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Estate and succession planninig for farmers 2015 12-04
- 1. Retirement, Estate, and Succession Planning for Farmers Priorities and Risks for the Family Farm January 26, 2016 Wabash, IN REMC
- 2. Succession and Retirement Planning - Roadmap Planning Goals Starting point – Assessment Risks Planning Tools Financial Health
- 3. Planning Goals Protect the Family Farm Transfer Farm to the Next Generation Planning for Retirement Minimize Taxes (and other risks) Starting point is to determine your goals, and to prioritize the goals This will provide a guide and clarify your path
- 4. Planning Goal - Protect the Family Farm Step 1: Farm Assessment
- 5. What is the “Family Farm?” Essential Businesses Livestock Grain Trucking Other? Essential Assets Land Equipment (tractors, trucks, etc) Inventory (livestock, grain)
- 6. What is the “Family Farm?” Land – How is the Land titled? (Who owns the farm?) Individuals Corporations Limited Liability Company Trust
- 7. How is the farm currently organized? Schedule F – all land and assets under one name (or Mom and Dad as joint owners) One or more entities (Corporation, LLC, Trust) with all ownership held by Mom and Dad One or more entities with assets held majority by Mom and Dad One or more entities with assets held minority by Mom and Dad
- 8. Who are the Family Members? Generation 1 – Mom and Dad Generation 2 – Children On-Farm Off-Farm – how involved? Generation 3? Other key players (key employees? inlaws? Are these people included in the planning discussion?
- 9. How the farm is organized – Why is this important? Current protection of assets (lawsuit, bankruptcy, divorce) Ease of transfer of assets (give or bequeath “shares of stock” versus “pieces of land” (or equipment)) Future protection of assets (lawsuit, bankruptcy, divorce) Preservation of assets over time (maintain land under single ownership, maintain farm operation)
- 10. Conclusion 1 – Step 1 Farm Assessment Critical Businesses of the Farm Essential Assets of the Farm Members of the Family Gen 1, Gen 2, Gen 3 On-Farm and Off-Farm Level of interest, level of involvement in farm operations
- 11. Planning Tools to Accomplish Your Goals Step 2 – Analysis of Risks to Farm Planning
- 12. Risks in Planning Estate Taxes – Affects estates > $10.9M (married) or $5.45M (single) If this is YOU – Seek professional help (attorney or CPA) immediately!! You can afford it and you need it. NO Indiana Inheritance tax (as of 2012) Other Risks 4D risks (Divorce, Death, Disability, Disagreement Capital Gains Taxes
- 13. Risk In Planning 5D Risks Divorce Disability Disaster Disagreement Death
- 14. Risk In Planning Capital Gains Land can carry significant capital gains risk Evaluation Questions Do you need to consider “stepped up basis” at your death? Is it likely that the land will be sold? If yes, WHEN? GEN2? GEN3 Can plan for protection entities (LLCs) that can be unwound or position for stepped up basis for land
- 15. Conclusion 2 – Step 2 Risk Assessment Evaluate the risk to the farming operation Transfer ax Risk – not as big of concern as in pre-2012 days (Estate Tax $10.9M – no Indiana Inheritance tax) 4D risks – family issues across generations Capital Gain Risks – what happens if the farm ground is sold?
- 16. Planning Tools to Accomplish Your Goals Step 3 - Farm Organization
- 17. Planning Tools – Organization of Farm Organization of Farm Assets into logical parts (Essential Businesses) Land Livestock Equipment Operations Communication among family members is KEY!
- 18. Planning Tools – Organization of Farm Parameters for organization WHO runs the essential business(es)? Will the “business” continue after the current operator? Livestock contracts may be particular to the operator If there are no “on farm” heirs, the “next generation“ may be only interested in cash rent HOW will the farm be managed in GEN2? On Farm manager Off-Farm owners/profit shares
- 19. Planning Tools – Organization of Farm Organize the Family Farm TODAY to address future expectations and needs Divide key businesses into component parts that can be ended or continued separately Corral liability into one entity to protect the remainder of the farm assets. Look for “manageable” and “logical” components
- 20. Planning Tools - Types of Farm Entities Sole Ownership Limited Liability Company C-Corporation S-Corporation Partnership or Joint Venture Trusts
- 21. Planning Tools - Types of Farm Entities Sole Ownership Best use - Land or other operations that will end at owner’s death While, generally, the “sole ownership” model is still a valid one, the protections that can be added by the use of an LLC, as well as the greater flexibility of transfer of ownership, suggest that other “entity” models are a better choice.
- 22. Planning Tools - Types of Farm Entities Limited Liability Company - Flexibility Best use – Operations Also good use – Land ownership by informed owners Easy to add/remove owners Profit share directly to owners Lower expectation of increasing value of business Limited Liability Company - Protection Best Use – Insulation of High Risk Assets Employees Road Equipment
- 23. Planning Tools - Types of Farm Entities Corporations (C or S) Best Use – Longevity of structure, Build Value Protection against “raiding the corporation” Protection against risky heirs (divorce, bankruptcy, creditors) Frequently used to pay living expenses (IRS is looking at this now, and may start challenging) Concerns – Tax and transferrability Capital Gains captured and held forever High tax to dissolve or get out of corporation Inflexible form
- 24. Planning Tools - Types of Farm Entities Partnerships and Joint Ventures Best Use – temporary or project-based activities (as opposed to overall “farm operations”) Also good for – unrelated parties cooperating on projects Might Be Good For – combined buying power and marketing power CAUTION Partnerships and joint ventures are NOT protected from liability. If ONE partner gets in trouble, ALL are at risk! If you choose a Partnership Form, be sure you are well- insulated from the actions of your partners!
- 25. Planning Tools - Types of Farm Entities Trusts Best use – Impaired GEN1 or GEN 2 owners Limited duration – ends at either death of GEN1, or no later than GEN3 (Rule Against Perpetuities) Inflexible structure (cannot add people, remove people) Not an “operations” entity – intended to be a “holding” entity ONLY EFFECTIVE IN LIMITED CIRCUMSTANCES
- 27. Now you are organized What’s next?
- 28. Planning Tools Step 4 Estate/Succession Planning
- 29. Planning Tools - Succession Planning Planning tools to aid the succession planning process – Company/Corporation By-Sell Agreements Ante Nuptial (Pre-Nuptial) Agreements Estate Planning Tools Last Will & Testament Trusts Living Trusts, Special Needs Trusts, Testamentary Trusts Lifetime Gifts Life Insurance
- 30. Last Will & Testament Components of LW&T What is in your estate? Assets Form of Assets Who are the Objects of Your Affection (OYAs)? Spouse Children Grandchildren When do you want your OYAs to receive their inheritance? At your death At Spouse’s death At GEN2 death
- 31. Trusts Purpose of Trusts To protect assets from the people who benefit from those assets To protect assets from probate process To protect assets from outside risk To protect heirs from outside risk
- 32. Trusts Types of Trusts Special Needs Trusts – For people who receive federal assistance and/or have other life challenges Living Trusts – Can be revoked while you are alive Testamentary Trusts – Generally cannot be revoked or changed Land Trust – Method for holding (usually) farm real estate, but also used for land conservation purposes
- 33. Lifetime Gifts PROS Removes assets from your estate CONS Assets are given at YOUR Basis – LAND Locked-in Capital Gain Not really helpful if your estate is LESS than the FED Estate Tax Threshold Requires tax return for gifts in excess of annual exclusion Requires appraisal for larger non-cash gifts.
- 34. Life Insurance Purpose of Life Insurance Help to pay estate taxes (if any) Help to equalize estate between non-farm and on-farm children Give life insurance to non-farm children Give farm assets to children CONS Can be very expensive Removes cash from operating capital “Second to die” policy
- 35. Other Tools Power of Attorney Health Care Power of Attorney Living Wills
- 36. Planning Tools Step 5 Financial Health
- 37. Financial Health Do you have what it takes to keep your farm intact? Planning for retirement Conventional retirement accounts (IRA, 401K) Planning for passive farm income (cash rent, or passive owner interest in farm operation) Planning for transfer to next generation (Our program today) What assets need protected? What people need protected?
- 38. Summary Farm and Business Planning
- 39. Farm and Retirement Planning - Summary Planning Goals Starting Point – Assessment Risks Planning Tools Financial Health WATCH – that you plan for both the business(farm)as well as your personal needs, and know the difference
- 40. Succession and Retirement Planning - Destination 1 • Planning Goals 2 • Farm Assessment 3 • Risk Analysis 4 • Succession Plan 5 • Financial Health
Editor's Notes
- Most farmers are busy with the business of farming, and give little or no thought to retirement or succession planning until well into the later years. It is important to start the retirement and succession planning process sooner, rather than later, in order to take advantage of maximum flexibility and minimize tax or financial impact of transition. Additionally, it is important to have a plan in place in case the unexpected happens, and transition needs to be implemented immediately. Having a plan in place can make transition – at any time – more manageable and predictable for all concerned, whether it’s the first generation that formed and operated the family farm for years, or the second generation – whether off farm or on farm – or even down to the third generation, who may be underage, or have little relationship to the family farm.
- We will be covering a lot material in this program. Hopefully, many of the terms and tools will be familiar to you, and we can concentrate on how the tools work together, and what options will work best for your farm operation. As we discuss Succession and Retirement Planning, we are going to focus on these five overall elements – Goals, Assessment, Risks, Tools and Financial Health. Not only are these important elements to the planning process, but they provide a flow chart to help navigate decision-making and help evaluation options.
- First, and as with any major project, it is important to recognize and understand the goals of the project. Once you identify your goals, you need to prioritize the goals in order to find a starting point for planning purposes. The goals presented here are in an order of a typical priority for transferring the family farm. Protect the Family Farm is a #1 goal of most farm operations – Generation 1 typically wants to keep the family farm intact, keep the farm real estate intact, keep the farm operation intact (as much as possible), so that the most efficient and profitable organizational structure can be maintained in the next generation. There is usually a fair degree of concern that if the farm is divided up among Generation 2 heirs, if there is a Gen 2 “on-farm” heir that will continue the farming operation, dividing the farm among all heirs will put the on-farm heir at risk for being able to maintain a living income from the farm production. At the same time, Gen 1 wants to ensure that all Gen 2 heirs – whether on-farm or off-farm receive a fair value for their ownership interest in the farm, whether it is value of ownership or value of annual income. The second priority is the transfer of the family farm to the next generation (Typically, Gen 2). This generally means a goal of keeping the farm intact and minimizing the cost of transfer (whether it be transfer taxes like Estate Taxes or dollar cost of making the transition) A lesser priority to many farmers, but which should be an important consideration, is Retirement Planning. It is not necessarily, and may not be wise, for the Gen 1 owners to maintain complete and primary control of the family farm until the day they die. Transition planning to Gen 2 necessarily involves retirement planning for Gen 1 in order for Gen 1 to maintain income and lifestyle enjoyed while actively farming, even if not at the helm. Finally, minimizing taxes and other costs and risks to transition is key to preserving the value and assets of the family farm. Failing to consider and plan around risks and taxes will guarantee that both will take a chunk of the farm as penalty for failing to plan. So – what are your goals? What is your priority? This is the starting point.
- With protecting the family farm as the primary goal, the first step is to understand what you mean by “The Family Farm.” Farm Assessment is the first stop in our planning.
- Most farmer have a good idea of what they own, and a value of each element of the operation. This is usually needed for bank financial statements and tax returns. This is also a good starting point for purposes of succession planning. What are your “Essential Businesses?” How is your operation organized? Are all aspects of the farm operation under one operational entity (such as the Schedule F individual farmer)? What are the “Essential Assets?” What is owned – what is rented? What is “paid for” and what is mortgaged? How is the land used? Is the equipment solely for farm use? Is any equipment leased from – leased to – another (non-related) operation? Is inventory stored? Is the farm-grown grain stored, used for on-farm livestock, sold immediately or marketed over time? Dividing your entire farm operation into essential businesses and essential assets can suggest whether reorganization might be needed (or helpful) and how the farm might be more efficiently reorganized for both current use and for succession planning.
- Generally, there is no “right” answer to organizational structure of farm land assets; however, there might be “more right” options, depending on how you farm, who is involved in the farming operation, and what risk or opportunities you have now…. And what might come down the road, later. Generally – Individual ownership is the most flexible but the most risky ownership model Limited Liability Company model is very flexible, and can have strong owner-transfer restrictions and creditor protections built in. Corporation is least flexible, most restricted Trusts are flexible while Gen 1 is alive (like individual ownership), but very restricted for Gen 2 (and beyond) See Chart (handout)
- We’ve talked about organizational structures from a business and inheritance perspective. This is ownership structure from a “majority interest” perspective. Things to consider – Is this the best organizational structure for the current farming operation? Is this the best organizational structure for the transitional operation – that is, as Gen 1 withdraws from farming, and Gen 2 steps up, will the operational structure support the transition smoothly from both a management and a tax perspective? Is this the best organizational structure for the long-term operation – When Gen 2 is in charge and beyond, will the organizational structure benefit the expected operations for the next 20 years?
- Who are the “people at the table” and what is their interest in the farm operation? Mom and Dad (Gen 1) Built the farm and accumulated the assets Gen 2 can include both on-farm and off-farm children. What are their goals? How much do they want to be involved in the farm (today? At Gen 1 death?) How well do Gen 2 members get a long with each other? How well doe Gen 2 members manage their own affairs? Are there any special considerations to Gen 2 (Special Needs, out-of-country residency, criminal, financial or marital trouble)? Is there a Gen 3 to consider – with people living longer, Gen 3 can reach adulthood and be involved (or not) on the farm while Gen 1 is still active Are there non-relative people to consider? (key employees – active (or disruptive) in-laws)? Most importantly – are they involved in the planning and discussion of succession?
- While there is not a “one-size-fits all” or “one right answer” to how the farm business should be organized from either a current operations or a succession planning perspective, both the current (today’s) climate of assets, debt, and risk, and the future (what risks Gen 2 may have – or marry), can suggest the level of complexity or planning needed to protect the farm operation intact to the next generation. Another reason to look at organizational structure is the opportunity (or the need) to wind down, reorganize, or separate out certain aspects of the farming operation at transition points. For example, if the current operation consists of land, grain, livestock, and trucking for third parties, separating those operations into three distinct units will allow individual transition planning for each. Non-farm heirs typically do not want the risk and labor of a livestock operation, but can understand and appreciate landownership and cash rent income. An on-farm heir actively involved in livestock and who provides all the labor for the livestock operation should be able to claim all the profits from a mostly labor-intensive business. Alternatively, if no one is interested in maintaining the livestock operation, it can be wound down and the barns rented to a third party.
- A critical analysis of the structure of the family farm from the point of view of: Current operations Transition Long-term structure With a review of risks to the farm: Current liability risks to family members Risks brought by family members Can show: Whether the farm should be reorganized (and how) What planning considerations need to be included for succession of the farm to the next Generation
- Now that we know What you have and have separated the farm operation into component parts, we will take a closer looks at the risks.
- The next step in this analysis involves the financial risks to the farming operation. For this purpose, we are not referring to liability risk. Liability risk is always present, and your best security for liability risk is to have good farm insurance and insist on good farm and safety practices. For purposes of this workshop, we are NOT going to delve deeply into the more advanced estate planning techniques used by larger estates. While a lot of the same analysis and outcomes will apply, there are more aggressive techniques that are beyond the scope of this presentation. If your estate is pushing the $10.9 million-dollar mark (for married couples), seek immediately consultation with your local attorney or CPA. You can afford it, and you need it. Generally, death taxes are not a concern to most farmers. Indiana no longer has an Inheritance Tax, and the Estate Tax limit will be increased for married couples $10.8 to $10.9M exemption amount for 2016. For now (or until Congress decides, otherwise), this exemption is permanent and will continue to be increased and indexed for inflation. Additionally, even with no pre-planning, a surviving spouse can elect to “port” the deceased spouse’s unused share of the $10.9M exemption amount, so the Gen 1 couple can take full advantage of the available exemption amount. Other risks are (1) relationship oriented or (2) capital gain oriented
- (See handout on 5D Risks) 5 D risks can affect any family member at any generation, and different planning techniques may be in play for issues at Gen 1 as opposed to Gen 3.
- Capital gains issues for farmers primarily attach to (owned) farm ground. Many times, farm ground is acquired – or inherited – early in Gen 1 career, and carries a very low basis relative to current market prices for farm ground. Planning techniques may different if the overall goal is “to retain all or most of the farm land into future generations” versus “sell farm ground as needed, keeping (or not) only sentimental farm real estate (i.e., inherited land, homestead land, land where the children were raised). Regardless, a discussion of “Stepped Up Basis” is important at this point. Generally, when assets are inherited, those assets acquire a fair market value basis, regardless of the acquisition basis. For example, Grandpa Joe inherited farm ground from his father 50 years ago. At the time, the farm ground was valued at $500 per acre. Today, that same ground is valued at $10K per acre If Grandpa Joe were to sell the land to his children or to a third party, he would recognize significant capital gain on that sale. However, if Grandpa Joe bequeaths that same farm ground to Junior, then at Grandpa Joe’s death, Junior will inherit the ground tax free at a basis equal to the current fair market value. While one argument might be that there will ‘never’ be a sale of the farm ground, it does not hurt to ‘plan for everything’ by included planning techniques favorable to the sale of the land, even if there is no foreseeable need for such a sale. Even if you don’t think the land will be sold until Gen 3, planning for a step up in basis at Gen 2 provides additional flexibility for Gen 2 estate planning. Note that, if Gen 1 has estate planning issues, chances are high that Gen 2 will face similar estate planning issues.
- Step 1 was to evaluate the assets. Step 2 is to assess the risk that either the assets or the family (or both) carries that will affect the ability to preserve the farming operation to achieve desired goals. What about the “soft risks” of the 4Ds?
- Now that we have discussed WHAT you have, and what RISKS your farm operation might encounter, how can we use this information to ORGANIZE the farm operation to maximize the wealth and business transfer to the next generation, while minimizing the risks associated with (1) wealth transfer or (2) business operations.
- We have talked about the core businesses of a farm operation. If the farm operation is not already organized across the core businesses, now is the time to review whether reorganization would be beneficial. For some farmer, segregating the core operations into separate and distinct businesses can allow maximum flexibility, minimum overall risk, and allow heirs to be involved to the extent of their interest (that is, it might be “fun” to be a landowner farmer who raises corn and soybeans, but not so much for livestock, unless the heir lives and works on the farm and has a close connection to the animals). It also gives the opportunity for the on-farm heirs to claim and grow certain elements of the farm business (such as a quad for a livestock operation), on his or her own efforts (and not have to share the rewards of the hard works), or wind down or get out of certain elements of farming that none of the heirs wish to continue. If equipment is owned jointly between family members, using a formal structure for that joint ownership provides security to all participating members by setting forth expectations, financial commitment (and rewards), and exit strategies. While family members may agree today about managing the farm assets, change in family structure, including the application of one of the 4D can ruin even the best of intentions and turn misunderstanding into mayhem. With more than one Gen 2 family member involved in the operations, setting up a formal business structure can allow habit and process to replace concerns and bewilderment when a key family member is no longer in the pictures. In all things, be prepared to openly discuss your goals and expectations with the next generation (them as are old enough to participate on a meaningful level). Open discussion and encouraging exchange of ideas will help all family members understand goals (and ask questions) and participate decision making before it is too late.
- Review slide questions – WHO runs the essential businesses today? WHO will run the essential business after GEN 1? Is there a transition plan in place? Are all heirs “at the table” for discussion and ideas? While the discussion might not be “easy,” having open discussion at this point will allow the planning professional to recommend the path that best suits your goals. Failure to include Gen 2 heirs in the planning process may result in a costly reorganization after Gen 1, or a burdensome buyout between Gen 2 heirs One thing to keep in mind – if this is an asset you want to pass to the next generation, and an asset that you wish to have preserved as long as possible, it is critical that all heirs understand and agree with the process. If you find that there are off-farm heirs that don’t understand or want nothing to do with the farm, you can arrange alternatives for inheritance to meet your goal of treating all heirs fairly.
- Take your goal-setting and risk assessment results as a overlay for developing a reorganization model
- (See Previous handout about entity structure) Intro slide to section.
- Sole ownership is the traditional model for the family farm, and still the easiest for a single person (or married couple) to use. However, it has the highest liability risk, highest potential for transfer issues, and highest risk for division of the farm into component parts, some of which may be sold at the death of Gen 1 owners. It has some limited benefit for land ownership for small farms, where the addition of an entity structure would be more complicated than helpful Distinct farm operations that are expected to end at the owner’s death (swine barns, grower contracts, custom farming for others) Even under this scenario, there may be strong reasons to consider other models for non-transfer reasons, such as managing risk.
- Limited Liability Companies are the current ‘go-to’ operational model Easy in, easy out for owners Easy to create, easy to disband for operations Tax on profit paid at owner level, which is typically a lower rate Can be structured to leave control in the hands of the owner/manager of the farm operations, while providing oversight for big decisions by other owners. You can have as many or as few as suit your purposes. (Some quad (swine) owners have a separate LLC for each barn) You are limited only (mostly) by your imagination in how this is structured ALSO – good fit for third party participation Employee and payroll company – profit share for employees? High-risk assets – trucking company with sole assets as the on-road vehicles, and all profit is routinely distributed to owners each year, keeps all other farm assets insulated from the high risk business
- Corporations (S or C corps) still have a place in farm planning where a more formal structure is desirable. C corporation – traditional corporation, has its own tax profile, pays tax at the entity level. Dividend are also taxed. S Corporation – modified C corp where profit (and loss) is taxed (or deducted) at the shareholder level (typically a lower rate) Protection of the farm wealth from spent-thrift Gen 2 or Gen 3 (or their spouses) because severe tax penalty for removing assets from the corporation. Downside – Extremely awkward for farm ground. Low basis land is trapped for (nearly) forever. Any sale of the land will trigger capital gain Difficult to get value out of the corporation to the owners
- Partnerships and joint ventures, while still viable organizational structures carry serious risk. In limited circumstances, partnerships or joint ventures can be beneficial tools for combining resources for efficiency or leverage. However, note that ALL partners can be responsible for ONE partner’s liability. If you are looking for a long-term relationship, consider a Limited Liability Company – created specifically to provide liability protection to a partnership structure.
- Before S Corporations and before LLC, there was the use of Trust as a device to hold and control wealth into the next generations. In the 80s and 90s, Trusts were marketed as “probate-avoiding devices.” While the “avoiding probate” component is true, that is an extremely poor reason to choose a Trust as a farm entity option. Trusts should be used sparingly, and only under certain circumstances, such as to accommodate an impaired spouse or child, or an ‘at risk’ spouse or child who may be facing bankruptcy, divorce, or other “outside” influences. If you have a trust – see your Estate Planning professional to have the Trust document (and the rest of your estate plan reviewed to (1) confirm that your trust is up to date and (2) to unwind the trust if it no longer suits your purposes. In all my years of practice, I have only had ONE owner who properly used and managed a trust – and he is an accountant, not a farmer. Trusts are typically used as HOLDING devices – not as operational entities. Trusts should never be used for a “soon to expire” business, or a business that will not be expected to continue into the next generation.
- The chart you see here shows one option for how you may choose to reorganize your farm operation. The center circle – OPERATIONS – is set up to provide labor and equipment services for the other operations (grain, livestock, land). It holds the “high-risk” assets, and may (or may not) be passed along to the next generation. The LIVESTOCK organization is intended to be a stand-along entity and likely will be terminated at or before the Gen 1 transition to Gen 2 However, the flexibility of the Livestock organization as a stand-alone entity can allow one or more of Gen 2 heirs to continue, independently of non-farm heirs. The GRAIN operation may be included in the LAND operation, or may stand alone. If land is owned individually by GEN 1, but farming is carried out with GEN 2 participants, it may be more “fair” to have a stand-along GRAIN operation. The LAND operation “best case” will be held in an LLC for both tax and transition purposes, but can be held in the individual names of Gen 1 owners. It’s sole enterprise will be cash-rent (or share crop) to the Grain operation or to other farmers (family members or otherwise). The best reason for placing the land in an LLC is to protect the land from the (1) actions of the owners or (2) actions of the other operations.
- Step 1 – What do you have? Step 2 – What are the risks you face? Step 3 – HOW is the farm organized, SHOULD the organizational structure change, and HOW should it change? Step 4 – Now that you have everything identified, evaluated, and organized, you can implement estate planning tools to both protect your assets at your death and to ensure that the assets are transferred to the next generation in a manner that has the best opporytunity for preserving the family farm and providing for future generations.
- If you have an entity (LLC, Corporation), you should also have a “buy-sell agreement” or “shareholder’s agreement” which governs how ownership interest can be transferred. This accomplished two important goals: Prevents creditors or ex-spouses from becoming owners of the corporation, because the document provides that any unapproved owners have no vote Provides parameters for approved owners and transfers to accomplish a transfer without undue burden to the remaining owners (allows on-farm heirs buy out non-farm heirs at a fair price and fair time schedule) For any unmarried heir, indoctrinate them early (and often) into the importance of a pre-nuptial agreement. These agreements are rarely allowed after the wedding bells, but are important safeguards to the above issues. Note that, an “heir” may be able to voluntarily transfer ownership to a “non-heir” Typical estate planning tools – Last Will & Testament is a companion document to the Shareholder Agreement, and reinforces the transfer of farm (company) ownership to the next generation instead of the spouse. Trusts – used sparingly as part of the estate planning process – can control ownership of farm assets for minors and impaired persons While Lifetime Gifts are an options, and common estate planning tool, with the Federal Exemption at > $10M for a married couple, there is less need for “gifting plans.” NOTE _ any gift of an appreciated assets carries with it the original BASIS of that asset. If “gifting plans” are not needed, they can be counter-productive to the overall value and capital gain management Life Insurance – a great way to equalize the inherited estate between non-farm and on-farm heirs, if it is affordable.
- Last Will & Testament documents are both your “last directives” and a way to complement your business documents. LW&T provide for the legal disposition of your assets among the Objects of Your Affection (OYA) If you DON’T have a Will, your assets will be distributed according to State Law. This might NOT be what you have in mind. For example: Husband and Wife with two adult kids. Husband dies without a Will, Wife only inherits ½ the estate. Example 2: Husband and Wife with no kids. Husband Dies, Wife inherits ¾ of the estate and Husband’s parents inherit ¼. Example 3 – Husband and 2nd Spouse with Kids from first marriage, Wife inherits 25% If the second spouse dies without a Will, the estate will be distributed equally among the children. What about non-farm versus farm heirs? LW&T can also establish a process for inheritance
- - You should never use Trusts solely to avoid probate – it is not worth the expense and risk. For active farming operations, Trusts are cumbersome tools which can significantly impair flexibility (Who is in charge of the Farm? How can you decide to buy and sell property or equipment)? Trusts are not intended to be creatures of business. Trusts are intended to be holding entities for the benefit of current and future beneficiaries. Trusts are good for protecting impaired beneficiaries (elderly or special needs, or “spendthrift” heirs)
- Living Trusts (1) do not avoid or protect from taxes, (2) bypass the probate process (3) can become irrevocable at the death of the first spouse Special Needs Trust protect beneficiaries who have some impairment. Can allow distributions for HEMW (Health, Education, Medical and Welfare), but will not affect federal benefits. Testamentary Trusts come into effect at the death of the first spouse and are a way to (1) provide for the surviving spouse and (2) provide for future generations, particularly minors Land Trusts used to be a popular way to hold farmland, but can be easily replaced with LLCs. Land Trusts can also be used for oil and mineral leases.
- As of January 1, 2013, the Taxpayer Relief Act made the $5M (indexed for inflation) exemption amount permanent. This means that aggressive plans to gift farm assets to children to reduce the parents’ estate value are no longer necessary for most taxpayers. As of 2016, the Estate Tax Exemption Amount will be $5.45 M for single – or $10.9M for married taxpayers. Additionally the Portability Act ensures that a married couple can take advantage of the full $10.9M exemption, even if they don’t carefully plan. Gifts are still worth consideration for other reasons – Getting the next generation started in the farm business or for larger estate (or just for love and affection). If you want to make a significant gift of farm assets (land, equipment, or ownership in a corporation), talk to your attorney or CPA for guidance.
- Life insurance is a terrific tool to help balance your estate plan and pay expenses at your death If you have non-farm heirs, this can equalize your estate to allow the on-farm heir to inherit the farm, but still provide an equal inheritance to the non-farm heir If your farm is large enough to be at risk for estate tax, life insurance can help pay that tax debt Life Insurance can help pay off farm debt. NOTE- Life insurance is NOT taxable if a human is a beneficiary (spouse or child). Life insurance IS taxable if payable to the estate If a single policy is too expensive, consider a “second to die” policy that pays on the death of the second spouse, but not the first. This can help achieve the same estate planning goals with less expense.
- When you consider “estate planning” you should also consider three additional “non-business” tools: Power of Attorney allows your spouse or child to make financial decisions for you if you cannot. Health Care POA is specifically for making health care decisions. The POA and HCPOA representatives can be the same or different people. A Living Will tells the world that you do not want “extraordinary measures” to keep you alive. This only applies if you are in a “persistent vegetative state.”
- We have discussed goals, assessment of the farm operation, analysis of risk, organization of the farm for best operation and succession planning, and estate planning tools. The last step (and not the least) is assessment of financial health. Your financial health is important not only to implement your estate plan, but to ensure your lifestyle is preserved as you consider retirement.
- In assessing your financial health, you need to consider both your personal retirement goals and the continuation of your farm operation. What is the best financial structure to accomplish both goals? Note that as Gen 1 plans for retirement, Gen 1 income can change from “active” Schedule F income to “passive” cash rent income, or the blended “Farm Share” income. For example - Rent income to a non-active farm owner allows the active farm owners to send income to the retired (or non-active) farm owners as a deduction to the farm operation (rent expense), and provides rent income without self-employment tax to the non-active owner. Financial planning with retirement and succession planning in mind can present opportunities to help both the retiring and the active generations.
- You see the 5 critical elements to succession planning. All assessments are important, and the successful planners will carefully consider each element as it related to the overall Succession. Remember to plan for both BUSINESS and PERSONAL needs, but know which is which so that you can use both to best advantage.
- - Start with your goals -Assess your farm structure and decide whether that works for you TODAY – then think about whether it will work for the NEXT GENERATION Analyze the risk to the FARM and the risk to the PLAN – what can go wrong? What can you do to minimize that risk? Prepare your succession planning documents – lack of the basic documents can ruin your plan and cost your heirs and the estate a bundle Don’t forget to include an assessment of your financial health. What will it take to preserve your lifestyle into retirement? How can the farm continue to the next generation?