Agricultural Estate Planning
The family farm is a treasured asset that owners generally love to see maintained and passed down through the generations. The significant assets that tend to accompany the family farm such as land and farm equipment require care and attention when developing an estate plan that fits your situation.
What’s wrong with simply giving the family farm to my kids?
Depending on the size and value of the farm and equipment, a family farm transferred by devise could be subject to significant estate, gift and/or generation-skipping transfer taxes. Generally speaking, the law permits an individual or married couple to transfer certain assets during their lifetime without incurring any transfer taxes on two scales: an annual ceiling and a lifetime ceiling. Under current federal gift tax law (as of 2014), an individual may give up to $14,000 of value to another person during a calendar year without activating the gift tax. For married couples, the tax exemption for gifts is up to $28,000. Under current estate tax law (as of 2014), an individual may transfer up to $5,340,000 total during life or after death without activating the transfer tax. For a married couple, the transfer ceiling is $10,680,000 to avoid estate taxes. The transfers made during the individual or married couple’s lifetime will reduce the total estate planning transfer threshold by the value of gifts made (unless gifts were in the $14,000 limit).
In addition, if the owner wanted to transfer assets to grandchildren, the transfer could be subject to generation-skipping transfer taxes. Under current federal law, an owner might activate the generation-skipping tax if assets are devised to an individual two or more
generations away from the owner or to a non-relative if the difference in age between said non-relative and the owner is at least 37.5 years. Fortunately, in 2014, an individual has a lifetime exception of $5,340,000 of assets that could be transferred to a “skip-person” without triggering the tax.
Once the threshold of the estate tax limit and the generation-skipping tax limit has been exceeded, the assets in the estate will be subject to a tax rate of 40%. This is an increase from 35% by passage of the American Taxpayer Relief Act in January 2013 and Congress may raise or lower the threshold from year to year.
If the value of my assets are higher than the tax thresholds, is there anything I can do to avoid these taxes?
Careful estate planning that takes advantages of the exemptions provided by law in addition to tools such as a dynasty trust could help minimize or eliminate the impact of these taxes on your estate.
A farmer that is functioning as a sole proprietor may also benefit from changing the farm enterprise to a different business structure for the purposes of estate planning and taxation. Each business structure has its benefits and drawbacks:
1. Sole Proprietorship:
a. Pros
i. Owner has complete control over business.
ii. Business does not get taxed separately (profits and losses recorded on owner’s individual tax returns).
iii. No formal registration or business record keeping required.
b. Cons
i. No limited liability (owner’s personal assets are at risk if the business is sued)
ii. May be difficult to distinguish personal assets from business assets for the purposes of estate planning and taxation
2. Partnership
a. Pros
i. Business does not get taxed separately (profits and losses recorded on owner’s individual tax returns).
ii. No formal registration or business record keeping required (although partnership does file Form 1065 with IRS every year.
iii. Responsibility of partners can be outlined in partnership agreement
b. Cons
i. No limited liability (partner’s personal assets are at risk if the business is sued)
ii. Joint and several liability (each partner liable for every partner’s obligation so everyone can get sued for one partner’s acts)
iii. May be difficult to distinguish partner’s personal assets from business assets for the purposes of estate planning and taxation
3. Corporation
a. Pros
i. Limited liability (owner generally stands to lose only what he or she invested in the corporation)
ii. Corporation is distinct legal entity that owns business property for purposes of estate planning and taxation
iii. Corporation governed by established by-laws and can have a succession plan separate from each owner’s personal assets
b. Cons
i. Double taxation (corporation’s profits get taxed at company level, and then each owner’s share is taxed again as personal income). This may vary depending if your business can qualify as a “C” corporation or a “S” corporation under Michigan law.
ii. Formal registration and fees necessary, in addition to director meetings, shareholder meetings, issuance of stock and other obligations required by law.
4. Limited Liability Company, or “LLC”
a. Pros
i. Limited liability (owner generally stands to lose only what he or she invested in the corporation)
ii. Limited liability company is distinct legal entity that owns business property for purposes of estate planning and taxation
iii. Limited liability company governed by an operating agreement and can have a succession plan separate from each owner’s personal assets
iv. Business does not get taxed separately (profits and losses recorded on owner’s individual tax returns)
b. Cons
i. Formal registration and annual fees necessary
ii. Fringe benefits to owners such as health insurance premiums may be difficult to distinguish as a business expense rather than taxable income of an individual owner
An attorney can help you decide what business structure can best serve your business needs and your estate planning needs.
