If you thought your estate plan was all set and up to date, maybe you need to review it in light of two recent occurrences. Last year's changes in federal tax law, coupled with the recent run-up in land values to lofty levels, are creating estate planning issues that many farm families need to consider.
Neil Harl, professor emeritus of economics and ag law at Iowa State University, says you may want to give your attorney or estate planner a call and review your situation. Harl has held meetings with attorneys and estate planning professionals this fall providing them with an update on tax issues. He's talking about what you need to be aware of in dealing with the exclusion rate on the federal estate tax and how you can use that provision to your advantage in your plan.
"With farmland prices as high as they are today, you may have an estate tax problem and not realize it, and there may be some ways you can avoid that or at least improve the situation," he explains.
Tax law changes and rising land values affect estates
"We've talked for years about the problem of the spouse dying first and the effects on their estate," explains Harl. "It's usually a situation where the couple hadn't done much planning and hadn't thought a lot about the fact that the ownership was not evenly divided." The problem has been if the spouse without much property died first, then you can't take advantage of what's left of the $5 million "applicable credit amount," as the exclusion is now called, at the second death.
Congress started listening to this situation and began talking about portability, five or six years ago. The portability provision was finally put into the tax bill that passed and was signed into law in December 2010.
Harl gives the following example of how this works. Assume the wife dies first, unexpectedly, owns very little property and her husband dies a year later. It used to be there was no benefit from the wife's unused $5 million applicable credit amount or exclusion. But the 2010 law has a provision in it, called portability. It lets the estate of the second spouse who dies, use what is left of the applicable credit amount from the estate of the first spouse to die.
"This provision kind of bails out those folks who didn't do a lot of planning," he notes. "We already could take care of the situation where the spouse who owned most of the property died first, because that was solved with what is called the marital deduction, a provision of the tax law that has been in effect for a long time."
But the tax law didn't provide for the other possibility, to take care of the situation where the spouse who doesn't have much property dies first. "Now, you need to realize there are some important requirements here," says Harl. "That's what is causing a lot of concern and interest focused on the need to review and possibly make some adjustments in your estate plan."
This new provision is only for people who die after 2010
To take advantage of this new provision, the first spouse to die has to die after 2010. This new provision is not for those who died before 2011. It's only for those people who die after 2010.
Harl adds, "You also need to realize this new provision is really only for two years. The death has to occur before 2013 because this is part of what will sunset at the end of 2012. But I think there's a fairly good chance Congress will extend this provision. So I wouldn't worry too much about having to have the second spouse die before 2013, because I think this provision will probably be extended."
Several key points to be aware of on the exclusion issue
First, keep in mind the first spouse has to die after 2010, says Harl. Second, you have to file a federal estate tax return with the first death, even though there weren't enough assets to require a federal estate tax return to be filed. It's a fairly bulky form but it won't be quite as complicated for those folks who don't have a lot of property. Third, you have to elect to let the surviving spouse use the remaining amount.
Also, it's important to realize that the surviving spouse shouldn't re-marry, at least to a well-to-do spouse. That's because if the new spouse dies, before the surviving spouse dies, it could cost you what was left over from the death of the first spouse.
"People need to think about this last point, in terms of what they do after the death of the first spouse, because it refers to the last deceased spouse," cautions Harl. "You have to be careful who your last deceased spouse is, whether it is someone who is wealthy enough that they already used up their $5 million exclusion or whether it is someone who has a lot of property. You could use their remaining amount, but you can't add these."
The way the provision was proposed originally to be put into the law, it would have allowed you to stockpile these exclusions--have multiple spouses over a period of time, and stockpile what was left of each one's $5 million. But that is not possible now. The language in the final version was changed so the law now says "the last deceased spouse."
What will happen to existing estate plans after 2012?
The big concern is what's the future of these new estate planning rules? What's going to happen after 2012? That's only a little over a year away.
"There's not much being said yet in Washington about this," says Harl. "We do know that the estate tax law we have now sunsets at the end of 2012. If the new provisions that are currently in effect are allowed to sunset or expire, it would take us back to the law we had in 2001, which allows for a one million dollar applicable credit amount, at a 55% rate, and a new basis at death."
It's not clear what Congress is going to do. Harl thinks most likely they'll keep the $5 million exclusion and the 35% rate and a new basis at death. There are some people in Congress who would like to repeal this provision totally, there are some who would like to pull it back to the 2009 level of $3.5 million, and there are some who would like to keep it at $5 million, pretty much what we have today.
Changes in federal estate taxes are far down on the priority list of things causing immediate concern for lawmakers in Washington these days. They're more focused on where to cut federal spending right now. But estate tax laws are also a big issue that will need some action.
A lot of time and expense goes into estate planning
This is getting to be crazy, having to review and rewrite estate plans because congress keeps changing the law. A lot of time and expense goes into writing estate plans and there are a lot of issues that have to be covered and a lot of this has to be set down in stone for farmers' estate plans. Yet here we are with a sunset coming up at the end of 2012?
Harl answers, "We think it is important, as you get into 2012, you need to talk with your estate planner, your attorney and your CPA. Also, get an idea of where you are in terms of the property values of your estate."
Things are changing rapidly, not just in the tax rules but land values are rapidly rising and this is striking. "Those people who we didn't think had much of a problem with their estate plans are going to maybe end up, if land values stay on their current upward trajectory, with estate tax liability problems," says Harl. "These people need to have more concern than they've had in the past."
What's the most likely scenario? What about the basis?
What is the most likely scenario of what could happen with this exclusion provision in the federal estate tax law? Could we see an extension of what we now have from Congress? "Yes, we could see an extension," says Harl. "And right now by a fairly small margin, I think that might be the most likely outcome. That is, a continuation of the $5 million exemption and 35% rate and a new basis at death.
For most farm families, the basis is the big issue. "That's what we really need to keep our eye on," says Harl. "I think Congress is now aware of this; they weren't in 2001. But I think they are now and they realize 98% of farmers don't have to pay federal estate tax. Farmers are all concerned about basis because that means getting a new start, tax-wise at death, so the heirs don't have to go all way back to 1940 or 1950 when the farm was bought and use that figure for figuring the gain on sale."
So if you've had a death within the last 9 or 10 months in your family, you need to be on top of the spousal change, and you also need to be aware of what could happen in the next 15 months, watching for what Congress eventually does.
For deaths that occurred in 2010, important deadlines
"I'd like to add one footnote," says Harl. "For people who died in 2010, there are some very important deadlines. And those deadlines have just been extended again. So depending on which way you want to go in handling the income tax basis for death in 2010, you need to watch the deadlines."
One deadline is January 17, 2012 for filing the form if you want to use the so-called carryover basis provision. "Or if you would rather use the tax provision we had in the past, new basis at death, it's less complicated," says Harl. "Watch those deadlines and be sure you have the right option for your situation."
NOTE: ISU professor emeritus Neil Harl has published a newly revised 16th edition of his popular book, "Farm Estate and Business Planning." It is available in print and in all forms of eBook. The 454-page softcover book is a guide for farmers and ranchers who want to make the most of state and federal income and estate tax laws to ensure the least expensive and most efficient transfer of their estates to their children and heirs.
"This edition is rather special," says Harl, "in light of the tax legislation passed and signed into law in December 2010." The book has extensive coverage of that landmark legislation and updates the 26 chapters with recent developments in farm estate planning and business planning since the 15th edition was published in 2001. The book is easy to read and is designed for farm families. The book can be downloaded from the Agricultural Law Press at www.alp.omnistorefront.com. Or email Robert@AgLawPress.com or call 360-200-5666.
For farm management information and analysis, go to ISU's Ag Decision Maker site www.extension.iastate.edu/agdm and ISU Extension farm management specialist Steve Johnson's site www.extension.iastate.edu/polk/farmmanagement.htm.