Often, the family farm is not just an asset but is also the livelihood for one or more members of the family and an integral part of the family business. In other cases, it may be a legacy property that is rented to other farmers. With this breadth of variation in the circumstance in mind, I would like to outline one potential path, again, by no means the right approach for all farm owners, but in hopes of identifying some key issues to consider in your own planning.
To begin with, one of the primary goals of estate planning is the effective and efficient transfer of assets from one generation to the next. Similarly, in business succession planning, the primary goal is often an effective and efficient transfer of management responsibility while ensuring the financial security of the owner(s). In both areas, the goal of minimizing transfer taxes is often a close second. Certain assets present unique challenges, and also opportunities, for leveraging transfer tax exemptions for the benefit of future generations. The family farm is one such asset.
Let’s illustrate with an example: a couple owns a family farm, and at an age where they would like to retire, maybe to relax lakeside with their grandchildren while some their children carry on and grow the family farming business. This couple may own and/or rent substantial acreage; let’s say they own 1000 acres across multiple parcels, one of which contains their family residence. Let’s say one parcel, of 200 acres, is the comparatively lower yield, but is a perennial target for local real estate developers. The couple would like the family farm to continue on; they would prefer to minimize or avoid altogether the sale of farm assets upon their deaths.
In our example, there are no formal business entities in existence for the family farming operation, they have done it as generations before had done, with handshakes and an understanding of bringing crops, produce, and/or livestock to market. They own their equipment themselves. They have five children, two of which participate full time in the farming operation and live nearby, while the other three do not (and, after college, moved off to big cities at either coast).
These clients, while sophisticated business owners and operators, prefer to keep things simple. To that end, they have Wills that were drafted after their children were born but have not been updated since. Most of their net worth is tied up in the land, the equipment, and the ongoing farming operation. While they have some liquid investments, they are looking for income generation to supplement their other sources for retirement. Hopefully, by now you are starting to get a sense of how widely individual circumstances can vary, and how substantially it may affect planning.
For this couple, we might recommend the creation of at least three limited liability companies (LLCs): one to hold the 800 quality tillable acres and run the farming operation; one to hold the 200-acre parcel ripe for development; and, one to hold the equipment. First, we ensure that the land is not encumbered with any debts or mortgages. We then have a surveyor carve out the family residence and we deed the remainder into the appropriate LLCs. Once the LLCs are properly formed and capitalized, we engage a professional, independent business valuation firm to provide valuations of the farming operation and of the individual units of the LLCs. These units may be able to take advantage of valuation discounts for lack of control and lack of marketability, and we plan to mitigate any valuation premiums for control or swing-vote status. The couple’s tax advisor is involved throughout this process.
We then assist them in developing a gifting program designed to leverage their lifetime gift tax exemptions to transfer LLC units to their children and grandchildren (Current lifetime exemptions are $5.12 million per donor, though this amount is set to change on January 1, 2013. Good thing they are dealing with this now!) The LLCs and the gifting program is designed in such a way as to allow the couple to retain control of the operation and of their assets while beginning the process of transferring farm assets to future generations. This transfer keeps the farm in the family, encourages the family to work together, protects the assets from divorces, or other creditors or liabilities, all while maximizing transfer tax savings.
The couple also updates their estate plan by creating revocable trusts. These trusts own the LLC units and are designed so as to maximize the couple’s federal estate tax exemptions while providing for the desired farm succession. Together with their LLC unit gifting program, they are able to shift a large part of their farming operation to their two children who will continue on with it, while giving the non-participating children interests in the LLC containing the 200-acre parcel. These non-farmer children can then derive income from the rental of the land, or contemplate the eventual sale of the parcel, without liquidating the farming operation as a whole. The couple is able to transition control and retire at their own pace with the peace of mind knowing their life’s work will continue on in the family safely and securely. A successful result all around!
The proposal outlined above is absolutely not a one-size-fits-all. The purpose of this article was merely to introduce some key topics to get family farmers thinking about what plans they have or do not have, in place. Any good plan will be tailored to an individual or family’s unique circumstances and their particular estate planning goals.
Author: Adam S. Russell is an estate planning attorney at Tuesley Hall Konopa, LLP. Practice areas include trust and estate planning, estate administration, tax planning, charitable planning, and charitable trusts, trust funding, special needs trusts and supplemental needs trusts, prenuptial agreements, and probate. Additionally, Adam is licensed to practice in both Indiana and Michigan and regularly meets with clients in our South Bend, Elkhart and Cassopolis offices.
You can contact Adam by calling 574.232.3538 or by email firstname.lastname@example.org.