By Polly J. Dobbs, Attorney, Bingham Greenebaum Doll LLP
I’m a farm girl and an estate planning attorney. So naturally, I’m passionate about helping farm families efficiently transfer ownership of their land, buildings and equipment to the next generation.
Too often I sit down with farming clients who misunderstand the estate planning process. Their misunderstanding is usually the result of overhearing inaccurate information. Perhaps they’ve heard a couple neighbors discussing death taxes and loopholes at the grain elevator and pick up some more chatter at the local diner. This secondhand advice, while perhaps well-meaning, will inevitably become their estate planning downfall.
Here, we explore five common examples of estate-planning-gone-wrong for farmers.
1.“I’m going to give away the remainder interest, but hold on to the life estate to retain control and income stream.”
The only goal this plan accomplishes is avoiding probate administration. Retained interests such as this cause 100 percent of the value to be taxable upon the death of the life estate holder under the Federal Estate Tax. This is not a good plan for someone trying to minimize death taxes.
2.“I plan to title my property jointly with my children and their spouses so that it automatically passes to them at death.”
Yes, this avoids probate; however, it also puts the farm squarely within the marital estate of your child's potential future divorce. Leaving your child outright ownership could make the family farm susceptible to claims by the child’s creditors and subject to division by a divorce court in the event of that child’s failed marriage. Consider leaving your child's inheritance in a trust or creating an LLC to achieve goals of keeping the farm within the family.
3.“I’m doing nothing because I’m worth less than $5 million,” or the similar reasoning: “Because the wife and I are worth less than $10 million.”
Most farmers are land rich and cash poor with little to no estate planning in place. This situation is a ticking time bomb that will explode into a liquidity problem after death when it’s time to pay potential state and Federal death taxes. Many farmers keep a “dirt savings account” and do not have any other savings or investment accounts. As the value per acre of our tillable land continues to increase, the bottom line on the farmers’ balance sheets skyrockets, and most aren’t aware of the tax problems lurking at their death.
Farmers are generally familiar with the Federal Estate Tax; there are numerous articles addressing this topic in farm journals. However, most are unaware of the potential hit their state's inheritance or estate tax could give to their children. Our current federal laws allow each decedent to pass $5.25 million of assets free from Estate Tax; a married couple can pass $10.5 million. However, state death taxes deserve careful consideration. Not every state taxes property transferred by a decedent. For example, Indiana has a new law that repealed its inheritance tax for every decedent who dies on or after January 1, 2013. However, some states impose significant taxes at death, so it is a wise idea for each farmer to find out how his own state’s laws affect his estate plan.
Also, many farmers have a false sense of security and think they don’t have a tax issue because their farm is worth less than $5.25 million. However, if his neighbors are selling farm ground for over $14,000 per acre, that farmer may be worth several million dollars more than he thinks, and his heirs will owe significant taxes at his death. It’s crucial to take a look at a farmer’s accurate balance sheet given today’s value of farm land when discussing taxes.
4.“I want to treat all my kids exactly the same.”
Many times, estate planning isn’t about tax planning – it’s about family dynamics. A farmer is lucky if there is one child who wants to return home (or stay home), but it’s more likely that a farmer has at least three children. Treating the children fairly does not necessarily mean treating them equally.
A typical will would leave all assets equally to the children which, without planning, would yield “tenants in common” ownership. A series of complex questions might arise from this situation, though. Does the child who actively farms have to pay cash rent to the non-farming siblings? Would the majority of the non-farming siblings out-vote or second guess each decision made and question the yields acquired by the on-farm sibling? The one farming child may also wish to buy out the other siblings’ share of the farm, but that could easily become a huge burden on the farming child. In no time, these scenarios would lead to a family feud.
If one child is going to be managing the family farm, there are methods of planning that allow that child to have control and be provided with a reasonable salary for services rendered. After paying the child a manager’s salary, net profits can be divided equally among all children. A farmer’s estate plan should be drafted so that non-farm children cannot second guess the on-farm child’s daily decisions. Large decisions can require supermajority or even unanimous agreement, but daily decisions can be left to the one who’s in the tractor cab.
5.“I’m just going to copy what my neighbor did.”
There is no cookie cutter approach to estate planning, especially not for farmers. For some farmers, it might make sense to do some gifting during their lifetime in order to reduce the size of the taxable estate at death. This is an especially attractive option given the current Federal Estate Tax laws that provide each individual with a $5.25 million unified exemption, which can be used during lifetime or at death.
For other farmers, lifetime gifting might not be advisable. If the next generation will likely sell the farm, then their “basis” in the property becomes very important. Careful analysis is necessary to determine whether the Federal Estate and/or state death taxes saved by lifetime gifting are greater than the capital gains tax triggered by an after-death sale. It’s best if the estate planning attorney, accountant and financial planner are all involved in such analysis.
It may also make sense to transfer the farm ground to a business entity first, such as an LLC, so that certain transfer restrictions can be put in place to accomplish the farmer’s goals. Some goals may include restricting property ownership to blood descendants; preventing or restricting future development of tillable acreage or historic green spaces; and providing protections in the event of a child’s divorce.
Estate planning is important for all families and business owners, but it is crucial for farmers.
Raised on a farm herself, Bingham Greenebaum Doll LLP attorney Polly J. Dobbs helps farmers create holistic succession plans that are tax efficient and provide the desired succession of control to the next generation while treating all family members fairly. If you have questions about the role estate planning plays in your family farm, please contact her at 765-473-5872 here: http://www.bgdlegal.com/professionals/947/polly-j.-dobbs/
DISCLOSURE REQUIRED BY CIRCULAR 230. This Disclosure may be required by Circular 230 issued by the Department of Treasury and the Internal Revenue Service. If this article, including any attachments, contains any federal tax advice, such advice is not intended or written by the practitioner to be used, and it may not be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer. Furthermore, any federal tax advice herein (including any attachment hereto) may not be used or referred to in promoting, marketing or recommending a transaction or arrangement to another party. Further information concerning this disclosure, and the reasons for such disclosure, may be obtained upon request from the author of this article. Thank you.