With every harvest comes the age old question: Do I farm another year, or is it time to get out? It’s a question many of my clients wrestle with, especially in poor economic times. The topic tends to come up in the late fall and winter, so now is a good time to review the new federal estate tax laws and share a few thoughts on farm succession planning.
Starting in 2018, the federal exemptions for gift, estate and generation-skipping taxes approximately doubled what they were prior to tax reform. In 2018, the exemption amounts are $11.18 million, indexed for inflation. As before, the surviving spouse can elect to use the deceased spouse’s unearned exemption amount (“portability”). Although it isn’t new, the thing to keep in mind is that assets are still stepped up to fair market value at date of death. This includes equipment, buildings, prepaids, unharvested crops and harvested crops not yet sold.
Even though exemption amounts are large, succession planning is still important. It has both economic and non-economic benefits. It forces the older generation to take ownership of the process of determining if the farm will be passed down or sold. A little planning can also create huge financial and tax opportunities for the retiring farmer that could be lost in an unplanned transition.
It also allows the retiring farmer the opportunity to deal with the age old issue — fair but not equal.
The financial benefits of succession planning are clear. While most farm operations do not have a value in excess of $24 million, there are some. With proper planning and creativity, most estate taxes can be avoided. State laws pose a challenge here. Depending on what state you live in, farmers may be surprised that their state has an inheritance or estate tax. Currently, 18 states have these taxes. There are also two states that have a gift taxes on pre-death transfers. While the federal exemption is $11.18 million, a few states have estate taxes that affect farmers with assets as low as $1 million. Considering farm land value and the cost of equipment, that is a relatively low amount, but those state estate and inheritance taxes can often be reduced or eliminated with proper planning.
Another economic issue estate planning addresses is cash flow. One of the most important exercises I have my client do is to calculate family living expenses without the farm. Why is this important? Many times, the line between farm expense and non-farm expense is blurry. For example, if you no longer farm, you will still have to pay for electricity for the barn without being able to deduct it. So understanding how much you really spend is critical to figure out how much you need when you exit. I have my clients work backwards, determining their income needs in retirement and then figuring out how to get there. Sometimes that means they can’t retire yet.
Besides economic issues, estate planning addresses important family issues. I tell my clients, “The best last gift you can give your kids is for them to hate you.” What does this mean? While alive, parents have the ability to address the difficult issues rather than passing them down to their kids to resolve. As important as the family farm is to you, it is meaningless if there is no “family” left after you are gone.
Editor’s Note: Tax Columnist Rod Mauszycki is a CPA and tax partner with the accounting firm of CliftonLarsonAllen, in Minneapolis, Minnesota. Send questions to email@example.com