Estate and Gift Tax Provisions
Tax Reform Act of 1976
As They Affect Agriculture
James S. Wershow
OCT 31 1977
**^* W~ofr y-lr
Florida Cooperative Extension Service
Institute of Food and Agricultural Sciences, University of Florida
John T. Woeste, Dean
I I I I I I
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ESTATE AND GIFT TAX PROVISIONS
Tax Reform Act of 1976
As They Affect Agriculture
James S. Wershow
ESTATE AND GIFT TAX PROVISIONS
.... .. .. ... James S. Wershow'
The Tax Reform Act of 1976 has been called "the most sweeping
tax measure to clear Congress" since the enactment of the Internal
Revenue Code of 1954. The new provisions affect almost every tax-
payer either directly or indirectly. Of particular interest to the
farmer and his family are the extensive reforms in the area of
estate taxation--the excise tax that is imposed on the value of a
decedent's property at his death. The new provisions are quite com-
plex and require future administrative and judicial interpretation.
However, some of the major provisions will be discussed in simplified
ESTATE AND GIFT TAX REFORM
The basic thrust of the estate and gift tax reform has been a
unification of the previously separate taxes. Under the pre-TRA
1976 law, lifetime gifts were taxed at approximately 75 percent of
the rates for the estate tax on property passing at death. The lower
gift tax rates created tax planning opportunities through lifetime
transfers of property rather than devises by will.
The Tax Reform Act replaces the separate rate schedules with a
single unified schedule (with rates ranging from 18 to 70 percent)
applicable to the aggregate of the "taxable estate" and "adjusted
taxable gifts." 2001. In addition to changing the rates, the Tax
Reform Act replaces the previous $60,000 estate tax exemption and
the $30,000 lifetime gift tax exemption with a unified credit of
$47,000 against taxes that would otherwise be due under the unified
rate schedule. 2010, 2505.
To cushion the impact of the change on the tax revenues, the
credit will be phased in over a period of five years, from $30,000
for bequests by decedents dying in 1977, to $47,000 in 1981. 2010.
The phase-in for the credit against gift tax varies from this only
for the first six months of 1977, during which the credit against
gift tax is $6,000.
In general, the rates are slightly higher than under the old
law and the credit is more generous than the old exemptions. The
overall effect is that many smaller estates (under $200,000) will
be subject to less tax than under the old law, or no tax at all;
larger estates will be more heavily taxed since the rates have in-
creased for the amount in excess of the available credit.
IVisiting Professor, Food and Resource Economics Department, IFAS,
University of Florida, Gainesville, Florida.
2All section references are to the Internal Revenue Code of 1954 as
It should be noted that despite the elimination of the $30,000
lifetime gift exemption, the $3,000 annual per donee exclusion is
still available under the new law. 2001(b), 2503(b). Under the
pre-TRA 1976 law, gifts made within three years of death were pre-
sumed to have been made "in contemplation of death" and were thus
included in the decedent's gross estate for estate tax purposes.
However, the executor could avoid the inclusion by proving that the
decedent did not in fact make the gift in contemplation of death.
Under the new law, gifts in excess of the $3,000 annual exclusion
made within three years of death will be included in the gross estate
without regard to the decedent's true motive. 2035.
With regard to the unification of the estate and gift taxes,
consideration should also be given to the changes in the marital de-
ductions for both lifetime gifts and transfers. (See discussion
REVISED LIMITATIONS ON MARITAL
DEDUCTIONS IN ESTATE AND GIFT TAXES
Under the pre-TRA 1976 law, a spouse was allowed deductions
against his gross estate (for estate tax purposes) or taxable gifts
(for the purpose of the estate tax) for property transferred to his
spouse. Both of these provisions have been liberalized by the Tax
Reform Act of 1976.
Under the pre-TRA 1976 law, the estate could deduct up to a
maximum of one half of the adjusted gross estate for property trans-
ferred at death to the decedent's spouse. For example, if the
decedent's adjusted gross estate were $300,000 and property worth
$250,000 were transferred to the spouse, the estate would be en-
titled to a deduction of $150,000.
Under the Tax Reform Act, this limitation is increased to a
maximum dollar limit of $250,000, or 50 percent of the adjusted gross
estate, whichever is greater. 2056(c)(1). This change is intended
to benefit estates of $500,000 and under, since at levels above
$500,000 the 50 percent deduction provided by the current law will
provide the greater benefit. Thus, under the new law, if the adjusted
gross estate were $300,000 and property worth $250,000 were trans-
ferred to the spouse, the estate would be entitled to a deduction of
$250,000, a significant increase from the $150,000 that would have
been allowed by the pre-TRA 1976 law.
An exception to the effective date provisions of the new law is
designed to shield bequests to spouses under certain so-called
"marital deduction formula" clauses in wills executed prior to
January 1, 1977, and not amended thereafter from the impact of the
increased deduction if the decedent dies prior to January 1, 1979,
and the state passes no relevant inconsistent statute. 2002(d).
Applicable to gifts after 1976, the Tax Reform Act also
liberalizes the marital deduction for gifts made to spouses. Under
pre-TRA 1976 law, the deduction was limited to 50 percent of the
value of the gifts made to the spouse. The Tax Reform Act, of 1976
allows the first $100,000 of gifts to the spouse to be deductible
without any percentage limitation. Gifts between the first $100,000
and $200,000 are taxable, and gifts above $200,000 are allowed a
50 percent marital deduction. However, although both the estate and
the gift marital deductions are for many taxpayers more generous under
the Tax Reform Act, the deductions overlap at one point to reduce the
liberality of the changes.
The liberalized estate tax deduction, discussed above, is reduced
by the amount by which the new gift tax deduction amount exceeds 50
percent of the value of the gifts to the spouse (i.e. whenever, the
value of the intervivos gifts which qualify for the marital deduction
gift provisions does not exceed $200,000). 2002(a)(1)(B). For
example, there is a maximum marital deduction of $250,000 for a
$300,000 adjusted gross estate. However, this $250,000 would be re-
duced to $200,000 if $100,000 worth of lifetime gifts had been given
by the decedent-donor.
Similarly, if the gifts had been $185,000 instead of $100,000,
there would be a corresponding reduction of $7,500 leaving a maximum
marital deduction amount of $242,500. In each case, the reduction is
by the amount of the marital deduction allowed for lifetime transfers
in excess of 50 percent of the value of the transferred assets. Hence,
in the first case the calculation would be $250,000 less the difference
between $100,000 and 50 percent of $100,000 while in the other it would
be $250,000 less the difference between $100,000 and 50 percent of the
TAXATION OF GENERATION SKIPPING TRANSFERS
Another major reform restricts the utility of a common estate
planning device--the so-called "generation skipping" transfer. The
most common example is a gift in trust by the father, with the income
to his son during his life, and then at the son's death, the principal
of the trust to be paid out to the son's children. Under the pre-TRA
1976 law, there would be an estate tax due on the death of the father,
but not on the death of his son when the property passed to the next
generation, since the property would not be considered part of the
The new law, which is detailed and complex, is designed with
certain exceptions to subject this second transfer to an estate tax,
and applies to those situations similar to the above in which for one
generation the property would otherwise escape taxation. The new law
includes the trust property in the son's gross estate for tax purposes,
but the tax generated by the inclusion will be paid out of the trust
assets, not the son's estate. 2601-2603, 2611-2614, 2621-2622.
While collecting additional revenues currently escaping taxation,
the new law also has the effect of reducing the accumulation of in-
herited wealth by future generations. While the new law is basically
prospective in application, the transition rules for existing trusts
require detailed consideration and competent legal advise regarding
the effect of the law on existing estate plans and any changes made
SPECIAL RULE FOR FARM PROPERTY VALUATION
The basic concept of the federal estate tax is that it is a tax
on the transfer of property from the decedent at his death to his
heirs or beneficiaries. In general, the value of all the property
the decedent owned at his death is added together to get the "gross
estate"--the amount that is subject to tax. The value of the pro-
perty included in the gross estate is generally determined by the
property's fair market value on the date of the decedent's death.
Under the pre-TRA 1976 law, the gross estate could then be reduced
by certain specified deductions allowed by the tax code.
Prior to the Tax Reform Act of 1976, the estate tax could be
particularly burdensome on the estates of farmers. The reason for
this was that a farmer's primary asset--his farm real estate--was
included in his gross estate at its highest and best use value.
Therefore, the farmer's gross estate and consequently the amount of
estate tax due would be inordinately large. Compounding the problem,
most estates of farmers have insufficient liquid assets with which
to pay a substantial estate tax created by the inflated value of the
farm property. Therefore, it was necessary in many cases to sell
the farm to raise money to pay the tax, thereby depriving the farmer's
family of its main source of livelihood and removing productive
property from agricultural use.
To reduce this burden on farmers, the Tax Reform Act of 1976
allows the executor of a farmer's estate to elect to value the farm
real estate at its value as a farm, not at its highest use value.
2032A. There are two ways to determine this "current use" value:
1) by examining relevant factors such as comparable agricultural
sales of nearby land and capitalization of expected income yield or
rental value. 2032A(e)(8); 2) solely by capitalizing the gross
cash rent less property taxes on comparable farmland. 2032A(e)(7).
Using the gross cash rent as the basis for valuation will in
most cases give the most favorable valuation. This basic figure of
gross cash rent less property taxes is capitalized at the average
annual effective interest rate for all new Federal Land Bank Loans.
Example: $200 per acre cash rent. Property taxes of $24 per
acre. 8 percent Federal Land Bank Loan interest rate. Thus $176
(cash rent less property taxes) /.085 (FLB interest rates = value
of land per acre (in this example $2070.59). In making these
calculations average figures for the last five years before death
should be used.
However, the use of this special valuation is subject to certain
limitations and prerequisites:
1. The special valuation cannot decrease the value of the
property by more than $500,000. 2032A(a)(2). For
example, if the highest use value was $2,000.000 and
the farm value $1,000,000, the special valuation could
only reduce the estate value to $1,500,000.
2. The farm property must represent a specified minimum
proportion of the value of the decedent's adjusted
gross estate. These threshold requirements are:
a. 50 percent or more of the adjusted gross estate
must consist of realty or personalty devoted to
a qualified use, 2032A(b)(1)(A), and
b. 25 percent or more of the adjusted gross estate
must consist of realty devoted to a qualified
use. For instance, an adjusted farm estate of
$800,000 must have at least $200,000 (25 per-
cent of $800,000) of farm realty devoted to a
qualified use with at least $200,000 more in
personalty similarly devoted; in terms of per-
centages, if 25 percent of the adjusted gross
estate were farm realty, then at least an
additional 25 percent would have to be per-
sonalty; further, if 49 percent were qualified
realty, then only 1 percent would have to be
qualified personalty. Yet if only 24 percent
were qualified realty, there could not be any
use of these special valuation provisions.
3. The property must have been used by the decedent or
his family for farm purposes both at the decedent's
death and for five of the eight preceding years.
Operation by a farm manager does not qualify.
4. The property must pass by will or intestacy to a
"member of the decedent's family," which is
specially defined by the new law. 2032A(b)&(e).
5. All parties with an interest in the property must
sign an agreement consenting to the special valu-
ation and accompanying conditions. 2032A(b)(1)(D).
The effect of the lower valuation is to reduce the amount of
estate taxes on the decedent's property. However, in exchange for
the estate tax benefit of this lower valuation, the new statute
imposes restrictions on the subsequent use of the property by the
member of the decedent's family who received the property. If
within 15 years of the decedent's death, the member of the family
now owning the property stops using it for farming purposes, or
sells it to someone other than another member of the family, an
additional estate tax will then become due. 2032A(c)(1).
During the first 10 years, the additional amount is basically
the amount of tax the decedent's estate originally saved by using
the special valuation for farm property instead of the normal fair
market value. 82032A(c)(2). After 10 years, the additional tax
potentially due is phased out over the following five years.
If the property is sold or ceases to be used for farm purposes
after 15 years from the decedent's death, there is never any ad-
ditional estate tax due. 2032A(c)(3).
Therefore, the new Tax Reform Act conditions the use of the
special valuation for farms by restricting, under the threat of
additional estate tax, who may take the property from the decedent,
what it must be used for, and how long the person must hold it
prior to selling it.
The qualified heir who receives the farmland from the decedent
is personally liable for any additional tax imposed as a consequence
of subsequent disqualifying use. 2032A(c)(6). In addition to this
personal liability, a federal tax lien on the specially valued pro-
perty arises at the time of an election and continues until no
further potential liability for the additional tax exists or until
the Treasury accepts a substitution of security for the lien.
DEFERRED PAYMENT OF ESTATE TAX
The Tax Reform Act has facilitated payment of estate taxes by
allowing deferment of payment up to 10 years if it can be shown that
"reasonable cause" exists for the deferment. 6161(a)(2). This
"reasonable cause" requirement is a liberalization of the "undue
hardship" standard which existed prior to the tax reform act.
Estates composed of closely held businesses are also allowed
a liberalized installment method of payment. Prior law is continued
in that if the value of the closely held business exceeds 35 percent
of the value of the gross estate or 50 percent of the value of the
taxable estate, the executor may elect to pay the estate tax in
up to 10 annual installments. 56166A.
If a closely held business exceeds 65 percent of the adjusted
gross estate, however, the Tax Reform Act now allows a deferral of
all 10 year installments up to five years, 6166, and with certain
limitation interest due during periods of extension is now limited
to a 4 percent rate. 6601(j).
Taken together these provisions should aid in reducing the
incidence of forced sale of farms qualifying as closely held business
to pay estate taxes due.
A significant reform in TRA 1976 and one which will eventually
affect the estates and beneficiaries of all decedents who own pro-
perty at death is the change from the "stepped up" basis rule of the
prior law to the new statutes' "carryover" basis rule. 1023.
Under the law prior to the Tax Reform Act of 1976, the bene-
ficiary would take a basis in the property he received equal to its
fair market value on the date of the decedent's death--a so-called
"stepped-up" basis. This was very advantageous for the beneficiary
as the following example will illustrate:
Under the pre-TRA 1976 law assume the decedent owned property
with a basis of $10,000, but which had a fair market value of
$50,000. If before his death, the decedent sold the property at its
fair market value, he would have realized a taxable gain of $40,000.
However, if he dies and wills the property to a beneficiary, the
beneficiary's basis is $50,000 and not $10,000. Therefore, if the
beneficiary then sells for $50,000, he has no gain since his amount
realized is the same as his basis. Because of the step-up in basis,
no one ever paid any tax on the $40,000 appreciation in the value
of the property.
Therefore, the new Tax Reform Act requires beneficiaries re-
ceiving property from a decedent to use a "carryover" basis and not
a "stepped-up" basis. This means that the-beneficiary must use the
decedent's basis as his own. The act does authorize an upward ad-
justment, however, for federal and state estate taxes attributable
to the unrealized appreciation which occurred during the decedent's
lifetime. 1023(3). In the above example, assuming no estate tax
attributable to the unrealized appreciation, the beneficiary would
take the decedent's $10,000 basis in the property. If the bene-
ficiary then sold the property for its fair market value of $50,000
he would have a taxable gain of $40,000, the same as if the decedent
himself had sold the asset.
The impact of the radical change to the carryover basis has
been softened somewhat by the inclusion of a "fresh start" rule.
Basically this permits a partial "step-up" in the beneficiary's
basis to include the increase in the value of property prior to
January 1, 1977. 1023(h). The "fresh start" rule is applicable
only to property acquired before 1977 for decedent's dying after
January 1, 1977. The effect is to delay the impact of the new
carryover basis provisions.
The provisions of the pre-1976 TRA law and the law under the
Tax Reform Act of 1976 may be illustrated by the following examples
for non-farm property and for farm property:
I. Treatment of Non-Farm Property
Assume that a decedent owned property before his death in which
he had a basis of $25,000. When he died, the property was worth
$35,000. For present purposes we assume that no estate tax is at-
tributable to the appreciation unrealized at decedent's death. The
property was devised by will to the decedent's son. The son soon
after receiving the property sold it for its fair market value of
$35,000. Under the old law, the following would be the tax results:
1. The estate would include the property in the decedent's
"gross estate" at its fair market value of $35,000.
2. The beneficiary son would take a basis equal to the
fair market value of the property at decedent's death
3. When the son sold the property, he would have no tax-
able gain since the amount he realized on the sale
equaled his basis in the property.
For the results under the Tax Reform Act of 1976, it is neces-
sary to assume that the property had been owned by the decedent for
1,000 days, 400 of which occurred before January 1, 1977. The tax
results under the above facts would then be as follows:
1. The estate of the decedent would include the pro-
perty in the gross estate at its fair market value
2. The beneficiary would take the decedent's basis in
the property--a "carryover" basis--of $25,000, plus
a "step-up" or "fresh start" for appreciation at-
tributable to the period prior to January 1, 1977.
The amount of the fresh start allowed to the beneficiary
for his basis would be calculated as followed:
Fair market value of property $35,000
Minus decedent's basis -25,000
Amount of appreciation $10,000
The total appreciation of $10,000 is then multiplied by a
fraction based on the relationship of the number of days prior
to January 1, 1977 that the decedent owned the property (400),
to the total number of days the decedent owned the property
$10,000 x 400/1,000 = $4,000, the amount of the "fresh
start" which is added to the carryover basis of $25,000,
for a total basis to the beneficiary of $29,000.
3. When the beneficiary's son sold the property, he would
realize a taxable gain of $6,000, the difference between
the amount he realized on the sale--$35,000--and his
basis as determined in (2)--$29,000.
Note that the difference in the two situations is that
under the old law, no one pays income tax on the appreciation
in the property, while the new law will result in taxable
II. Treatment of Farm Property
For the comparison of impact of the old and new law on farm pro-
perty passing from a decedent to his beneficiary, assume the same
basic facts as above except that the real property is a farm. How-
ever, further assume that the fair market value of $35,000 is based
on the "highest and best use" value, and that the property is worth
only $30,000 as a farm at the decedent's death. Again, assume that
the property passes by will to decedent's son who initially continues
to operate the property as a farm, but then sells it within 10 years.
Under the old law, the tax result would be identical to those
described in the above example for non-farm property. The fact that
the property was used as a farm would have no effect on the value of
the property for estate tax purposes or the basis of the property in
the hands of the beneficiary.
Under the Tax Reform Act of 1976, however, the results would be
quite different in the case of farm property. To repeat the facts,
the property has a fair market value based on "highest and best use"
of $35,000 at decedent's death, but a value of only $30,000 as a
farm. The decedent's basis was $25,000. The decedent owned the
property for 1,000 days, 400 of which were before January 1, 1977.
At his death, the farm property passed by will to his son, who
initially continued the use as a farm, but who sold the property
within 10 years for $35,000. The following are the tax results
under the new law:
1. If the executor elects and the property qualifies for
the special use valuation, the decedent's executor can
include the farm property in his gross estate at the
value of $30,000, the farm use value of the property,
This special valuation is permitted by the Tax Reform
Act of 1976 and will reduce the estate taxes by re-
ducing the total value of the "gross estate."
2. The beneficiary's son would take the decedent's basis
of $25,000 plus a partial "fresh state" basis based
on the amount of time the decedent held the property
before January 1, 1977. The total basis would be
calculated as follows:
Value of property as a farm $30,000
Minus the decedent's basis -25,000
Amount of appreciation $ 5,000
(Note that the farm value and not the highest use value
is used in this calculation. The new law requires the use
of the value used for estate tax valuation purposes, and
on these facts, the special farm valuation was used.)
The total appreication of $5,000 is then multiplied by a
fraction based on the relationship of the number of days before
January 1, 1977 that the decedent owned the property (400) to the
total number of days the decedent owned the property (1,000).
$5,000 x 400/1,000 = $2,000 of fresh start basis,
which is added to the carryover basis of $25,000 for
a total basis to the beneficiary of $27,000.
3. When the beneficiary's son sold the farm property with-
in 10 years there would be two separate tax consequences:
(A) The beneficiary would have to pay additional
estate tax since the farm property that re-
ceived the benefit of the special estate tax
valuation has now been terminated. This
additional estate tax is essentially the tax
the estate originally saved by using the
(B) The beneficiary would have a taxable gain of
$8,000, the amount by which the amount
realized on the sale exceeds his basis.
$35,000 $27,000 = $8,000
The above examples and hypothetical calculations present
the effects of the new law in a highly simplified form and
view the tax impacts in isolation from other relevant tax
and non-tax considerations.
Individual situations require careful analysis of all facts by
competent tax counsel.
COOPERATIVE EXTENSION WORK IN AGRICULTURE AND HOME ECONOMICS
(Acts of May 8 and June 30, 1914)
Cooperative Extension Service, IFAS. University of Florida
and United States Department of Agriculture, Cooperating
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This publication was promulgated at a cost of $236.96 orll.8cents
per copy, to inform men and women in the agricultural industry
about significant changes in tax law that affects management of
business and property.
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