By Patrick J. Early, CPA
Somerset CPAs – Agribusiness Team
2012 could possibly be the end to the greatest opportunity in memory for keeping the farm in the family. Tax laws that were extended and modified at the end of 2010 are set to expire at the end of this year and if you own land, you may never have a better opportunity than now to move it tax free to the next generation.
Federal gift tax laws have long limited the value that could be passed down tax free to your children. Up until a few years ago, this amount was as low as $2 million (husband and wife). Up until to 2009, this amount steadily increased to $7 million. In 2010, the limit was temporarily raised to $10 million.
Will it be extended beyond 2012? No one really knows for sure but without positive action from Congress and the President, it will not. In fact, it is scheduled to go all the way back down to $2 million.
Since gift and estate tax rates are scheduled to go back to almost 50 percent, the potential family tax savings could be in the millions! If you own a farm, this may not be news to you, but many of the families we work with still have not done anything to take advantage of this window. Why? It can usually be summed up in one word – control. Most people are just not ready to turn over the source of their livelihood to their children.
But is there a way to achieve the tax savings without giving up control? In short, the answer is yes, but you have to be careful to make sure the transfers are structured in a way that still qualifies as a gift. Although there are many variations, there are two basic vehicles that allow this to be accomplished.
The first is the use of an LLC. The strategy is to first transfer the farm land into an LLC. The LLC would have two classes of ownership units – managing and non-managing. A typical model would have a small percent of the ownership in managing shares, say 5 percent, and the remainder in non-managing shares. On day one, mom and dad would own all of both classes of shares. On day two, they would gift shares to the children. The percent of shares gifted would depend upon the value of the shares and the desired ultimate gift, but the goal would be to use as much of the $10 million as possible. The makeup of the gift would primarily be non-managing shares, but gifting some managing shares is also wise. Although mom and dad can keep enough managing shares to remain in control, it is important that the children are involved in management. When the IRS successfully attacks these, it is because the transfer was just a sham and mom and dad are still running the farm exclusively for their benefit. Sometimes, fear of the IRS keeps families from moving forward with this strategy. Rest assured, it is a time proven strategy that, properly structured, has passed inspection many times.
LLCs may also offer the opportunity to discount the value of gift. Again, properly structured, this may allow you to transfer as much as $15 million of land and still be under the $10 million threshold. Your tax advisor will be able to explain this opportunity in more detail.
The second vehicle is a trust. Trusts are usually not as flexible as an LLC, but they come in all shapes and sizes and can typically be structured to accomplish the same thing. The basic model is to put the land into a trust for the benefit of the next generation. You can even use a Dynasty trust to make sure it is passed to generations after that. In order to count as a gift, the trust has to be irrevocable. That means once you have put the land into the trust, it belongs to the trust until such time as the trust document calls for it to be distributed out to the named beneficiaries. Mom and dad can serve as trustees so they still make all the decisions about the land. Again, this cannot just be a sham. As trustees, they have a fiduciary duty to the trust beneficiaries. Still, they retain control of all decisions relating to the trust asset so they are still in charge.
With both of these strategies, it is very important that you understand exactly what you are getting into. It is vital that you work with an advisor who understands all the pluses and minuses. This is not a set of documents you should buy over the internet and set up yourself. But when they are set up properly, they are powerful tools that may allow you to keep the farm in the family and potentially save millions in taxes.