Down on the Family Farm: How to Avoid Five Common Estate Planning MistakesPolly Dobbs Attorney
January 30, 2013 — 1,782 views
Down on the Family Farm: How to Avoid Five Common Estate Planning Mistakes
January 24, 2013
By Polly J. Dobbs, Attorney, Bingham Greenebaum Doll LLP
I’m a farm girl and an estate planning attorney. So naturally, I’m passionate about helping farm families efficiently transfer ownership of their land, buildings and equipment to the next generation.
Too often I sit down with farming clients who misunderstand the estate planning process. Their misunderstanding is usually the result of overhearing inaccurate information. Perhaps they’ve heard a couple neighbors discussing death taxes and loopholes at the grain elevator and pick up some more chatter at the local diner. This secondhand advice, while perhaps well-meaning, will inevitably become their estate planning downfall.
Here, we explore five common examples of estate-planning-gone-wrong for farmers.
- “I’m going to give away the remainder interest, but hold on to the life estate to retain control and income stream.”
The only goal this plan accomplishes is avoiding probate administration. Retained interests such as this cause 100 percent of the value to be taxable upon the death of the life estate holder under both the Federal Estate Tax and the Indiana Inheritance Tax. This is not a good plan for someone trying to minimize death taxes.
- “I plan to title my property jointly with my children and their spouses so that it automatically passes to them at death.”
Yes, this avoids probate; however, it also puts the farm squarely within the marital estate of your child's potential future divorce. Leaving your child outright ownership could make the family farm susceptible to claims by the child’s creditors and subject to division by a divorce court in the event of that child’s failed marriage. Consider leaving your child's inheritance in a trust or creating an LLC to achieve goals of keeping the farm within the family.
- “I’m doing nothing because I’m worth less than $5 million,” or the similar reasoning: “Because the wife and I are worth less than $10 million.”
Most farmers are land rich and cash poor with little to no estate planning in place. This situation is a ticking time bomb that will explode into a liquidity problem after death when it’s time to pay Indiana Inheritance and potential Federal Estate Taxes. Many farmers keep a “dirt savings account” and do not have any other savings or investment accounts. As the value per acre of our Indiana tillable land continues to increase, the bottom line on the farmers’ balance sheets skyrockets, and most aren’t aware of the tax problems lurking at their death.
Farmers are generally familiar with the Federal Estate Tax; there are numerous articles addressing this topic in farm journals. However, most are unaware of the potential hit the Indiana Inheritance Tax will give to their children. Our current federal laws allow each decedent to pass $5.25 million of assets free from Estate Tax; a married couple can pass $10.5 million. However, our Indiana Inheritance Tax allows only a $250,000 exemption per lineal descendant (with tax rates between 1 percent and 10 percent). A sibling, niece or nephew only gets a $500 exemption (with a tax rate between 7 percent and 15 percent). You may have heard that the Indiana Inheritance Tax has been repealed, but it’s a slow phase-out, disappearing 10 percent each year until its total repeal in 2022. So unless a farmer can guarantee not to die until 2022, he needs to consider the Indiana Inheritance Tax.
Let’s consider an 800 acre farm at $6,500/acre, which would be worth $5.2 million. This would trigger no Federal Estate Tax, but assuming that the farmer dies in 2013 leaving the property equally to his three children, there would be a $233,201 Indiana Inheritance Tax bill due after death. If this farmer had all his savings in the dirt and no liquidity available to write this check to the Indiana Department of Revenue after death, this will inevitably cause problems for his children. Also consider that $6,500/acre is probably a low estimate of fair market value depending on the location of the farm and its soil quality. Many farmers have a false sense of security and think they don’t have a tax issue because their farm is worth less than $5.25 million. However, if his neighbors are selling farm ground for over $14,000 per acre, that farmer may be worth several million dollars more than he thinks, and his heirs will owe significant taxes at his death. It’s crucial to take a look at a farmer’s accurate balance sheet given today’s value of farm land when discussing taxes.
4. “I want to treat all my kids exactly the same.”
Many times, estate planning isn’t about tax planning – it’s about family dynamics. A farmer is lucky if there is one child who wants to return home (or stay home), but it’s more likely that a farmer has at least three children. Treating the children fairly does not necessarily mean treating them equally.
A typical will would leave all assets equally to the children which, without planning, would yield “tenants in common” ownership. A series of complex questions might arise from this situation, though. Does the child who actively farms have to pay cash rent to the non-farming siblings? Would the majority of the non-farming siblings out-vote or second guess each decision made and question the yields acquired by the on-farm sibling? The one farming child may also wish to buy out the other siblings’ share of the farm, but that could easily become a huge burden on the farming child. In no time, these scenarios would lead to a family feud.
If one child is going to be managing the family farm, there are methods of planning that allow that child to have control and be provided with a reasonable salary for services rendered. After paying the child a manager’s salary, net profits can be divided equally among all children. A farmer’s estate plan should be drafted so that non-farm children cannot second guess the on-farm child’s daily decisions. Large decisions can require supermajority or even unanimous agreement, but daily decisions can be left to the one who’s in the tractor cab.
5. “I’m just going to copy what my neighbor did.”
There is no cookie cutter approach to estate planning, especially not for farmers. For some farmers, it might make sense to do some gifting during their lifetime in order to reduce the size of the taxable estate at death. This is an especially attractive option given the current Federal Estate Tax laws that provide each individual with a $5.25 million unified exemption, which can be used during lifetime or at death.
For other farmers, lifetime gifting might not be advisable. If the next generation will likely sell the farm, then their “basis” in the property becomes very important. Careful analysis is necessary to determine whether the Estate and/or Inheritance tax saved by lifetime gifting is greater than the capital gains tax triggered by an after-death sale. It’s best if the estate planning attorney, accountant and financial planner are all involved in such analysis.
It may also make sense to transfer the farm ground to a business entity first, such as an LLC, so that certain transfer restrictions can be put in place to accomplish the farmer’s goals. Some goals may include restricting property ownership to blood descendants; preventing or restricting future development of tillable acreage or historic green spaces; and providing protections in the event of a child’s divorce.
Estate planning is important for all families and business owners, but it is crucial for farmers. If you have questions about the role estate planning plays in your family farm, please contact a member of the Wealth Transfer group at Bingham Greenebaum Doll LLP.
Polly Dobbs Attorney
Bingham Greenebaum Doll LLP
Polly is a member of Bingham Greenebaum Doll LLP's Estate Planning Practice Group and concentrates her practice in the area of estate planning and wealth transfer.