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.

Having just recently returned from my taping for the Legacy Project on farm succession planning, I will be trying to do several posts over the next few weeks on this very important subject.

Elizabeth Williams from the DTN/Progressive Farmer had a very good post on the five steps needed for the farm transition.  The article dealt with a young farmer who lost his mother due to brain cancer.  The estate did not owe any current tax since the assets passed free of estate tax to the husband, but if he had passed away that same year, they would have had a major estate tax problem.

The five steps mentioned were:

1. Get Experienced Legal Help – Find a good agricultural estate tax attorney (or a good farm cpa) to help design an estate plan to meet the unique needs of the farm estate plan.
2. Recognize that your Paperwork will Increase – If your estate goal is to reduce estate taxes, transfer property to the next generation with the least income/capital gain tax and divide your assets equitable among your children, that usually means multiple farm entities.  This requires separate bank accounts, year-end meetings and compliance, etc.  However, to do it right, more paperwork will result.
3. Allow the Next Generation to Control or Own Something that is “Theirs” – It is important for the children to have some skin in the game to promote the pride of ownership.
4. Listen and Talk to Each Other – No one can read your mind.  Not being transparent can cause a multitude of problems.  “A lot of animosity can build up when off-farm family members don’t know what the deal is. What is the on-farm sibling getting?”
5. Respect the Division of Labor – The most successful family farm operations have distinct, complementary divisions of labor.  As I said on my TV taping, find what each member does best and let them do it.  The farm will be better off and the family member will feel best about themselves.  Part of that comes from clearly defining the expectations that go along with ownership and management of the farm.

The cost of not planning can be very high!  Even a 500 acre farm can generate a large amount of estate tax starting in 2011 if no changes are made to the estate tax laws.

For a primer on “Transferring the Farm”, go to the University of Minnesota’s Center for Farm Financial Management.

Just wanted to give all of my readers a heads up that I will be appearing on the Leave a Legacy TV show this Thursday morning (the 25th).  It will generally take the place of AgDay and you may want to check your local listings for time.  You will also be able to view it on the Leave a Legacy site at Agweb after the show at a later time.

I enjoyed doing the show, but as my wife would say, don’t plan on changing your day job.

Most farmers are assuming that since there is no estate tax for 2010, that this must be a good thing for all taxpayers.  The reality is that many farmers may end up paying more in taxes than under the law in effect for 2009.  This is due to the fact that carryover basis will no longer be in effect for many estates.

Under the old law, when a person died, all of their assets were revalued for income tax purposes  based upon the value at the time of death.  Then when the heirs sold the assets, this was the “cost” that they could use in determining their gain or loss.

For example, suppose, a farmer died owning equipment that was worth $1 million dollars that had been fully written off.  Under the old law, you could step up the value to $1 million dollars and depreciate it over 5 to 7 years.  If instead, you decided to sell the farm equipment for $1 million immediately, there would be no tax owed.

Now, when you inherit the equipment, you get no step up in basis, and when you elect to sell the equipment, the gain will be completely taxable.  Also, this sale will not qualify for capital gains treatment, therefore it will be subject to ordinary income tax rates.  At a 35% bracket, this would result in owing $350,000 of tax.

Therefore, due to not having an estate tax, we went from (1)  complete step up in value to date of death value, (2) no estate tax being owed for all estates under $3,5 million, and (3) full write of assets over time as depreciation against other income  to owing $350,000 in income taxes.  This does not sound too good to me. 

I am hoping that Congress gets their act together and fixes this, but I am not too hopeful.  I will keep you updated.

As a CPA, I have been involved in many family meetings.  Sometimes, I act as an advisor to the participants.  At other times, I may actually be part of the family that is having the meeting.

I remember having a client several years ago that had several children that were actively involved in the business during their lifetime.  We hada family meeting with several advisors and it became apparent very quickly that strains of the family dynamic and how it affected their relationships.  Very quickly, the perceived problems of childhood, parenthood and other factors came out and you almost had a civil war on your hands.  We were able to get it back on track, but it was touch and go for a while.

Dr. Donald Jonovic writes a monthly column in Successful Farming that I think is always worth reading.  A recent column from the print version of the magazine dealt with  Family Rules of Conduct for these meetings.  Dr. Jonovic listed several rules for effective meetings.  Some of the ones that I feel are especially relevant are:

• Always treat each other the way you would treat important friends or colleagues.  – Too many times I find that family will treat each other worse than any other friend or acquaintance.  We should really treat our family better than our friends.  If we do, many of our family problems would be cured.
• Keep your business and personal disagreements confidential and within the family. – Disagreements should be handled in-house.  Don’t put them in the “outhouse” so to speak. 
• Keep meetings fun – Farming is fun and having meetings about farming and family should be fun.  Have some type of family interactive game or other ice breaker to keep things loose.
• Do not equate difference of opinion with disloyalty – Remember that having people always agree with you means they go over the cliff with you when things go wrong.  Encourage people to give you a different viewpoint.  This is always the best way to learn.
• Leave your cell phones at the door – This may be tougher for our Gen X and Gen Y family members, but it is only for an hour.  They can survive and will learn to enjoy it.

There are many other good points, but to make your meetings effective, implement as many as you can.

 Our CPA firm deals with many newly formed businesses each year.  When two or more people get together to form a business, it is almost like a boyfriend and girlfriend getting together for the first time.  They are usually fairly giddy with excitement over the new venture and look forward to the business being there forever.  However, like many human relationships, many of these unions will end in divorce and it can be painful.

I like to remind my clients that they need to be extremely diligent in building in a rip cord in case the business does not work out.  Just as in parachuting for the first time, the rip cord is designed to get you to the ground safely when things do not always work out.

In your business agreement, you need to make sure to document what will happen in the following situations:

• What happens if one of the partners becomes disabled or dies?  Will you use life insurance to take care of these situations?
• What happens if one or more of the partners goes bankrupt?
• What happens if one of the partners decides to leave the business?  Are the remaining partners required to purchase the interest?  If so, what is the price and terms and how is it determined?  What if the parties can not agree on the price, how is that resolved?
• What type of restrictions are built in to the transfer of interests?  If not handled correctly, you may end up new partner that you did not know about or want.

These are just some of  the issues that need to be built into the “rip cord” wording to make sure that it works.  Remember, in these situations it is almost always better to design the rip cord up front than to try to come up with the right one when it is too late.

Thanks to Senate gridlock, taxpayers who are trying to do effective estate tax planning are in for a case of estate tax whiplash over the next few months.  The federal estate tax is due to disappear for one year starting in about two weeks, however, it may reappear unexpectedly and retroactively.

When the Senate refused to act this week, it opened the door for the estate tax to disappear in two weeks, although nobody knows for how long.  Under current law, the estate tax disappears on January 1, 2010 for the whole year and then reappears on January 1, 2011 at the old 2001 rates.  Also, the gift tax maximum rate will fall to 35% and for some assets inherited in 2010, the step up in basis will disappear (with the step up in basis, the capital gains tax is based upon the difference in value between what you sell it for and what it was worth at the time of death.  With the new law, you use “carry over basis” which means you need to go back and find out what the heir originally paid for it and use that basis.  This could end up being an accounting mess).  All this happens because the 2001 tax act phased out the estate tax over a 10 year period, repealing it entirely in 2010.  But the estate tax returns in 2011 under 2001 rules – a $ 1 million exemption and a 55-percent top rate.

The House had passed a law a couple of weeks ago making the current top rate of 45% and exemption amount of $3.5 million permanent.  Senate republicans wanted the rate lowered to 35% and the exemption at $5 million.  But lacking any unity in the Senate, Democrats failed to even get the Senate to vote on the issue.

The whiplash mess is that we are not sure if Congress will get their act together in early 2010 and pass a new estate tax law and whether it will be retroactive to January 1, 2010.  Senate Finance Committee Chair Max Baucus (D-Montana) has promised to revive the issue next month and make it retroactive to January 1, 2010, but that may not happen. 

In the meantime, I would not be making any large gifts assuming the new law will be in place.  You will want to watch and see what happens and when the dust settles, make your plans then.

An article in the Denver Post today and in other papers outlined a program in Iowa that is designed go help young non-farmers become farmers by hooking them up with farmers that are ready to retire.

This particular program is located in Iowa at Iowa State University and is headed up by Dave Baker.  The program is called the Beginning Farmer Center and it appears that they have helped up to 30 beginning farmers get partnered up with retiring farmers over the last three years. 

Although the program is designed to help younger people who want to get started in farming, but do not have the needed capital to do it on their own, it appears that there is no age limit on who can participate.

If you are nearing retirement and have no heirs who are interested in farming, this program or others like it in other states may help you partner up with somebody who wants to farm and would be willing and able to continue your farming legacy.  It is worth taking a look at it.

The people behind Successful Farming have developed a network for new farmers called Farmers for the Future.  They have had at least one conference and Loren Kruse, Editor-in-Chief of Successful Farming recapped the key ideas from the last conference.

This recap had many good ideas for new farmers, but I think almost all of the ten themes listed apply to all farmers.

The themes were as follows:

• Follow up your dreams with a written plan
• Look for other opportunities
• Build an attitude for success
• Hone your people skills
• Make your farm as special as a s business
• Know your strengths
• Build your reputation for things that matter
• Try new things
• Balance family and farming
• Help others grow

The three themes that really stood out to me were:

Follow up your dreams with a written plan- I am a firm believer in writing what you want to accomplish.  It does not need to be fancy, but write down on paper (or type it, etc.) what your goals are for the farm.  Make sure to list both business, i.e. how many acres I want to farm, what types of crops, etc. and personal, i.e. do you want your spouse and children involved, etc.  Although I have not seen a study, it is my firm opinion that a study would show that a written plan is achieved much more than a verbal plan.  If it is in writing, your spouse, banker, marketing advisor, attorneys, will all be happier.  WRITE IT DOWN.

Know your strengths- I think too many people spend too much timing on correctly their weaknesses and not enough time on expanding and promoting their strengths.  By the time you are out of high school (I would say kindergarten for most people), your traits are pretty well set for life.  Why get frustrated on trying to fix weaknesses that are very hard if not impossible to change, while you could be enjoying enhancing what you do well.  You can always find other people or advisors to do what you do not do well.  PROMOTE YOUR STRENGTHS.

Build an attitude for success – Attitude can be more important than perceived reality.  If you think you will be a success, it will be much easier than if you think you will be a failure.   Surround yourself with others that believe in you and your farm, continue to read and learn.  These steps will build a stable platform for farm success (and life success).  BUILD A SUCCESSFUL ATTITUDE.

I think over the next several months major changes will be made to the estate tax laws.  Right now, each individual can have a tax-free estate of $3.5 million.  Next year it is unlimited, however in 2011, it reverts back to $1.0 million. 

I think Congress will make changes this year to make the current $3.5 million estate permanent and indexed to inflation.  I also think they will allow married couples to combine the estates if it was not used up at the first death.  Farmers will most likely be allowed to reduce their farm valuations by a larger amount than is currently allowed.  All of these amounts may also be indexed with inflation.

This means that most farmers should be able to pass on their farms to heirs on a estate-tax free basis.  If the total value of the farm and other assets is less than $7.0 million, then it should be estate-tax free.  I know there are many farms with a value greater than $7.0 million, but compared to the old $2.0 million combined limit, these new amounts will make many more farms free from tax.