Although the new tax law did not impact the estate tax laws, the changes are extremely beneficial to farm couples with larger estates. However, to take full advantage of them, you need to act soon—ultimately your delay can cost your heirs millions. Here are three reasons to plan now.
1. Estates with $35 million should owe no estate tax. The new tax law made one change to estate taxes—but it was a major one. Beginning in 2018 through 2025, the lifetime exemption for gifts and estates has been doubled. It will be almost $11.5 million starting in 2019 for each person.
This means any farm couple can be worth almost $23 million and owe no gift or estate tax (excluding state estate taxes). With some simple estate planning, your estate can easily be worth closer to $35 million or $40 million and still owe no estate tax.
For example, by placing your farmland (likely your largest valued asset) into a limited liability company, we can take close to a 35% discount on the value of that farmland. A couple with $30 million of land will reduce the value of their estate by about $10 million by placing it into an LLC versus owning it outright.
This can be a smart tool for farm couples, however, the clock is ticking. The lifetime exemption is expected to go back to the old level of around $5 million (indexed to inflation) beginning in 2026 (and it could happen sooner).
2. Basis can be more important than estate taxes. Since the lifetime estate exemption is so high now, you need to plan for certain assets to go through your estate. These assets include grain inventory, cost of growing crop, prepaid farm expenses, equipment and buildings. Farmland might be important to pass through the estate if the plan is to sell the land.
The main reason for wanting it to pass through the estate is the heirs will get a “step-up” in value to fair market value at death. During your life, a gift will keep the basis (likely zero), but at death, your heirs will either be able to sell the grain for no tax cost or start to depreciate the assets all over again.
However, make sure these assets are in the right entity. If a farm couple has these assets in either a C or S corporation, there is no step-up, but rather, the stock will get an increase to fair market value. If the assets are held individually or in an entity taxed as a partnership, a full-step will be allowed based on the ownership held.
If stock is held, the only value is when it is sold. If this creates a capital loss, it can only offset other capital gains or $3,000 of other income each year. Creating a $2 million capital loss is not wise.
The primary reason any S corporation is created for farmers is to reduce self-employment tax. However, a LLC should get the same tax savings and will allow for full step-up. The savings of a few thousand dollars per year in self-employment tax yet losing possibly millions of tax savings can be very short-sighted.
3. Annual gifting is a powerful tool. The annual gift tax was bumped to $15,000 in 2018. It is sometimes misunderstood, as many believe this restricts them to giving away only $15,000 per year. The reality is you can give up to $15,000 per year to as many people as you want. If you keep it under this amount, no gift tax return is required, no gift tax is owed and it will not reduce your lifetime exemption amount.
For example, a farm couple with three married kids and 10 grandchildren have 16 annual gift tax exemption amounts, which is $240,000 (16 x $15,000). However, if you are giving away interests in an LLC owning land, this allowed value is likely closer to $350,000 to $400,000. If you follow this plan for a decade, $5 million of value can be easily transferred and permanently escape estate tax at your level.
Certain assets are better to give away. If the land will not be sold, this is a good asset. Giving away assets with low value that get a step-up in basis should be the last to be gifted. We want these assets to go through the estate if possible.
Have all of your succession planning questions answered by Paul Neiffer, Polly Dobbs, Dick Wittman and Rena Striegel at the 2019 Legacy Project Conference, Jan. 14-15 in Chicago. Register now at TPSummit.com
Paul Neiffer is a tax principal with CliftonLarsonAllen and author of the blog, The Farm CPA. He recently purchased a 185-acre farm. Driving his cousin’s combine is his idea of a vacation.