Estate Planning: More Than Just Tax planning

By Heather Gessner

Since 2006 SDSU Extension has hosted estate planning and farm transitions educational programs. In that time there have been changes made to the estate tax laws, commonly referred to as Death Taxes in the media.

The latest changes, made in the American Taxpayer Relief Act of 2012 (ATRA), relieved some of the death tax anxiety and provided a more stable guideline for the ag community as it sets up the Federal Estate Tax Exclusion at $5 million plus inflation. This means the personal exclusion in 2015 is now $5.43 million.  For around two thirds of South Dakota’s producers this limit excludes them from a Federal Tax Payment (2012 Ag Census, USDA). To create a rough outline of an operation’s potential Federal Estate Tax bill combine your farm/ranch balance sheet and your personal assets.

This sample farm exceeds the Federal Estate Tax Threshold and thus the family would owe a 40% federal estate tax on the $971,000 that exceeds the $5.43 million cap. When you make your own list make sure to include the value of the homestead, winter or summer homes you own, the value of any collections (tractors, guns, paintings, etc.) as well as all assets to be included in your final valuation. If you or your spouse stand to inherit significant assets consider the possible impact of this on your estate plan as well.

For those under the $5.43 million exemption this does not mean you do not need to create an estate plan. The size of your estate is not the only relevant planning factor. Each estate also needs to create a map of asset distribution to ensure your goals for your family and the farming operation are accomplished.  Depending on these goals, there are other factors that may prevent you from passing the assets on in the manner you expected.

Protecting Your Assets

A common concern voiced by farmers and ranchers is “I don’t want the nursing home to get it all.” If this is your goal, a plan needs to be implemented to protect your assets from a necessary sale or asset lien. The situation can be summarized as follows: in order for you to qualify for Medicaid to cover long term care costs, the family must first spend down the value of your assets (in the example $6.3 million). The nursing home does not take your land or assets, but it expects to be paid and your family has the obligation to pay for the care provided. Payment can be made by using cash reserves, sale of assets, loans from a bank, or other resources, all which could leave the other healthy spouse in a tough financial predicament.  Another payment source would be long term care insurance. Each family needs to consider if they can qualify for long term care insurance offer, and if the benefits of this insurance outweigh the expense of buying this product. Also determine how the family’s other revenue streams would work in combination with the potential insurance monies in order to accomplish the goals of the family.

Federal Estate Taxes are the main driver for many farms and ranches to put a plan together. However, other components such as capital gains tax and loan to equity ratios need to be considered when creating an estate plan that can keep the family farm together. Common estate planning tools such as limited liability corporations or trusts may also be useful for families to consider, if they have goals that include keeping the land for a returning family member. In addition to potential liability protection, these entities often enable ease of asset transfer and lay ground work for protection against disability, disagreement, dissolution, death and divorce. Creating the rules to the game before life’s realities impact the family business is a key driver in the success or failure of any business plan.

Creating Your Estate Plan

The average age of South Dakota farmers and ranchers has been increasing in recent decades and reached 55.9 years of age in 2012 (2012 USDA Census of Age). Of the 31,989 farms in the state 37 percent are operated by a farmer/rancher 65 years of age or older. Transitioning these acres to new owners will be occurring in the next 10 years, either through a well-designed plan for transition or via the death of the current owners and an abrupt change in ownership. No plan is perfect but having a plan is certainly the better avenue.

Getting started may be the hardest part for families. There is a lot of information about wills, trusts, insurance, gifting, and other tools available on the internet, in every agriculture magazine and newspaper and through Extension. So where do you start? At the end.

At The End

At the end: If you could tell your attorney what you want your family and farm/ranch to look like after you die, what would you say? This outlook defines the goals you have and enables your team of professionals to create the plan that is as unique as your family’s circumstances.

If a sample farm describes their “At the end” as:

• Keeping the on farm kid, Bill, farming in a very similar manner, as before my death,
• Ensuring my wife has income to do all the things she wants to do and,
• Providing an inheritance for my off farm children Jeff and Alice, and
• Providing for the education of my grandchildren,

Knowing what the end is supposed to look like helps your team of estate and transition professionals know what tools could be used to accomplish your wishes.

Here are some points to kick start the process in this example. Bill is on the farm, so a transition plan needs to be discussed. Questions for the family include:

• Is Bill ready/willing to take over the operation?  When will management decisions transition?
• Does Bill have enough equity to qualify for a line of credit that cash flows the operation?
• Has the business side, as well as the labor side of the business been taught and transferred?
• Once you retire what will be your source of income and will it outlive both you and your spouse?
• How do you balance Bill’s need to control assets with the goal of not having to pay capital gains taxes on land the family already owns?

This transition of management and potentially the lifetime ownership transfer of some assets should also be communicated to the off farm kids, Jeff and Alice. This helps ensure the off farm kids understand the goal of passing on the land to the family. It also ensures they realize Bill’s sweat equity or the value of the everyday assistance he provides for you to grow the business and allow for your retirement.
Estate Protection & Asset Transfer

Both the goal of protecting the estate as well as the goal of a smooth asset transfer can work in tandem. With a goal of keeping the land and assets as a unit for continued operation by Bill, oftentimes the family will have the attorney create a trust and/or create a limited liability company (LLC) to own the land. In order to protect the assets the family frequently utilizes life insurance to provide a cash inheritance to the off farm kids, and utilizes long term care insurance to protect the assets needed for the farming child.

Families that either do not qualify for or purchase insurance and end up saving for years to build a large sum of cash in a sinking fund. This fund will be used to pay for long term care expenses and to partially offset the value of the business assets kept together for the farming child. Creating a sinking fund is hard for most agriculture operations as most producers are conditioned to put cash back into the operation versus putting it into investment tools.