Estate Planning and Administration

Family Farms: Legacy Planning

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Introduction

Family farms are essential to American agriculture. Most farms in the United States – nearly 90 percent – are family farms. They are owned and operated by individuals or families. Some family farms have passed through several generations, each expanding holdings and continuing a meaningful and important tradition in agriculture. Illinois boasts more than 9,200 Centennial Farms and Missouri nearly 3,000.

The family farm faces special challenges. As family farms pass from generation to generation, family members often develop divergent interests. Some children are drawn to other occupations and leave the farm community, believing that few opportunities exist in agriculture. The size of some operations simply is not large enough to support additional family groups and land may not be available to expand. By contrast, farming is now big business and requires expertise beyond knowing the basics of crop production. The ever increasing costs of land, supplies, and equipment often make it difficult for families to enter or continue, much less expand, farming operations. Those children who wish to continue farming lack the resources to acquire the interests of siblings who do not wish to remain in agriculture. Estate taxes, too, may place a further burden on maintaining the family farm. Dissension among the family follows, leaving some to opt for ending a farming tradition.

This information is intended to promote discussion and planning about how you – the farm owner or operator – might deal with your family farm. What will be your agriculture legacy? Importantly, what works for some families may not work for others. There are no fixed rules. What is important is that farm families review their own circumstances and decide how best their goals might be achieved.


Back From the Future

When thinking about estate planning, you should begin by moving your thoughts to a time years ahead ... a time when you are no longer here. Take a look back from the future. How would you like to see things? And, as things now stand, what do you see? What is to happen based on the planning you’ve done?

Some questions you might ask yourself:

  • What would be the ideal disposition of my estate, including any family farms?
  • Why do I want to continue the family farm?
  • What would I like to have happen with my farm assets – land, machinery, livestock, etc.?
  • Are there those in the next generation or beyond who are really interested in continuing farming?
  • Am I really doing my children a favor by encouraging them to continue farming?
  • Are my children really capable of continuing the family farm?
  • Would it make sense for those who wish to farm to downsize their operation?
  • How concerned am I about treating all of my children equally from a financial perspective?
  • Am I willing to reduce the amount of or delay the distribution of my estate to non farming children to allow another child or other children to continue the family farm so long as they continue as operators?
  • Would the children who farm be expected to buy out the non farming children? Are they really able to do so?
  • Would it make sense to simply give each child a separate farming interest or land? Would other children allow the farm to continue to be operated together? Should they be required to do so?
  • Is it possible or would it make sense to separate the farm operation itself from the ownership of land?
  • How will the non farming children be provided for? Should they be and to what extent? What assets do I have to make that possible?
  • How well do my children really get along? Could they work together in a farm operation?
  • Are there other circumstances that affect what should be done (e.g., disability, in laws, possible divorces, etc.)?
  • Who, among my children, would be best able to hold the family farm operation together?
  • What other issues do I believe are important to address?

The best way to achieve your estate plan is to have a clear understanding of what you would like to see. Start by taking a look back from the future.


Some Estate Planning Questions

Once you have a perspective of what you'd like to see looking back, you should consider to what extent your estate plan achieves these goals. You should also consider how you might achieve these goals if they are not being met by your current estate plan. Are they possible and what do you need to do to get them accomplished?

Some questions you should consider:

  • Does my will or trust reflect what I want to have happen with my estate, including farm assets?
  • What succession planning has been incorporated in my estate plan?
  • How appropriate and realistic is my succession planning?
  • Have I made specific provisions for the disposition of family farm property?
  • How have I addressed equalizing my estate for non farming children, assuming I want to do so?
  • Should I consider the purchase of insurance to provide for the equalization of my estate, paying estate taxes, satisfying debts, or other purposes?
  • Do I have special provisions included in my estate plan to allow the child or children who farm to continue to do so?
  • Should I provide special purchase rights to the child or children engaged in farming, such as an option to purchase, time to purchase, a discounted purchase price, the right to select among real estate interests, etc.? Do I provide special farming protection, such as the right to farm while the child or children continue to materially participate in the farming operation? What about further generations?
  • Are my children who will continue the farm operation preparing for that through the purchase of their own land or equipment? Have they considered insurance on you?
  • In order to place my children in a better position to continue the farm operation, have I considered gifts, sales, or other means to implement succession planning now? Or would implementation of my plan be advisable now for other reasons, such as anticipated increases in land values?
  • If children will be treated differently, am I really comfortable with what I have in place?
  • Have I considered and anticipated family dissension? Or the death of children, including those engaged in farming? How are these sorts of issues being addressed?
  • Do I have a corporation, limited liability company, trust, family limited partnership, or other arrangement to provide control and continuity or to achieve other purposes?
  • Do I know and have I realistically considered the impact of federal and state estate taxes? Have I made provisions for taxes? And what about income tax issues?
  • Do my children understand my plans and accept them (even if they don't agree with them)? Should I disinherit any child who seeks to contest my estate plan?
  • Should a third party be involved to provide an independent source of control, management, or perspective?

These questions are not exhaustive. However, they touch on the pragmatic issues that must be dealt with in any estate plan where a family farm operation will be successfully continued.


Estate Tax Considerations

Generally

Estate taxes are a critical consideration for many family farmers. Where the estate tax applies, the effective tax rate is substantial. Few can afford not to plan as much as possible to avoid estate taxes. Estate taxes have brought to a close many family farming traditions.

Some basics of the estate tax are:

  • Anything given by one spouse to another is not taxed. Therefore, as between spouses, estate taxes are not a consideration.
  • Each individual has an estate tax untaxed amount. For the year 2016, the federal untaxed amount is $5.45 Million. This amount from tax is inflation adjusted. When the federal estate tax applies (over the untaxed amount), the tax rate is 40%.
  • Some states also have an estate tax; Illinois is an example. The Illinois untaxed amount is limited to $4 Million and is not inflation adjusted. Also, Illinois does not allow portability. This means that to take advantage of the untaxed amount, planning is required to take advantage of both exemptions. This is usually done by establishing a trust.
  • The Illinois tax is not insignificant. For a $5.45 Million estate, the federal tax would be zero but the Illinois tax would be nearly $400,000 or over 27% of taxable amount over $4 Million. If there is a federal tax, the state tax is deductible which results in effectively lowering the state tax.
  • Some states, such as Missouri, do not have an estate tax. Even where one lives in a state without an estate tax, land or property having a “situs” or tax location in a state with an estate tax will be subject to the state's state estate tax. Those who reside in or who relocate to a state without an estate tax may wish to consider changing the tax situs of land through a corporation or limited liability company which, ordinarily, is taxed for estate tax purposes in the state of residence.
  • Where spouses properly plan their estates, they are able to avoid estate taxes for twice the estate tax untaxed amount. This has become simplified somewhat for federal estate tax purposes because federal law allows portability. The unused estate tax untaxed amount of the first spouse to die may be used by the survivor. If, for example, spouses leave their entire estates to each other, the survivor’s estate tax untaxed amount would be double (or, currently, $10.90 Million). States, such as Illinois, do not allow portability and, so, planning is necessary – usually through a trust – to address this difference.
  • • There is also a gift tax. The gift tax law permits a person to make annual gifts of $14,000 (for 2016) to any number of people one wishes. Together, a couple may give $28,000 annually. Annual gifts are frequently used to reduce one's estate and, thereby, estate taxes. Where gifts exceed this amount, the estate tax untaxed amount is reduced. In other words, the $5.45 Million untaxed amount is reduced by the amount of any gifts to an individual over the annual gift amount. If lifetime gifts exceed the untaxed amount, gift taxes are then payable at the same rate as the estate tax.

Farm Tax Planning Provisions

Public policy in the United States favors preservation of family farms. Three special provisions are included in the Internal Revenue Code to help accomplish this goal. Notably, they are limited and one no longer applies.


Special Use Valuation: Section 2032A

Special use valuation of farmland is permitted under Section 2032A of the Internal Revenue Code. Where real estate is used for farming purposes, the real estate may be valued in accordance with a formula based on rental value rather than fair market value. Estates may be reduced by no more that $1 Million, adjusted for inflation ($1,110,000 for 2016). Where farm land is a major asset, one’s estate protected from estate tax may thus be increased by this amount based on fair market value. Portability also does not apply to Section 2032A and, so, planning is necessary if it would benefit both spouses.

The formula usually applied under Section 2032A is this: The average annual gross cash rental (after payment of general real estate taxes) for comparable land for the five most recent calendar years is divided by the average annual effective interest rate for all new Farm Credit Bank Loans in the district where the property was located for the year of death. For example, if the cash rent after real estate taxes would be $325 per acre and the interest rate five percent, the real estate would be valued at $6,500.00 rather than its fair market value – presumably a greater value.

There are a number of detailed rules that must be met to use Section 2032A. At least 50 percent of the decedent's gross estate must be farm real and personal property, and at least 25 percent must be farm real estate. The real estate must have been owned for at least five of the previous eight years and during this time a family member must have materially participated in the farming of the real estate. Special rules apply once an operator is on Social Security. The real estate must pass to family and be farmed by a family member. If the real estate is not farmed by a family member for ten years, the estate taxes must then be paid.

It is important for farm owners to recognize that Section 2032A special use valuation is not automatic or a given. Planning is required to make certain that the requirements of the section are met and maintained.


Extension of Time to Pay Tax: Section 6166

Where estate taxes are due and closely held business interests, such as farms, are involved, the Internal Revenue Code may permit an extension of time to pay estate taxes. Section 6166 allows estate taxes attributable to the business interests to be paid in ten equal annual installments commencing the fifth year after the due date on which the estate tax return is due.

Interest is charged on the deferred tax at a rate as low as 2% for a portion of the tax due. There is a cap on the amount of tax on which this rate applies – for 2015 $588,000. Further, deferral only applies to the tax attributable to the closely-held business.

An estate qualifying for Section 2032A would ordinarily qualify under Section 6166. However, the requirements are not as strict – a 35% rather than 50% requirement – and the extension of time to pay may be available even for some estates that are not eligible under those sections.


Family-Owned Business Interest Exclusion Repealed

Occasionally references are made to Section 2057 of the Internal Revenue Code. This increased the untaxed amount to $675,000 where family-owned business interests were held at a time when the untaxed amount – now in excess of $5 Million – was less than this much lower amount. It ceased to apply beginning in 2014.


Generation Skipping

Where farm operations are likely to remain in a family for several generations, generation skipping may be appropriate tax planning. This does not save taxes when you die, but may save taxes when your children or even future generations pass away.

Generation skipping is accomplished by letting future generations use farm real estate or other assets for their lifetimes only – essentially an income interest. The property then passes on to the next generation. This may be continued for several generations. Where real estate would not be sold anyway, the savings over generations may be significant. Of course, one really has no idea of what the estate tax structure will be generations from now or whether it will replace by some other tax.

Generation skipping has been a cornerstone of estate planning for America's wealthiest families. Because of this, the maximum that may be placed in generation skipping arrangements has been limited. Currently, though, the limit is favorable and equal to the estate tax untaxed amount which, again, is in excess of $5 Million. The savings over generations may be significant and, for some family, well worth considering. Legislative efforts are made to greatly reduce the generation skipping exemption.

Although there are circumstances where generation skipping might be considered, complications result. It is sometimes quite difficult to effectively plan for changes and challenges that are multiple generations hence. Some flexibility may be incorporated. However, for farm owners, generation skipping mostly is used to plan for grandchildren already identified as entering the farm operation. This planning also assumes real estate will not be liquidated by future generations.

It is important to note that portability doesn’t apply to generation skipping. Where there are spouses, planning is therefore required in advance of the first death. Each spouse must undertake his or her own generation skipping.


Planning

Estate taxes should be considered where they are likely to be incurred. Where they apply, the rate is high, even confiscatory. Clearly the untaxed amounts should be utilized. If estate taxes remain an issue, gifts, insurance, and other techniques to reduce, discount, or at least freeze the values of assets may be considered. Gifting also may include charities.

Planning will vary from family to family. Many farm families are, as often stated, “land-rich and cash-poor.” Where this is the case, farm couples often leave all assets to each other except for land and farm operating entities which are then used to fund tax planning. Even this common plan may be affected by considerations of land appreciation (and, yes, depreciation), income tax considerations, and estate tax untaxed amount portability or lack of portability. The key is to consider – individually – what is appropriate not only from a tax point of view but a farm family perspective.


Letting Go

Perhaps the most difficult thing for many farm owners to do is to let go. Your success didn’t just happen. It took time, effort, and commitment.

Letting go is difficult. Still, the best succession planning often involves doing just that. Letting the next generation begin to take advantage of farm opportunities, assume control of the farm operation, and begin to take your place is important for succession planning. Not only may this be good tax planning, but it also confirms a child's – and frequently a spouse’s – farming interest, commitment, responsibility, and ability. It also lets the child earn the sense of pride and independence that comes from gaining equity for the child's efforts – likely one you yourself had. Still, it is difficult for many to not purchase a key tract, acquire a farm in one’s name that was wanted for years, or be the decision maker. Nonetheless, letting go often is important to assure successful succession of a farm operation. As we live longer, the need to make this transition is all the more important because children are often faced with their own retirement and mortality when your plan is implemented.

Letting go does not necessarily mean you should ignore reality. There may be a need to protect a parcel's contribution to an operation. You may be essential to financing expansion and continued operation. In the long run, however, the future must be faced and this may involve encouraging a future generation's financial growth and success rather than one’s own. Succession planning doesn’t just happen!


The Schmiedeskamp Firm Assists Farm Families

As you consider the future of your family farm, seeking the advice of experienced estate planners is important. The Schmiedeskamp Robertson Neu & Mitchell LLP Estate Planning and Administration Group works with farm owners to achieve their operational and planning goals. Our Group provides estate planning and administration services from the simple to the complex, from the small farm to the agricultural enterprise. Services relate to wills, trusts, beneficiary arrangements, farm business entities and other estate planning techniques and approaches. We advise our clients regarding the effective and efficient transfer of wealth and succession planning. We work closely with your accountant, financial, insurance, and other advisors. For more information about the Estate Planning and Administration Group and all our lawyers, please visit www.srnm.com.


Closing

The purpose of this information is to promote thought and discussion. Estate planning should reflect your vision of the future. This requires that you take the time and effort to consider the many personal, practical, legal, and tax issues that will impact the future of your family farm operation.


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This is not intended to be legal advice, but rather, to provide accurate information regarding education law matters. For more information regarding education law matters, please contact any member of our estate planning and administration group: Dennis W. Gorman (dgorman@srnm.com), James A. Rapp (jrapp@srnm.com), Harold B. Oakley (hoakley@srnm.com), Michael A. Bickhaus (mbickhaus@srnm.com), Natalie L. Oswald (noswald@srnm.com) or Joseph B. Ott (jott@srnm.com). Our telephone number is (217) 223-3030. Please visit our website: www.srnm.com. We invite and welcome all questions and comments. © 2013 Schmiedeskamp Robertson Neu & Mitchell LLP Vol. 2015-1







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