We had a reader ask the following question:

“Is there any way to reinvest money from the sale of equipment(retirement) rather than pay ordinary income tax on it?”

Most farmers when they retire have a large amount of income from selling the final crop and their equipment and many times very little expenses to offset it with.  This results in a large amount income tax being owed, thus reducing the farmer’s after tax cash flow.

One method that we use to reduce and spread out this tax burden is the use of a charitable remainder trust (CRT).  The farmer will contribute their equipment and unsold grain inventory to the CRT.  Based upon the term of the trust, the farmer will get a tax deduction for this transfer.  The CRT will the sell the equipment and grain and owe no taxes on the sale.  Rather, this gain is accumulated and as the CRT makes payments to the farmer, they are taxed on the distributions when they receive the payments.  These distributions can be fixed at a certain annual amount or a percentage of the trust value each year.

In order to be a valid CRT, at least 10% of the assets transferred into the trust must be expected to go to charity at the end of the trust term.  A CRT is a great method to defer the tax for several years on the sale of farm equipment and final grain sales.

If this is something you are interested in, you need to review it with your tax advisor since there several calculations that must be made.

One example is as follows:

Farmer is retiring and has $1 million of farm equipment and $750,000 of final grain inventory to sell.  He does not need the cash immediately and wishes to use this as retirement income.  If the farmer sold the equipment and inventory for cash in his name, the total taxed owed would be about $750,000 assuming a top federal and state tax bracket.  He would have $1 million left over to reinvest at lets say 4% a year or $40,000.

By putting these assets in the CRT, it could sell the equipment and grain and pay no tax.  The CRT would have $1,750,000 earning 4% or $70,000 per year.  The CRT would then distribute this income and some principal out the farmer each year and it is likely that the farmer would be in a lower tax bracket on that income.

We had a reader ask the following question:

“Can i give a lot of shares in a family farm corporation to my kids gift tax exempt. Is this just a one time thing.”

The subject of gifts can be misunderstood for many farmers.  In general, you can give up to $13,000 (the annual exclusion amount) to as many people as you want each year without having to file any gift tax return.  This money is generally not taxable to the recipient, however, you are not able to deduct the gift either.  

You are also able to gift more than this amount by making payments for medical or educational expenses directly to the institution.  If you make the check to the individual who then writes the check, the limit for reporting is the $13,000 annual amount. 

You are not limited to only making one gift to a person per year.  You can make multiple gifts; it is the total amount for the year that is important.  If less than $13,000 no reporting for that person is required.

The lifetime exclusion for 2011 and 2012 is currently set at $5 million.  In 2013, it is scheduled to revert back to $1 million, however, discussion about making a higher amount permanent is ongoing, but with 2012 being an election year, we would not count on this happening soon.

For the reader’s question, an annual gift of corporate stock equal to the annual gift exclusion amount could shield substantial amounts of stock from gift tax.  For example, assume a farmer and his spouse have 4 children who are married.  Each year, the farmer can gift 4 x 2 x $13,000 (gifts to child and spouse) or $104,000 of corporate stock value and his spouse can gift the same amount.  This equals a total of $208,000 annually and over ten years this would exceed $2,000,000 in value that would escape gift taxes. 

Additionally, with the lifetime exclusion being $5 million this year and next, the couple could gift immediately $10 million and not pay any gift tax and the appreciation in value would escape their estate.

Over ten years they could easily gift $12 million and if they take advantage of corporate stock discounts that may be available for the lack of marketability and minority interest, they may be able to gift upwards of $20 million of stock value over a 10 year period.

This is one of my longer posts, but this year and next it is extremely important to review your current gifting program and see if it makes sense to gift more assets to your children and grandchildren.  As with all tax related considerations, make sure to review this with your tax advisor.

One of the newly proposed estate tax rules in the proposed tax act is the allowance of estates to combine both spouses lifetime exemption to maximize the estate tax savings.

Under current law, if the first spouse passes away and if their estate is less than the current lifetime exemption, the excess is lost forever.  For example, if a farmer passes away worth $2 million and leaves the farm to the spouse and then the spouse passes away with the farm worth $8 million dollars, the second estate will pay estate taxes on $3 million or about $1 million in total estate taxes (this assumes a $5 million lifetime exemption for both).

Now, under the proposed new law, when the second spouse passes away, the estate can combine the $3 million not used in the first estate plus the $5 million in the second estate.  This results in a total combined estate exemption of $8 million which is equal to the total value of the estate which means there is no estate tax owed.

As you can see, the new proposed law can easily save the estate $1 million or more.

The Senate is expected to vote on the bill by the end of this week and then send it to the house.  If the house simply votes on the bill as is, we should have the bill in place by Christmas.  However, if the House makes changes, we will most likely not have a bill until after Christmas and it may not become law until right after the first of the year or it may become caught up in the lame duck status of Congress at that time.

I ran across another thought provoking article in Cornhusker Economics.  In the article, they performed an analysis of farmers in Nebraska based upon their ages.

In 1982, 13,436 farmers in Nebraska were under age 35.  In the most recent census in 2007, this number had dropped to 3,353 or a 75 percent decrease.

The number of operators aged 65 or over increased from 8,777 to 13,062 in 2007 or about a 49 percent increase.

Based on these numbers, over the next several years, there will be about 13,000 Nebraska farmers pondering these three options regarding their operations:

1. Will they sell the land, machinery and livestock to the highest bidder, or
2. Will they rent the land, machinery and livestock to the highest bidder, or
3. Will they transfer it to a successor to farm

For many operators, option 1 or 2 will most likely be the best option.  For others, option #3 will allow them to see their life’s work continue on.  The rest of the article discussed the University setting up the “Nebraska Network for Beginning Farmers”.

I would be curious to find out which of the three options our readers are pondering.  If I get enough response, I will post the results in a later post.  If interested, send me a quick e-mail with the following information regarding you and your operation:

• Your age
• Your home state
• The size of your operation in acres or head
• The type of operation
• Major crops grown
• Which option you are leaning toward
• Whether you have identified who either the higher bidder will be or your successor
• Are they related to you
• Other information you think is pertinent

Again, if I get enough responses, I will post the data.

In my last post, I gave an update on the current estate tax law and how it my apply to farmers for 2010.  In that post, I referred to the term “Step Up” and I am using this post just to explain what the term Step Up or Step Down means.

Up until this year, when a person died, the property that passed through to their heirs received a step up or down in cost basis to the fair market value at the time of death.  When the heirs would sell the property, this is the amount they would use for their cost basis.  For example, if a farmer owned land that he paid $100,000 for and it was worth $500,000 when he died, the heirs would be able to use the $500,000 when determining their capital gain when they eventually sold the land.  Conversely, if the fair market value at death was $50,000, then that would be the value they would use.

For the last several decades, this has been rule for inheriting property and then selling it by the heirs.  Starting this year, the IRS requires to Step Down any property, but use cost only on the other property that is worth more than what was paid for it originally.  However, the executor can make an election to step up value of up to $1.3 million or an additional $3 million for a surviving spouse.  In addition, the final income tax return for the person dying will be required to fill out a schedule showing the cost basis of all assets passed on to their heirs.  This cost basis is what the heirs will have to use in computing their capital gains tax when they sell any of these inherited assets.

As you can see, although there might not be any federal estate tax, there will be extra capital gains taxes and a lot more work for the executor and their professional to do.

I am currently in a financial investment conference in Chicago for a couple of days and during one of the sessions, the current estate tax situation was discussed.  There appears to be at least 6 billionaires that have died this year and under the current law, they will owe no federal estate taxes, however, in most cases, they will owe state estate taxes.  Now, this appears to be a good deal, however, there is an income tax cost to not have an estate tax.

This cost relates to there being no step up in basis of the assets that are inherited by the heirs.  They can elect to step up $1.3 million in assets or an extra $3 million going to a surviving spouse.  Lets see how this might affect a farmer with a decent size estate.  Lets assume that a farmer dies with land valued at $10 million and equipment valued at $2 million.  Assume there is no other assets and the basis in these assets is only $1 million.

There will be no federal estate tax due, however, most likely about $1 million of state estate will be due.  Now lets assume the heirs elect to step up the equipment by $1.3 million and then they sell the assets in 2011.  The capital gains rate for the land including state income taxes will be about 30% so, they will owe about $2.7 million of federal and state income taxes.  On the equipment, there will be a gain of $700 thousand and assumption top bracket of about 50% for federal and state taxes will result in total taxes on this gain of about $350 thousand.

Therefore, in total, the estate and heirs have paid estate taxes of $1 million and income taxes of about $3 million for total taxes of $4 million.  Under the law in effect for 2009, there would have been estate taxes of about $4.5 million and no income taxes. 

So you can see that even there is no federal estate tax for this year, a farmer who passes away with certain tax facts can almost pay the same amount in state estate and related income taxes. 

Please make sure to review your situation with your tax advisor.

Also, these laws are most likely to change during this year or next and we will keep you posted.

Congress back in 2001 dropped the maximum tax rate on dividends received by a taxpayer from 39.6% to 15% (plus any applicable state income taxes).  But under the so-called Sunset Rule, these special low rates expire at the end of 2010.  Beginning in 2011, the top rate is expected to go back to 39.6% and beginning in 2013, the effective top rate will be 43.4% after taking in account the new Medicare surtax of 3.8%.

What this means to a farmer who has a C corporation that is in the top tax bracket both at the corporate level and at the individual level is as follows:

• For 2010, your maximum combined corporate and individual income tax rate will be 44.75%
• For 2011 and 2012, your maximum combined rate will increase to 60.74%
• For 2013 and thereafter, your maximum combined rate will be a whopping 63.21%.  This represents a huge 41% increase since 2010.

A tax planning tip is to review your current retained earnings and see how much you should drop out to you in the form of dividends.  If the corporation needs the working capital, you can always loan it back to it at very cheap interest rates.

One of my readers sent me a question about a farming operation that applies to many farm families.  I am going to summarize the question as follows:

Scenario:

160 acre cropland is titled as Kevin XXX and Mary XXX, JTWRS (50%) and The Jane M YYYY Trust (50%).  Kevin and Jane M are brother and sister.  Mary XXX is Kevin’s wife.  Kevin and Mary also have a 240 acre operation of their own.

Is a partnership return REQUIRED to be filed or can Jane M and Kevin XXX each allocate their share of expense/income attributable to the 160 acre operation.

Can you provide me some info?  What’s the penalty for not doing it correctly.

As you can see from the facts, this is a fairly normal situation where property was probably inherited from a mom or dad and it is titled as co-owners in the brother (including wife) and sisters name.  The brother is also farming other property.

Normally, anytime property is owned by more than one party, a partnership of some type is involved.  This usually requires the filing of a partnership income tax return.  Until a few years ago, the penalty for not filing a partnership income tax return was minimal as long as all of the partners reported their share of the income timely.

However, with last year’s new tax laws, the penalty for filing a late partnership income tax return can now be pretty steep.  The penalty is now equal to $195 per partner for each month that the return is late with a maximum of 12 months.  Therefore, under the current case, if a partnership return is required and they never file one, the IRS could assess penalties on three partners for twelve months at $195 per month.  This penalty would equal $7,020 which is substantial.

If the parties want to not to file a partnership return, then can make an election to opt out of the partnership rules.  I will discuss this election in a near future post, but as you can see, the penalty for not making the election can be substantial.

I will have a couple more posts on this subject over the next week or two.

Some of my readers may have noticed that I have started writing a blog on the Agweb.com site.  From my web traffic, I can see that many of those readers have checked out this site.  I am honored to be doing the blog, but with three weeks left in tax season, I am hoping that I can keep up the pace.  Many times I will post the same content on each site, but there will be times when it is unique to one or the other.

I got an interesting question from a reader on the Agweb site and I am posting that post here for your review.  The estate tax situation for this year is the craziest I have ever seen it in my 25 years plus as a CPA and who knows how it will end up.  This is a reply to a question that I think many farm families will have.

Here is my original post:

We have gotten a response from one of our readers asking the following:

“Our mother has transferred the farm to her two sons and there is a clause stating they will get a step up in basis when she passes away.  They are wondering if she dies in 2010, will this property get a step up in basis?”

There are not enough facts in the question to make a complete answer, but I will outline what the rules are for 2010 as they stand now.

Under the old law, any assets passing to a heir received a step up or down in value to what it was worth at the time of death (or in some cases 6 months after death).

For 2010, this rule has been eliminated.  This means any property passing to an heir will have a basis equal to the lessor of:

• Their current basis (in most cases this is the cost) of the property, or
• Fair market value

The estate can make an election to write up any property to fair market value not to exceed $1.3 million to be allocated to any asset (or $4.3 million if the assets are going to a surviving spouse).  The estate will also have to file a report with the IRS and the heirs letting them know what the basis of all assets are.

So, in our readers case, if Mom bought the land for $200,000 50 years ago and it is now worth $5,000,000, there is:

• No estate tax owed;
• The estate can step up the cost basis to $1.5 million;
• And the remainder of $3.5 million will be subject to capital gains tax when sold, which may be upwards of $800,000 assuming current federal and state income taxes.

Also, many states will assess an estate or inheritance tax if the estate exceeds a certain amount.

This means that income tax planning for 2010 estates is very complex and we are waiting to see if Congress will fix this.  We will keep you posted.

As advisors, we are actively involved in succession planning for farmers and other businesses.  This is usually a long process and will change over time and as the generations involved grow and mature, their goals will usually change.

There are three main goals related to this planning:

1. Protect – The primary goal of any succession plan is that both generations involved are still protected in the following areas:

                Financial – Are the owners transferring the business still protected from a financial standpoint.  Did they create enough retirement and other assets outside of the farm to protect their retirement income

                Operational – Does the succession plan provide protection from operational issues such as the new generation being ready to take over the farm operation.  Nothing will ruin a farm family quicker than the next generation taking over sooner than ready.

                Entity – Does the succession plan provide for legal and entity protection.  Are they taking advantage of limited liability companies, corporations and trusts where appropriate.

   2.  Provide – Once protection is taken care of, the next step is to provide for both generations.  Is there enough cash flow to provide a normal living standard for both the current generation and the new generation.  If not, how will the farm family address this.  Will they have a spouse work off the farm or one of the heirs.  Will they do custom farming, etc.

  3.  Prosper – After the farm family is protected and provided for, then comes the time to prosper.  Does the farm family have enough management time and experience to expand the farm operation with more acres.  Or do they have excess machine time and people to do custom farming.  Each farm family has different goals when it comes to the prosper stage, but they must always remember to protect and provide first.

What stage is your farm operation in?

For an online video presentation of my “chalk talk” on this subject on the AgDay special “The Legacy Project” go to this link.  Here you will see a farm family discussing their succession plan with Kevin Spafford, host of The Legacy Project” and myself giving him advice.  Later in the show, Kevin and I have a chalk talk on the three P.

I hope you enjoy watching it and let me know of any future discussion topics that you would like to see addressed.