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Farm Estate Planning Strategies
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The Need for Estate Planning
One of the challenges of Planning is to make people
aware that they need to take action. Nowhere is
that more of an issue than with the family farm. * Iowa Farm Bureau
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Why is First Resources Involved?1. One of the most common methods of
paying Estate Taxes is Insurance – We sell insurance.
2. One of the risk factors for farms is Long Term Care – We sell LTC.
3. Investments are a key element in planning – We advise investors.
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Three Levels of Planning
1. Family Plan
2. Elimination of Tax
3. Management of Asset Cost and Continuity of Business
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Level 1 360 Acres @ $3,000 per acre.
1. Who receives the farm?
2. How do I treat other children?
3. Who will handle the estate?
4. How do I protect the farm from unexpected expenses?
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Level 2
800 Acres @ $3,000 per acre. Design wills/trusts that eliminate tax How do I treat other children? Who will handle the estate? Unexpected expenses?
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Level 3 1500 Acres @ $3,000 per acre
1. Minimize Estate Tax
2. How do I treat other children?
3. Who will handle the estate?
4. Unexpected expenses?
5. Management of Tax Payments?
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The Need for Estate Planning
The tendency to listen to politicians in Washington discourages effective action. For 40 years, they have talked about solutions and we still have a tax of 45% for all values over $2,000,000.
Minnesota tax is imposed for values over $1,000,000.
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What is Estate Planning?
Arranging your property to accomplish these goals.
Determining goals with respect to your property both during life and at death.
Protecting your assets from depletion risks.
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Who Needs Estate Planning?
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Everyone Needs to Plan Their Estate
Property ownership that fits a plan. Wills that distribute according to your wishes. Appointment of responsible people to handle the
estate. Reduce or eliminate taxation. Power of Attorney.
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Property Ownership
Joint Tenancy Bypass the will Non-probate Reduces stepped up basis Can be fully subject to
Medicaid claims
Tenancy in Common Proportionate Ownership Does not transfer to other owner at death Can raise questions of % ownership Subject to transfer by will or intestacy
rules Probate
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The Need for Estate Planning
Everyone has an estate plan! If you don’t develop one, the state has
one for you.
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State Provided Plan
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Article IIf no children,
All to Spouse
State Provided Plan
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Article II
If children only from marriage of husband and wife:
$70,000 to spouse ½ of excess to spouse
State Provided Plan
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Article IIIIf all children are not from
this spouse: ½ to spouse
State Provided Plan
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Article IV
Children receive equal shares by right of
representation.
State Provided Plan
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Article VIf a child has pre-deceased the
parent without grandchildren, then to
parent(s) of child; if not alive, then escheat!
State Provided Plan
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Election Against The Will Years of Marriage % Share____________________
1 year = Supplemental Amount ($50,000)1-2 = 32-3 = 63-4 = 94-5 = 125-6 = 156-7 = 187-8 = 218-9 = 249-10 = 2710-11 = 3011-12 = 3412-13 = 3813-14 = 4214-15 = 4615+ = 50
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Who Needs Estate Tax Planning?
3,000,000
2,000,000
1,000,000
4,000,000
1,500,000
2,000,000 2,000,000 2,000,000
3,500,000
1,000,000
2006
2007 2008 2009 2010 20112005
No
Est
ate
Ta
x
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Stepped-up Basis Congress giveth and taketh away!
While there is estate tax, the basis of property is “stepped-up” to the value at date of death or 9 months after death (Alternative valuation).
If death occurs when there is no estate tax, stepped up basis is limited or eliminated.
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Simple WillHusband’s
Estate($3,000,000)
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Simple Will
Wife’s Estate($3,000,000)
No Federal Estate Tax
Husband’s Estate
($3,000,000)
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Simple Will
Wife’s Estate($3,000,000)
Husband’s Death* No Federal Estate Tax
Husband’s Estate
($3,000,000)
Federal Estate Tax$460,000
Wife’s Death*
Wife’s Heirs($2,551,700)
* Assumes death in 2006.
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Simple Will Result
• No taxes at first death.
• Entire estate is taxed at second death.
Advantages• Transfer of maximum amount of property to
spouse outright.
• No federal estate tax at first death.
There may be substantial federal estate tax on death of surviving spouse.
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Unified Credit Trust WillHusband’s
Estate($3,000,000)
Husband’s Heirs
$2,000,000
No Tax*
Unified Credit (By-Pass) Trust
$2,000,000
*Assumes death in 2006 - 2008
Wife
WifeIncome
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Unified Credit Trust WillHusband’s
Estate($3,000,000)
Unified Credit (By-Pass) Trust
$2,000,000
Husband’sHeirs
$2,000,000
No Tax*
No Federal Estate Tax
Wife’s Estate($1,000,000)
Wife’s Heirs$1,000,000
No Tax*
*Assumes death in year 2006.
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Increased Unified CreditIf death occurs
in year. . .
200320042005200620072008200920102011
Amount passing estate tax free
$1,000,000 1,500,000 1,500,000 2,000,000 2,000,000 2,000,000 3,500,000Repealed
1,000,000
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Life Insurance Improperly Owned
$4 Million Estate
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Life Insurance Improperly Owned $1,000,000 of the Estate is Life Insurance
Estate
Life Insurance
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Life Insurance Improperly Owned
Estate
Life Insurance
Estate Taxes
0Estate without Life Insurance but with a unified credit trust:
$0 Taxes
With Life Insurance in the Estate:
$460,000 Taxes
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Life Insurance Properly Owned
Individuals
Trust
Life Insurance$4,000,000 Estate
$0 Taxes
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The Need for Estate Planning?
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Financial Burdens Estate settlement costs are too high
• Probate fees• Death taxes • Debts
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Financial Burdens Estate Settlement costs are too high
• Probate fees
• Death taxes
• Debts
Estate assets are improperly arranged• Liquidity
• Cash flow
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Financial Burdens
Non-LiquidAssets
Liquid Assets
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Common Mistakes
No written plan. Improper ownership of assets. Life insurance is improperly owned.
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Alwin C. Ernst Estate
Gross Estate$12,642,431
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Alwin C. Ernst EstateDebts $1,014,314
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Alwin C. Ernst EstateDebts
$1,014,314Admin. Costs
$78,862
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Alwin C. Ernst EstateDebts
$1,014,314 Admin. Costs$78,862
Estate Taxes$ 4,335,000
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Alwin C. Ernst Estate
Net to Heirs$6,571,548
45%Shrinkage
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Discuss Here the
“Estates of 4 Famous People”
Handouts
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Advanced DirectivesThe Advanced Directive or “Living Will” is the best method tocontrol medical care when you’ve lost communication
Assign an AgentDescribe your desire for pain reliefLimit medical treatment, if desired
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Power of Attorney
Assign Responsibility and ability to act on your behalf.
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Protecting Assets from Medicaid
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Protecting Assets from Medicaid
The Homestead Rule Detached Property Asset Retention Limits Equipment and Other Business Assets Income Limitations Spend-down Liens
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Protections for the Community Spouse Community Spouse Resource Allowance (CSRA):
– Minimum $28,001
– Maximum $99,540 Increased CSRA:
– Permitted, but rarely used. Minnesota follows the income-first rule.
Annuities
– Actuarially sound annuities are permitted (but restrictions apply; check with attorney).
Monthly Maintenance Needs Allowance:
– Minimum $1,604.00
– Maximum $2,488.50
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Transfers
Average monthly cost of nursing home care according to state:
$4,198.00
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Income
Is the state an “income cap” state?
NO
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Estate Recovery
Has the state expanded the definition of “estate” beyond the probate estate?
– No (but exceptions apply; check with attorney)
Has the state included a hardship?
– Yes
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CommonEstate Planning Strategies
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Common Estate Planning Strategies Outright Gifts Family Farm Owned Business Deduction Grantor Retained Trusts Charitable Remainders Trusts Irrevocable Insurance Trusts Wait-and-See Trusts Family Limited Partnerships
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Outright Gifts
$12,000 donor/donee
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Gift tax annual exclusion amount is $12,000 for gifts
made in 2006, and is subject to indexing in the future.
$12,000/donor/donee
Parent
Child 1 Child 2
Outright Gifts
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Gifting Through the Unified CreditHusband - $2,000,000 ► Gift to ChildrenWife - $2,000,000
Requires a gift Tax Return No Stepped-up basis Cannot retain control or enjoy the
benefit of Gifted property
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Gift Challenges
Estate Growth exceeds tax free gifts Gift assets may be essential to owners Gifting the Farm requires restructuring
and valuations
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Family Farm Business DeductionIf elected, Applies To Estates Prior To 2004 or After 2010
The deduction is the lesser of the unified credit equivalent or the adjusted value of the business
The business must pass to a qualified heir The business must be operated by a qualified
heir for five of any eight year period in the first 10 years after decedent's death
Many other rules apply
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Common Strategies
Grantor Retained Trusts Charitable Remainder Trusts Irrevocable Insurance Trusts Wait-and-See Trusts Family Limited Partnerships
Outright Gifts
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Grantor Retained Annuity Trust
Parent can RECEIVE INCOMEfrom the asset
Grantor
GRAT
Parent transfers“REMAINDER INTEREST”
in an asset
Child
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Clearance Sale! 20 - 30 - 40% Off!
Common Strategies
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Common Strategies Outright Gifts Grantor Retained Trusts Charitable Remainder Trusts Irrevocable Insurance Trusts Wait-and-See Trusts Family Limited Partnerships
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Charitable Remainder Trusts
Donor
Spouse or Children
Charitable Remainder Trust
CHARITY
Assets
Income
Remainder
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Donor
Heirs
Charitable Remainder Trust
Charity
Assets
Income
Remainder
Irrevocable Life Insurance Trust
Income from CRT
Beneficiary
Charitable Remainder Trusts & The Wealth Replacement Trust
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A sizable gift has been made to donor’s favorite charity.
Charitable Remainder/Wealth Replacement Results
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A sizable gift has been made to donor’s favorite charity.
A current income tax charitable deduction is available for the gift of remainder interest.
Charitable Remainder/Wealth Replacement Results
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A sizable gift has been made to donor’s favorite charity.
A current income tax charitable deduction is available for the gift of remainder interest.
The assets transferred to charity escape estate taxation.
Charitable Remainder/Wealth Replacement Results
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A sizable gift has been made to donor’s favorite charity.
A current income tax charitable deduction is available for the gift of remainder interest.
The assets transferred to charity escape estate taxation.
Donor receives cash flow from CRT (to pay premiums in the wealth replacement trust).
Charitable Remainder/Wealth Replacement Results
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A sizable gift has been made to donor’s favorite charity.
A current income tax charitable deduction is available for the gift of remainder interest.
The assets transferred to charity escape estate taxation. Donor receives cash flow from CRT (to pay premiums
in the wealth replacement trust). Amount passing to heirs has been preserved. Death
proceeds in irrevocable trust provide attractive replacement for assets given to charity.
Charitable Remainder/Wealth Replacement Results
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A sizable gift has been made to donor’s favorite charity. A current income tax charitable deduction is available for
the gift of remainder interest. The assets transferred to charity escape estate taxation. Donor receives cash flow from CRT (to pay premiums in
the wealth replacement trust). Amount passing to heirs has been preserved. Death
proceeds in irrevocable trust provide attractive replacement for assets given to charity.
Death proceeds are not includible in donor’s estate.
Charitable Remainder/Wealth Replacement Results
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Common Estate Planning Strategies Outright Gifts Grantor Retained Trusts Charitable Remainder Trusts Irrevocable Insurance Trusts Wait-and-See Trusts Family Limited Partnerships
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Attorney drafts trust Client contributes cash to Trustee Purchase life insurance policy
Mechanics of Irrevocable Life Insurance Trust
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Insurance Policy
Irrevocable TrustInsurance
Proceeds
$
$$
$
U.S. Treasuryfor Estate Taxes
Assets or Loans
C C Estate
CC
How the Irrevocable Insurance Trust Provides Estate Liquidity
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Common Estate Planning Strategies
Outright Gifts Grantor Retained Trusts Charitable Remainder Trusts Irrevocable Insurance Trusts Wait-and-See Trusts Family Limited Partnerships
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Wait-and-See TrustToday. . .own policy
After one spouse dies
Policy
After Second Death Death Benefit Cash
TRUST
TRUST
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Common Estate Planning Strategies
Outright Gifts Grantor Retained Trusts Charitable Remainder Trusts Irrevocable Insurance Trusts Wait-and-See Trusts Family Limited Partnerships
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Family Limited Partnerships
Corporate General Partners
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Family Limited Partnerships
Corporate General Partners
1% Family Limited
Partnership
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Family Limited Partnerships
Corporate General Partners
1% Family Limited
Partnership
99%Limited Partners
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Benefits of a FLP Reduces current income tax liability. Centralizes ownership of assets. Shields assets from malpractice & liability
claims. Lowers the value of your taxable estate. Minimizes probate expenses. Assets are not publicly displayed. Flexible, nothing is irrevocable.
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Common Estate Planning Strategies
Outright Gifts Grantor Retained Trusts Charitable Remainder Trusts Irrevocable Insurance Trusts Wait-and-See Trusts Family Limited Partnerships
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Valuing the Farm
What is the Fair Market Value of a Farm?”The price at which the property would change hands between a
willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable
knowledge of relevant facts.”
Remember…the reality is that the estate must make a good faith valuation of the property and the IRS can challenge that value.
The best method to obtain a value that will withstand scrutiny is to hire a competent appraiser
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Three Common Methods of Valuation
1. Market Data – An arms length sale of the property being valued, or if available, comparable values.
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2. Capitalization of Income – The projected net income of the property from the highest and best use of the property capitalized at a rate that reflects a fair return on this investment.
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3. Redemption Cost – An estimate of the cost of replacing a structure combined with an appraisal of the land.
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Alternative Valuation
The highest and best use provision is eliminated and the property is valued as a farm under section 2032(a) of the Internal Revenue Code.
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1. Must be elected.
2. The owner must be a citizen or resident of the U.S.
3. Cannot reduce the value by more than $840,000 (2003).
4. Must have been farmed for 5 of the last 8 years (retirement or disability exceptions).
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5. 50% of the adjusted gross estate consists of farm that was passed to a qualified heir.
6. 25% of the adjusted gross estate is farm real property.
7. Must continue to be operated as a farm for 10 years.
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The most commonly used method of valuation under this provision is the
cash rental approach:
Annual Gross Cash Rental,
minus Property Tax,
all divided by the
Federal Land Bank Loan Rate
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How You Can Help!
Estate inventory
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Creating a Transition Plan
1. Establish a process – Meet with the owners to lay the foundation of the process. Which advisors will be used? Who is in the first meeting? (Usually just the owners and a primary advisor)
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2. Establish Goals. What must be done to effectively transfer the business. What are their security needs now and in retirement? Do they have an intended buyer or someone who will receive the farm?
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3. What are the impediments to reaching these goals? Is there an equality issue? What would disability do to the plan? How do they execute the plan with the least tax and legal cost?
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Establishing the Process – The first meeting.
Who do you want the farm to go to? When do you plan to transfer the farm? What is the value of the farm? What terms do you want for the sale or
other transfer of the farm?
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What are your retirement goals? Is the farm the only source of income? Have you diversified the risk of having
adequate funds for retirement?
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If the children will not be receiving or keeping the farm, do you have a potential buyer? Do you want a full buy-out or will you carry a note on the property?
Are you willing to rent the farm for some period of time?
Will you consider a reverse mortgage?
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Who do you want in the next meeting? What do you want to accomplish (e.g. determine if
children want the farm, when, and under what terms). Have you discussed this topic with the children to
determine their interest and issues? What is your plan to ensure harmony, if possible?
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The process should end with wills, advanced directives, Power of Attorney, insurance, and agreements for purchase if appropriate.
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The Second Meeting… A family meeting Communication, Communication,
Communication Review discussions of first meetings Focus on results Design the family goals
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Goals
List the most important goals for the family.
The following are examples…
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1. Establish the who and how of transition of the farm.
2. Determine which children, if any, have an interest in working the farm.
3. Discuss and plan for equality of treatment between family members.
4. Establish a retirement plan, and a method of funding it.
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5. Account for events that can deter the plan and implement methods of dealing with those risks.
6. Establish wills and advanced directives and Power of Attorney.
7. Execute any documents that are needed to implement the plan.
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Risk Reduction
There are risks to any transition plan:
Disability Nursing Home Costs Change
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DisabilityA severe disability can significantly reduce income causing
acceleration of transfer or general dissolution of the plan.
– Rental Income– Social Security Disability– Private Disability Plans– Outside Income Group Plans– Retirement Plans
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Nursing Home Costs
Rental Income Retirement Income Long Term Care Insurance
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Dealing with Transition
The best laid plans often go astray.
Never has this been truer than with farm transition planning.
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1. It must be updated periodically.
2. It requires an impetus at time of implementation. (Who’s in charge of starting the transition)
3. The owners must deal with the emotional issues of change. (The Hero’s Farewell by Jeffrey A. Sonnenfeld).
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Final Tips
Volunteer to be the quarterback. Start Now Communicate openly with family
members about the transition goals and plan.
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Establish a vision and execute the documents to enable it to happen.
Deal with family equity. Select advisors and empower them to
do their job.
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Build a plan that makes you feel comfortable, and makes your family members feel they are being heard.
Implement the tools that you feel are necessary to reduce the risks in the plan.
Review the plan regularly.
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Thank You!
Thank you for attending today. Please fill out the evaluation form.
