Farmers have a lot on their minds as they finish planting, feed cattle, cut hay and manage countless other tasks. Since lawmakers started discussing new tax legislation, my clients have often mentioned another worry — how to prepare a farm for potential estate and inheritance tax changes.
Congress has multiple tax proposals on the table. Unfortunately, my crystal ball is broken, which leaves us shooting at a moving target. No one knows what will ultimately be signed into law. That said, you should take some time now to ready yourself for possible shifts in U.S. tax policy.
Expect changes to tax codes
The current tax code will look different. Unfortunately, we just don’t know how much change to expect.
Current proposals include reworking some of the tax brackets and thresholds, raising capital gains rates, lowering lifetime exclusions for gifts and estates, eliminating stepped-up basis, removing 1031 like-kind exchanges, and taxing transfers to family.
Your specific situation will dictate how these changes would affect you, but let’s walk through some potential situations that could happen if certain proposals become law:
Assets. For one, as the lifetime exclusion steadily increased in recent years and with portability between spouses, use of “his-and-her” trusts changed. Given some proposals, spouses may find it advantageous to separate assets.
Farm structure. Restructuring capital gains rates’ preferential treatment will affect succession and transition planning as the next generation takes over the business. Changes in how the net investment income tax defines income from a business may affect S corporation owners and LLC members.
Gifting. Whether stepped-up basis survives congressional negotiations will affect your decision to gift the farm to your heir or pass it as an inheritance. Current proposals not only affect the estate tax, but also the income taxes of the surviving spouse and heirs. Land isn’t the only item to benefit from stepped-up basis. Also consider crop, livestock and machinery values.
Eyes on capital gains tax
Farm country possibly feels most concerned about the proposal to tax capital gains when assets transfer to heirs through gifts or upon death.
Under current proposals, the first $1 million of transfers would be exempt. Transfers valued beyond that would have capital gains assessed just as if the assets were sold, even though they weren’t.
If you leave your heirs farmland, livestock and machinery, then the capital gains on each would need to be paid. However, heirs who keep assets wouldn’t have the cash flow from sales to cover the taxes. Would this require selling the farm to pay the tax?
This new tax could be deferred for “family-owned and -operated” farms. How that term is defined will become vitally important. Will it only include lineal descendants? If you leave farmland to your kids and they want to keep it but rent it, will this arrangement count as family-operated?
Of course, the deferred tax — presumably with interest — would be due as soon as the land wasn’t operated by family.
You can take action
Proactive farmers have asked if they should act now while under current law. Unfortunately, we don’t know whether new policies would apply retroactively. At least one proposal would affect transfers made after Dec. 31, 2020. It’s dangerous to jump and find out later you shot yourself in the foot.
Unless your crystal ball is in better shape than mine, you won’t know how to proceed until we get more clarity. However, you can take two important steps now:
1. Talk about transition. You and your spouse should spend a little time to consider your assets and develop a plan for how you want to treat your heirs.
2. Find an estate attorney. If you aren’t already working with an estate planning attorney, then you need to find one today. This is critical because you may only have a short time to make changes to your estate plan after Congress passes legislation. If that is the case, then all attorneys worth their salt will be overwhelmed assisting existing clients who are scrambling to make changes, and you’ll have an impossible task if you try to get a first-time appointment. Do your homework now, and find someone you trust to advise you.
If you want to pass your farm to the next generation, then get organized, and prepare to make educated decisions quickly if necessary.