***Editor’s Note: We received a great deal of feedback to the Mailbag segment that aired late last month. Below is a transcript of John’s comments, followed by viewer response:
Mailbag Transcript: Time now for our weekly look inside the Farm Report Mailbag…I’ve received several comments about my budget priorities – and I will answer more in the future – but one of my own neighbors picked up on a sleeper I had on my list. "I must take exception with your proposal to eliminate the stepped-up basis. Many would be forced to sell their farms without a stepped-up basis. How is that a good thing?" Dale English – Paris, IL. Dale, you are right. The basis step-up allows people to avoid a lot of taxes. But it strikes me as a blatantly unfair loophole. Here’s how this tax expenditure works. If I bought a farm ten years ago for $3,000 an acre and sold it today for $10,000, I would have to pay capital gains tax on the appreciation in value over the years of $7,000. This would apply to other types of assets like stocks, too. But if I die today, my heirs could sell the farm immediately with no capital gains because the basis or cost gets reset to the current value when the owner dies. My question is why? Why should death be a "get out of taxes free" card? If you research Internal Revenue code section 1014 you’ll find no good reason. It’s just a tax giveaway that benefits wealthier people. It also costs the treasury $60 billion a year. So if balancing the budget is the top priority for most American’s, if not for me, I think we should at least start by eliminating tax breaks that have no economic or logical justification.
Viewer Response #1: You are right on target with your comments regarding the stepped up basis tax. I know our opinion is not popular, but it is truly the right thing. We as American farmers think we can be exempt from paying taxes and then wonder why a first generation farmer cannot start farming. If you think those loopholes help us, think what it does for the truly wealthy people in America. Roger Cain -
Viewer Response #2: Concerning your argument against a stepped-up basis you overlook the other side of that coin – the estate tax. Therefore, your statement that death is a get-out-of-taxes-free card is not accurate. Let’s look at your example* of buying a farm 10 years ago for $3,000/acre and you die today when it is $10,000 an acre and let’s say you bought 1,000 acres. The valuation at death would be $10,000,000 and the federal estate tax (after the $5,120,000 exclusion) would be about $1,700,000. Do your heirs have $1.7 million to pay the tax bill or do they have to sell the farm to pay the estate tax? If they have to sell the farm without a stepped-up basis the gain on the sale is $7,000,000 (10,000,000 sale price – 3,000,000 basis) with a capital gains tax due of $1,050,000. So the total federal tax as a result of your death is $2,750,000. Add Illinois taxes and the total tax bill is probably about $3.5 million. Your elimination of stepped-up basis will probably cost your heirs about $1.3 million. That is not a get-out-of-taxes-free card. And if you want to eliminate stepped-up basis the natural progression is to eliminate the estate tax exclusion. (in 2010 there was essentially no basis step-up because there was no estate tax) Without that exclusion the federal estate tax bill is now about $3,500,000 instead of $1,700,000. Without the basis step-up and exclusion, federal and state taxes will consume about $5.3 million out of the $7 million increase in value. Yet you claim these tax breaks have no economic or logical justification. Your statement that code section 1014 is a tax give-away that only benefits wealthier people is also completely erroneous. It benefits, just as much if not more so, the struggling couple with children where the husband is out of a job. Due to the death of an aunt they inherit stock worth $10,000 knowing they can sell that stock to get the cash and won’t have to pay capital gains tax. Note also that the capital gains tax rate for those in the 15% tax bracket or lower is zero (I’m sure in your opinion, again no economic or logical justification). Dave Sauers
Viewer Response #3: You have over simplified the concept of stepped up basis. It has a useful purpose. Since you are in the business of farming, you should understand the costs associated with farming. If you truly want your son to take over the farm operation someday, think about the cost he would have to incur in your operation to get it rolling. Sure, you with a off farm job, can help subsidize the business for 2 families, but what if you were to pass away today. Unless you have a monstrous insurance plan to cover the taxes, he will find himself hard strapped to keep the operation profitable. Even with our current deduction limit, an extra tax on the overage can be hard to service. Not to mention other children not associated with the farm. My point here is that you have over simplified a very tough problem to deal with. I happen to have lost my father in 1976. With siblings and a mother that still needed income, the 80’s were a very tough time for me. I am still a farmer with much gained knowledge and wisdom. I hope my son, who is starting in the operation, gains wisdom from my trials and gets a stepped up tax break to pass the family farm heritage on to his son if they wish. Collin Jensen
Viewer Response #4: You are exactly right. That capital gain should be taxed. I applaud you for taking this unpopular position. Unpopular that is with the upper-middle-class. And frankly most established farmers are in that category. AND, the "death tax" , our long established inheritance tax should be reestablished at higher rates than at present. As I understand it, we established it to keep a broad base of property ownership, and avoid the European "peasant and nobleman" societal feudal system. Yet my local and national Farm Bureau rail against it under the guise of saving the family farm. They would effectively prevent any member of the lower classes from even dreaming to farm.
We’ve created so many tax loopholes for the upper middle class that noises about "the 1%" make us all fear losing our democracy. Another ploy used to pass assets to heirs comes to mind. I would love to hear you talk of it. In this state, at least, many elderly give all their assets, land, savings, etc. to their children, become low-income (at least ostensibly), and soon move into government subsidized housing, and as soon as possible go to Medicaid to finance their nursing home care. This, of course, preserves the assets for the heirs, leaving the expenses of long term care for the public to pay. Thanks for entertaining me for the past 10 or 15 years with your column, and now your TV commentary. Sincerely, a Kansas farmer, Howard Collett
Viewer Response #5: I listened to your comments today on the stepped up basis for property in an estate. There is a serious case to be made for a zero capital gains tax - in general property gains in value because of monetary inflation. In that way there may be no gain in purchasing power with the extra dollars from the gain in a sale, thus why tax that gain? You said something to the effect the Government loses money on the sale of estates as though that money is the Governments to start with! I would suggest to you that it is our money to start with and the Government never loses tax dollars, it only collects less. This whole discussion begs for a complete over haul of the tax system in this country. It was the actions of the Congress in the 60's and 70's that helped push gains on capital assets faster than one would imagine. The implementation of automatic cost of living increases in a whole variety of government and then non-government payments and wages, plus deficit spending, has helped inflate prices dramatically. Congress loved it because it allowed them to increase spending on their favorite programs. It was the beginning of a vicious circle that has led us to the brink of real problems related to what is popularly called inflation (when they really mean price increases). The amazing increase in inflation (increase in the money supply) recently will have consequences. On a different issue, I realize corn and beans create a whole lot of consequences for the rest of American agriculture, but it would be interesting to see something about the rest of the diverse number of crops and animals in this country. Farm Journal's infatuation with huge farms is a little much also. Many of those guys step on their neighbors toes and not infrequently go up in smoke. And a different item again. I became a committed fan when I read your column on brownie shaving a number of years ago. Sincerely, David Fenn - Curtis, WA
Viewer Response #6: I will give you a scenario where your example does not hold water. In Alaska a family homesteaded a hot springs. They improved the area over the years and eventually covered the spring for a swimming area. Then they put in a little cafe. The man died and although they had the nice springs that afforded them a living, they had no cash. The value of the land had a much greater value so the inheritance taxes were high. They had to come up with the taxes quickly and were forced to sell just to pay the taxes. The spring was purchased by a group of attorneys and doctors from Fairbanks and it is now a very fancy resort. Now that is an example of "not fair." You are assuming that (1) the land in your example was purchased as an investment. (2) That the land would sell quickly. (3) that the family WANTED to sell the land and not just live on it. In our operation, our children want to live here. The land value has increased. If they had to pay the higher tax rate there would be no cash to run the day-to-day operations. Please take this into consideration. There are a lot of us out here that are in this situation.