There are a lot of moving parts to consider when it’s time to transition the family farm. These include business and personal financial planning, management succession, the transition itself, and estate planning.
While successfully transitioning a family farm isn’t solely driven by good estate planning, it’s a key piece of the puzzle.
What’s estate planning?
At its most basic level, estate planning focuses on who will inherit property and when. Beyond that, an estate plan may include the following specifics:
- Guardianship of minor children
- End-of-life health care decisions
- Care of family members with special needs
- Proper titling of assets
- Protection and control of assets
- Privacy of family affairs
- Life insurance
- Estate-tax considerations
Do I need an estate plan?
Yes, everyone needs an estate plan. Estate plans aren’t necessarily complex or expensive, and they definitely aren’t only for the very wealthy or large family farms. It’s also worth noting that state tax considerations are just as important as federal taxes when making your estate plan.
Even if there’s already an estate plan in place for the farm, the 2020 economic environment might necessitate some adjustments. Read our article for insight on how to get started.
How do transfer taxes work?
Most gratuitous transfers—also known as gifts—are subject to a transfer tax unless the transfer falls under an exemption. Gift tax applies to transfers during life while estate tax applies to transfers that occur upon death.
- Unified credit. Also known as a lifetime exemption, this exemption allows an individual to transfer up to $11.58 million without incurring estate or gift tax. This amount equals $23.16 million for a married couple. The exemption is inflation adjusted and, under current law, will revert to half the current amount—approximately $6.8 million inflation adjusted—effective January 1, 2026.
- Annual exclusion. Gifts of $15,000 per donee can be made each year free of tax and without using any of the $11.58 million exemption. This amount is inflation adjusted and increases in $1,000 increments every few years. For a married couple, this is effectively a $30,000 exemption.
- Charitable and spousal transfers. Charitable and spousal transfers are generally exempt.
When is the right time to transfer ownership?
There’s no one right answer to when it’s the right time to transfer ownership—and often, the answer won’t have much to do with estate tax planning. There are, however, a few estate and income tax items that can help you answer this question.
One of the main reasons to consider transferring now instead of later is that the value of the estate is likely growing. This can cause problems if transferring is completed at death. Making transfers during life locks in the value of the transfer, which allows for use of the lifetime exemption at today's value while allowing future growth to accrue outside of the taxable estate.
If a farm is held until death, its tax basis will be adjusted to the fair-market value at the time of death. This could provide large income tax savings if the farm is eventually sold and more immediately for the following reasons:
- Income tax depreciation of the new adjusted basis of depreciable property
- Income tax deductions for certain cash-basis items
For example, if a cash-basis farmer dies while owning harvested crop with zero tax basis, the basis of the crop is immediately adjusted to its then-market value. It will likely result in zero taxable income when sold. This means the farmer will have deducted all the costs incurred in growing the crop and the heirs will pay no tax on selling it.
Farm property that has a fair value greater than its value for use as farm property can potentially be reduced for estate tax purposes by up to $1.18 million for 2020. This amount is inflation adjusted each year.
Some states offer exemptions and deductions for farm property. In Washington, for example, an estate composed of more than 50% of qualifying farm property is exempt from state estate tax on that property.
State Estate Taxes
Some states have an estate or inheritance tax that applies to transfers at death but not to transfers during life. For example, Washington doesn’t have gift tax and, unlike federal estate taxes, gifts made during life aren’t included in the taxable estate.
For many owners, the family dynamics and operational concerns of a farm carry more weight than estate- and income-tax saving opportunities. When everyone agrees on when and how to transfer ownership, however, these savings have the potential to keep more cash in the family and the farm—helping support the continued success of the business.
What if I’m ready to start estate planning but not ready to give up the farm?
Many farmers feel this way. The good news is that a lot of planning can be done—including transferring significant ownership of the farm—without giving up control.
If a farm isn’t already structured with control in mind, it can be restructured to provide for voting and nonvoting ownership. An owner who isn’t yet ready to give up the farm can then maintain voting ownership during the planning process. Once they’re ready to let go of control, they can transfer the voting ownership.
Most of my assets are tied up in the farm. What if my estate owes tax and there’s no money?
The tax benefits mentioned earlier in this article may help reduce the estate tax burden, but there could still be a significant liability.
Tax law provides limited deferral of the estate tax liability for qualifying estates, which may allow the estate to pay over a 15-year period after death. Life insurance may be a better solution, however, which is why it's important to quantify the problem and plan for it.
Most of my assets are tied up in the farm, but not all of my heirs can or should inherit the farm. How do I treat them fairly?
An oft-repeated mantra of estate planners is that fair doesn’t necessarily mean equal. Inheriting a farm carries a lot more risk than a large sum of cash, which is an example of why it usually doesn't make sense to attempt to provide exactly equal value to all heirs when the asset make-up is different.
Life insurance and buy-sell agreements can be a key tool for addressing this problem. It’s also possible that one heir may need to buy out the others. The key to addressing this question is understanding the make-up of the estate, family members’ goals, and the tax burden, and then working with advisors to craft a plan that’s fair.
Who should I work with for estate planning?
It’s important to have a good team. Key members include the following:
- Estate-planning attorney
- Financial advisor
- Life-insurance advisor
Depending on the size and complexity of an estate, additional advisors may be necessary.
We’re Here to Help
For more information about how to begin estate planning for your farm, contact your Moss Adams professional.