Farmers have a lot on their minds when they finish planting, feed the livestock, cut the hay, and handle countless other tasks. Since lawmakers began discussing new tax legislation, my clients have often mentioned another concern: how to prepare a farm for potential inheritance tax and inheritance tax changes.
Congress has several tax proposals on the table. Unfortunately, my crystal ball is broken, leaving us to shoot at a moving target. No one knows what will ultimately be signed into law. With that said, you should now take the time to prepare for possible changes in US tax policy.
Expect tax code changes
The current tax code will be different. Unfortunately, we just don’t know what change to expect.
Current proposals include overhauling certain tax brackets and thresholds, increasing capital gains rates, reducing lifetime exclusions for gifts and estates, eliminating the enhanced base, removing 1031 exchanges of the same nature and the taxation of transfers to the family.
Your specific situation will dictate how these changes would affect you, but let’s go over some potential situations that could arise if certain proposals become law:
Assets. On the one hand, as lifetime exclusion has increased steadily in recent years and with portability between spouses, the use of “him and her” trusts has changed. Given certain proposals, spouses may find it advantageous to separate the property.
Agricultural structure. The preferential treatment of restructuring capital gains rates will affect succession and transition planning as the next generation takes over. Changes in how the net investment income tax defines a business’s income can affect owners of S corporations and members of LLCs.
Give. Whether the strengthened base survives congressional negotiations will affect your decision to give the farm to your heir or pass it on as an inheritance. The current proposals affect not only the inheritance tax, but also the income tax of the surviving spouse and heirs. Land is not the only item to benefit from an increased base. Also consider the values of crops, livestock and machinery.
Eyes on capital gains tax
Perhaps the agricultural country feels most concerned about the proposal to tax capital gains when assets are transferred to heirs through donations or upon death.
Under the current proposals, the first million dollars in transfers would be exempt. Transfers valued beyond would have capital gains valued as if the assets were sold, even if they were not.
If you leave farmland, livestock and machinery to your heirs, the capital gains on each will have to be paid. However, heirs who keep assets would not have the cash from the sales to cover taxes. Would that require selling the farm to pay the tax?
This new tax could be deferred for “family” farms. How this term is defined will become of vital importance. Will it only include direct line descendants? If you leave farmland to your children and they want to keep it but lease it, will this arrangement be considered a family business?
Of course, the deferred tax – presumably with interest – would be due as soon as the land was not used by the family.
You can act
Proactive farmers asked if they should act now under the current law. Unfortunately, we do not know if the new policies would apply retroactively. At least one proposal would affect transfers made after December 31, 2020. It’s dangerous to jump in and find out later that you’ve shot yourself in the foot.
Unless your crystal ball is in better shape than mine, you won’t know what to do until we get more clarity. However, there are two important steps you can take now:
1. Talk about transition. You and your spouse should spend some time reviewing your assets and making a plan for how you want to treat your heirs.
2. Find a real estate attorney. If you aren’t already working with an estate planning lawyer, you need to find one today. This is essential because you may only have a short time to make changes to your estate plan after the legislation is passed by Congress. If this is the case, then any worthy attorneys will be overwhelmed to help existing clients who are scrambling to make changes, and you will have an impossible task if you are trying to get a first date. Do your homework now and find someone you trust to advise you.
If you want to pass your farm on to the next generation, then get organized and prepare to make informed decisions quickly if necessary.