated as a sale, using the increased rates detailed above, but each person could exclude $1 million in gain from recognition. We do not apply the $250,000/$500,000 exclusion for a principal residence in our farmland study. We begin with an estimate that 53% of all Iowa farmland acres and 17% of all Iowa owners would be impacted by the new AFP tax at death or gift. The average tax for these owners would be $623,888. These numbers, however, include all types of owners and land holdings, regardless of size. Figure 4 shows the percentage of impacted owners and acres, by owner type, when whole farm size is 200 acres or more. We discuss each category below. Figure 4. Owner and acre impact, 200 acres or more. Full-Time/Part-Time Farmers Many Iowa farmland owners have an interest in very small parcels of land. These owners will not be impacted by the AFP, based solely upon their farmland holdings, because their gain will not exceed the $1 million exclusion. The following charts show the number of farmland acres owed by full-time farmers, as well as the whole farm size in which the owners have an interest. As shown in figure 5, 32% of full-time Iowa farmers have an interest in fewer than 100 acres, and 53% own an interest in 200 acres or less. These interests comprise 21% of the acres owned by full-time farmers. Of the owners with an interest in less than 100 acres, the average number of acres owned by these individuals is just 37. Figure 5. Farmland owned by full-time farmers, by whole farm size. Our data suggest that no owners or acres attributable to whole farms less than 100 acres would face tax liability under the AFP at death or gift. Figure 6 shows new tax liability for whole farms sized at 100 acres or more. These estimates include a $1 million gain exclusion. Figure 6. New AFP liability for full-time farmers, by whole farm size. Among full-time farmers with ownership in a whole farm of 100 acres or more, we estimate that 46% of owners and 72% of acres would be impacted by the AFP tax at death or gift. That number jumps to 99% of owners and 98.2% of acres when the whole farm size reaches 500 acres or more. The average number of individual acres owned by a farmer with an interest in 500 acres or more is 656 acres. This group would face an average new tax liability of $978,342 at death or gift, although deferral may apply to some of these farmers. The average tax at death or gift for these owners would be 15% of the FMV of their farmland. We further estimate that 62% of full-time farmer owners with an interest in 200 acres or more-comprising 79% Iowa farmland acres-would be impacted by the AFP tax at death or gift. The average tax for this group would be $782,576 or 13% of the FMV of their farmland. Our data suggest that 57% of part-time farmers with an interest in 200 acres or more and 76% of acres owned by part-time farmers would be subject to liability at death or gift under the AFP. Average tax liability for this group would be $618,497, averaging 11% of the FMV of the property. Example 2 Married farmers in Buena Vista County own 722 acres of farmland as joint tenants with right of survivorship. In 2004, they purchased the land for $3,093/acre or $2,233,146. In 2021, the land is worth $9,972/acre, for a total FMV of $7,199,784. Thus, in 2021, they have $4,966,638 in unrealized gain in their farmland. The farmers are killed together in a tragic accident in 2021. Under current law, their land would pass to their heirs with no tax liability, and the basis of the property would step up to $7,199,784. Under the AFP, after applying a $2 million exclusion, the death of these owners would trigger the realization of $2,966,638 in gain from their farmland. This would generate $1,039,122 in tax liability ($519,561 per spouse), which is 14.4% of the land value. This number increases if the couple had other income or gain in the year of their death. It is possible this transfer could qualify for a deferral of the tax payment, depending upon whether the couple has farming heirs and depending upon the details of any deferral provision. Retired Farmers and Non-Farmers Likewise, we estimate that 29% of retired farmland owners and 10% of non-farmer owners would have new tax liability at death or gift flowing solely from their farmland holdings. We estimate average new tax liability for these categories at $530,237 and $527,563, respectively. Sixty-nine percent of all acres owned by retired farmers would be impacted by this new tax at death or upon gift. As with full-time farmers, however, the data is clearer when examining only those with an interest in a whole farm with 200 acres or more. As shown in figure 7, 63% of retired farmers with in interest in 200 acres of land or more and 84% of the land owned by these retired farmers would be impacted by the AFP tax at death or gift. Nearly all retired farmers and the acres they own would be impacted by the AFP at death or gift where the retired farmer has an interest in 500 acres or more. Figure 7. New AFP liability for retired farmers, by whole farm size. Our data show that the average new tax liability for retired farmers with an interest in 200 acres or more or 500 acres or more would be $582,659 and $1,002,543, respectively. As shown in figure 8, the average tax as a percent of the FMV of the property ranges from 13.4% to 28.3% for retired farmers, based upon their farm size. Retired farmers often have more unrealized gain because they have owned their land longer. Figure 8. AFP tax at death/gift as percent of FMV, retired farmers. Example 3 A retired farmer from Buena Vista County dies in 2021 owning 700 acres of farmland. In 1975, he purchased the land for $1,450/acre or $1,015,000. In 2021, it is worth $9,800/acre or $6,860,000. He dies with $5,845,000 in unrealized gain. Under the AFP, the retired farmer's death creates new tax liability of $1,863,178. This is 27% of the FMV of the land. We also analyze the estimated tax liability for retired farmers and non-farmers, broken down by rental arrangements. This is significant for potential deferral provisions applying to family farms. Forty percent of retired farmers who cash rent to non-relatives, for example, would face new AFP tax liability averaging $529,145 at death or upon gift. Thirty-eight percent of the farmers who cash rent to a relative would, on average, face an AFP tax of $261,363 at death or upon gift. Exclusion Amount All of our findings are based upon a $1 million capital gain exclusion from recognition (per owner) proposed to apply at the time of death or gift. As shown in figure 9, if the AFP were to remove the $1 million exclusion, we estimate that 93% of Iowa's farmland would be impacted by the new transfer tax. If the exclusion were set at $5 million, we estimate that number would drop to 6%, with only .6% of owners impacted by the AFP tax. Figure 9. Estimated impact of exclusion amount on acres and owners. Tax Deferral for Family Owned and Operated Farms The AFP suggests a tax deferral for current farmers who transfer their farmland to family members who continue to farm the land-payment of tax on the appreciation of certain family owned and operated businesses would not be due until the interest in the business is sold or the business ceases to be family owned and operated. Without more detail, it is impossible to analyze the impact of a deferral provision. It does appear, however, that the tax would be assessed at death or gift, but the payment deferred until such time as the land is no longer farmed by a family member. The definitions of "farming" and "family owned and operated" would be key to determining the reach of any deferral provision. When considering the definition of "farmer" it is important to note that only 17% of farmland owners within our study are full-time farmers and they own just 30% of the acres we analyzed. The average age of these full-time farmers was 61.5 years old. The average age of non-farmer and retired farmland owners in our study was 68.7 and 77.7 years old, respectively. More than 50% of Iowa's farmland is rented, most under a cash rent lease. More information about the demographics, leasing, and transition practices of these farmland owners could be found in the 2017 IFOTS report. 1 It is also not clear what impact a deferred tax would have on a farmer's ability to obtain credit. Although we did not perform extensive debt or income analysis, our data show that 72.7% of owners who would incur new tax liability at death or gift under the AFP own their property free of debt. That debt-free number falls, however, to around 40% for farmers that own 1,000 or more acres of farmland. Our data do not include information about other debt to which farmland owners are subject. Although our data do not include information about farm income, we compare the income potential of the farmland in our survey to the potential tax liability associated with that farmland. This could suggest the ability of an owner to pay a new tax at death or upon gift. To do this, we calculate the average cash rental income that could be collected for the farmland acres in our survey, based upon county-level cash rent data. We then estimate that Iowa farmland owners with tax liability could collect, on average, $165,421 in gross cash rental income from their land each year. This means that the owners' average tax liability at death or gift equates to 377% of the average annual gross cash rental income. The USDA forecasts average net cash farm income for farm businesses at $91,800 in 2021. This includes farms with annual gross receipts of at least $350,000 or smaller businesses where farming is reported as the operator's primary occupation. We emphasize in closing that the AFP is only a proposal. To date, no legislative language exists, and it is unclear whether a majority in Congress will support these or similar provisions. With this study, we present estimates of the AFP's potential tax impact on Iowa farmland owners, as proposed. The provisions will likely evolve as Congress debates a larger budget reconciliation bill this fall. Footnotes: 1. Zhang, W., A. Plastina, and W. Sawadgo. 2018. "Iowa Farmland Ownership and Tenure Survey 1982-2017: A Thirty-five Year Perspective." Iowa State University Extension and Outreach, CARD working paper #18-WP 580. ↩