The federal government wants to slow or eliminate generational wealth through a series of proposed new taxes and decreased exemptions. That was the message Michael Fraleigh, an attorney based in East Lansing specializing in business and succession planning, had for a group attending an educational session Aug. 18 at the AgroExpo in St. Johns, Mich.
The Biden administration, under the American Jobs Plan and American Families Plan, as well as Sen. Bernie Sanders, I-Vt., Sen. Elizabeth Warren, D-Mass., and others have multiple tax proposals that could greatly affect farming operations.
“There are proposals for raising the tax rates on income, capital gains and changing the rules regarding gifts,” said Fraleigh of Fraleigh Law Firm.. “But if I had to pick — the one most important thing or the scariest part of the proposals — it would be the transfer tax they want to impose,” he added, noting there is no current transfer tax.
The proposed transfer tax would be determined on appreciated assets. “So even if you have no estate taxes, [current $11.7 million lifetime exemption] Uncle Sam wants to tax the transfer of property out of your trust, out of your estate by will or by gift, during your lifetime at 39.6% of the value gained in the assets. That's in addition to any estate tax,” Fraleigh said.
The provisions being discussed also say that if assets are left in a trust, and not distributed, there could be a tax-deemed transfer every 21 years — 50 years is also being discussed.
“So there’s not going to be a way to leave it in the trust and not distribute it to the kids to avoid the transfer tax,” he said. “They're going to say if your trust was funded prior to 2005, they're going to do a deemed transfer tax [treating it as if you had sold it] in 2026 and every 21 years after. What they’re looking at is how much gain was added to that asset during that time, and they want 39.6%.”
Limiting asset transfer
The Biden administration, he says, does not want people passing assets from one generation to the next. “The concern, as it’s been reported, is that if your parents pass you $1 million in assets, and during your lifetime you grow it to $2 million for your kids, each generation down the line is getting an unfair advantage over other people,” Fraleigh explained. “My understanding is the government wants to collect those taxes and then redistribute them all through social programs.”
Under consideration is a 15-year window to pay the transfer tax (possibly with interest). However, to qualify, all the heirs must be actively participating in labor or management in the farming operation, Fraleigh said. “It's up in the air what happens when some of the heirs are farming and others are not. I’m not sure if that disqualifies everyone or just a portion.”
Another concern is that IRS debt will create a lien on the farm “That means if you needed that asset as security for an operating loan or to buy another piece of property, you're going to have to talk to your lender and see if they'll take a second position to the IRS — the IRS would get paid before the lender,” Fraleigh said.
Congress has a tendency to lump several provisions into one bill, he noted, and some of these measures may take immediate effect if it has enough votes. “It could take effect Jan. 1, 2022, but there’s also talk of making these provisions retroactive. I've heard dates as early as Jan. 1, 2021, and also sometime mid-April 2021.”
Now is the time to look at your financial, estate and succession plans, Fraleigh advised. “If your health is bad or you’re advanced in age, you may want to consider implementing part of your succession plan and the asset transfer this year before the law goes into effect, while you still have your $11.7 million exemption,” he adds. “There are proposals to drop that to $3.5 million or $5.6 million. If you’re going to get hit with that 39.6% transfer tax, it’s a pretty big financial incentive to do something about it now.”
Conversely, if a farm owner is in relatively good health, there is the option of waiting to see what gets passed, or if new leaders are elected who are more sensitive to the potential impact.
Another proposal aims to eliminate the stepped-up basis. The basis is the value of the property when it was purchased. Currently, the law allows for the basis to be readjusted to fair market value for land inherited upon death.
“If I bought land at $500 an acre and upon my death it was worth $1,000, the new basis would be $1,000,” Fraleigh said. “You don't pay taxes on it right now; you'd only pay taxes if it was sold for more than $1,000.”
If the stepped-up basis is eliminated, and the property is sold, capital gains would be due on anything over the $500 basis, he adds, noting some are predicting its elimination does not have enough support to pass.
There also are proposed changes on gifting money. Currently, $15,000 a year can be gifted to an individual without taxes for either party. There is no limit on the number of $15,000 gifts. One proposal seeks to limit gifting to $20,000 total without taxes, and no more than $10,000 per individual.