Build a Structurally Sound Estate Tax Plan

Paul_Neiffer

PAUL NEIFFER

As an agribusiness CPA and business adviser for CliftonLarsonAllen, Paul specializes in income taxation and accounting for the farm community.
paul.neiffer@claconnect.com

By Paul Neiffer

Just like a house, a succession plan requires a sturdy foundation to remain structurally sound for multiple generations. To succeed, your plan requires a floor, walls and roof built on the foundation.

The foundation: The proper entity structure for your land holdings is the groundwork for your plan. Without this structure, a farmer who dies owning farm real estate might owe estate taxes on the full fair market value of the land.

By placing the land into a proper entity, an estate might discount the value of farm real estate by at least 35%. An entity that owns farmland also allows for easy transfer of the land to heirs (either during life or at death). 

For example, farmer Sue owns land worth $10 million. If she passed away today, she would owe nearly $2 million in estate taxes. By placing the land into an LLC and gifting units to her children she reduces the estate value to about $6.5 million, which lowers estate taxes to less than $500,000. By placing the land in an entity, Sue might qualify for valuation discounts, reducing estate taxes by 75%. Also, she retains control of the entity to ensure her own retirement income.

The floor: An entity that owns farm equipment and inventories might qualify for a discounted transfer of the operation. The farmer is still allowed to discount the farm operation when transferring assets, and the entity can have voting and non-voting units or shares to vest control of the operation. 

The walls: Several types of walls are available in farm succession planning. Here are a few options:

  • Trusts: If your goal is to retain the farm in the family for multiple generations, a trust is a good option. A trust lets you freeze the estate value at the time of the first spouse’s death and not have any of the remaining growth get taxed in the second spouse’s estate. 

For example, if farmer John passes away with an estate valued at $10 million, $5.34 million is placed in a trust for the benefit of his spouse for her lifetime. The remaining $4.66 million is given outright. Over time, the trust increases in value by $5 million more than the rate of inflation. This $5 million increase is exempt from estate taxes when the spouse passes away.

  • Installment sales: To provide retirement income for the current owner, installment sales are a powerful tool. The sale price is often at a reduced level—creating a part gift and part capital gains situation. An alternative is an installment sale that allows the farmer to have the gain taxed at lower capital gains rates; the buyer gets a full step up in depreciable basis of the assets purchased, and it freezes the value of the estate at the sale price. 

As in our example, if John sold his land for $7.5 million in an installment sale, he would have a gift of $2.5 million (no gift tax would be owed, but his lifetime gift and estate exemption would be reduced accordingly), and it would freeze his estate at $7.5 million. The extra $5 million of appreciation would completely miss his estate.

  • Annual gifts: Making annual gifts, especially of the land entity, is often overlooked. Via annual exclusion gifts, it is fairly easy to gift at least $400,000 of value each year with no gift tax consequence and still retain all of the lifetime exemption amount ($5.34 million for 2014). 

The roof: Most farmers have some type of insurance coverage, but our roof requires the proper type of insurance and often a trust to own the insurance. Many farmers underestimate estate tax consequences because they fail to consider the death value of life insurance. With planning, we can get this value out of the estate and provide liquidity at the time of death. 

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