The STEP Act, the 99.5% Act, and the American Families Plan are all proposals that could fundamentally change the rules for tax and estate planning. Concerned farm families are calling in daily asking, “What do we do to protect our farm if the tax law changes?” That’s certainly a relevant question! But is it the best question to ask right now? If you have a typical will, revocable trust, or no plan at all, you might be missing an opportunity. I think a better question is, “What’s the one thing we CAN do today to that makes it easier to adjust and protect our farm if tax laws change in the future?” It’s a subtle, but important difference. My answer might not be what you expect.
Sure, we could talk about specialized trusts that freeze the estate value or remove assets from the estate. We could also talk about entity structures, qualifying for discounted valuations, and gifting strategies. (Actually, we do talk about these topics inside our GPS GROW Video Library. Click here to learn more.) The truth is, picking the right tools will depend on your specific situation, how the final tax law shakes out, and whether the laws become retroactive.
I’ve never been a fan of abdicating personal responsibility to just sit and wait on a government response. However, overreacting to the proposals right now could create a whole new set of problems in the future.
That’s why I believe the most important thing that you CAN do right now is to lock in on a solid farm succession plan. That is true even if it’s just a temporary plan to get you another five to ten years down the road. Here are four reasons why:
Reason #1: Historically more farms have broken up due to family issues than taxes.
Think about it. I bet you know of more farms that were sold because of family disagreements than taxes. Here’s some quick math. Let’s say a family has 1,200 acres split between four heirs. The farming son was paying the parents $225/acre in rent until they passed away. If the ground was worth $10,000/acre and he bought the three siblings out for $9 million on a 20-year note at 5% interest, his land payments amortized across all 1,200 acres would be $600/acre. By the time you add in $25/acre property tax his land cost almost tripled his previous rent, and he’s not gaining any more dirt than before! Would that ‘plan’ work for you? Your acres or land values may be different, but the ratios will work the same.
So even if you ‘beat’ the tax man for your estate, but the farm broke up because there wasn’t a cash-flowable plan to keep it together, did you really win? Remember, the final tax law probably won’t look exactly like the proposals, and you may live to see multiple revisions of these laws before your estate is distributed. Regardless of taxes, you still have the farm succession problem to solve. (And there’s a lot more to address than just cash flow!) Figure out the farm succession strategy that fits your farm and family situation best while you are waiting for Congress to act. You’re going to need it anyway!
Reason #2 – When gifting, you need to start with the end in mind.
Families have called in wanting to gift half of their operation to the kids today because they fear what the government is going to do. I completely understand, but you better think through the 2nd and 3rd order consequences of your gifting strategy. This includes:
- Gift recipients assume your cost basis on the gifted assets. This guarantees no step-up in basis upon the parents’ death. That’s not a problem if no one sells, but it could also be a missed opportunity.
- Income follows ownership for land and flow-through entities. If you gift your land base away, you should think through its impact on the resulting cash flow.
- Gifting equity away will impact your collateral allocation for current and future loans. Will split ownership among the kids on gifted land make financing easier or harder? Talk to your banker.
- If you set up a land holding entity and then gift the entity to the kids, does it make sense to comingle everything? Or would the farm heir benefit by having sole ownership on some farms?
I am not opposed to gifting and there are solutions for each of these issues. I’m just suggesting you need to think it through. This short-term thinking didn’t work out well for families who feared that the estate tax was going to $1 million due to the 2012 Fiscal Cliff. Their rushed gifts conflicted with their ultimate farm succession goals for their kids. Some also set life insurance policies up in Irrevocable Trusts that couldn’t be changed. They found out both were hard to unwind when the tax law settled and Congress actually INCREASED the estate tax to a higher limit than ever before ($5 million + inflation, per person).
If you’re going to try to gift your way out of a tax burden for your estate, then do it with the end in mind. In other words, your gifting strategy should be coordinated with your farm succession strategy. That means you need to get your farm succession plan knocked out first!
Reason #3: You don’t want to succumb to decision fatigue when the new tax law hits.
If you feel overwhelmed making decisions today, do you really think your decisions become easier once the new tax law gets passed? It’s going to take some time for advisors to figure this stuff out. Imagine every other family in scramble mode wanting to ‘just get something done’ at the same time. It could be a mess.
If you want to successfully transfer the farm to the next generation, you need to have a farm estate plan that addresses these three components:
- Estate Management Strategies
- Farm Succession Strategies (including funding options)
- Navigating Family Dynamics
Now let’s say you focused on your farm succession strategy today. It was coordinated with your core estate strategies and it was designed with the family relationships in mind. The only thing left would be to focus on tax reduction strategies, if needed, based on what laws get passed. Everything else is knocked out! This means your mind will be clearer for making those decisions without sacrificing or messing up your farm succession plan.
Now let’s flip it. What if you took the wait and see approach? I am concerned that families who wait and start from scratch to do ALL of this, while feeling the pressure of fundamental tax law changes, in the stress of the ag markets, in a politically charged environment, where advisors time is limited… well that’s the framework for making less than awesome long-term decisions. Again, think back to the to 2012 Fiscal Cliff. I believe the current environment is potentially far more difficult.
I fear that too many good farm families are going to burn out from decision fatigue at that point. Or they’ll make rash decisions and sign whatever papers they need to, just to make the tax pain go away. They’ll fall short of the true farm succession planning that they really need, and they’ll have a false sense of security because ‘at least they did something’.
Reason #4: Effective stewardship focuses on what is important and in your control.
Where are you focusing your energy right now? Is it on the things that are important and within your control? Or are you spending time on things that are important but outside your control? What Congress does to the tax laws is certainly important. But it’s not in really in our control right now. So let’s focus on what you can control.
You can control how the family farm gets distributed to the next generation. You can establish the operating rules and viable exit strategies for your heirs. You can define what ‘fair vs equal’ looks like for your family so your heirs and in-laws don’t have to. You can coordinate your asset ownership and financial tools with your legal documents, so each component of your estate compliments your farm succession plan. You can control the expectations you set by the plan you develop and how you communicate it to the family.
All of these things are important and within your control, and they are not subject to congressional approval!
That is why I believe the best thing that you CAN do today to prepare for the potential tax law changes is to focus on your farm succession strategy. It is the lead domino you need to knock down so you can then focus on estate and tax reduction strategies. It’s the one thing that can position you to respond quickly and more effectively if (or when) the tax laws change.