Assess priorities before creating an estate transfer plan

GREENFIELD, Ind. — Just as political administrations and power cycle in Washington, D.C., so do proposals for funding the services of federal government. As the Indiana Soybean Alliance (ISA) Membership and Policy Committee and Indiana Corn Growers Association (ICGA) take on lobbying Congress on behalf of the state’s row crop farmers, the groups’ leaders need to hear from members about how proposed federal tax and estate planning changes concern them.

In May, the Biden administration released its 2022 budget along with “General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals.” Commonly referred to as the “Green Book,” this publication summarizes an administration’s spending and funding proposals.

While it has no effect of law, leading food and agriculture consulting and accounting firm K•COE ISOM explained the Green Book’s details typically shape conversations concerning tax legislation in the U.S. House and Senate. On June 10, representatives from K•COE – which has offices across the country – spoke at an ISA/ICGA breakfast in Greenfield to explain some of President Biden’s proposals with the potential to impact farm estate planning and taxation.

Estate tax proposals

One proposal is to change estate tax thresholds. K•COE Principal Kevin Beasley said current law allows an individual exemption of about $11.7 million for the transfer of property/estate to heirs by gift or upon death – value above that level is taxed at 40 percent upon transfer. Married couples can pair their threshold and double the estate value to more than $23 million.

“Every administration wants to change the estate tax laws,” he noted, adding this tax was created in 1916 in part to help fund efforts in World War I; before then, it didn’t exist, despite some of the nation’s founders wanting to institute estate tax in the late 1700s to prevent the rise of an aristocratic class as in Europe.

In 1916, the individual exemption for estate tax was $50,000 – this didn’t change until 1976, when it doubled. Within two decades, it climbed to around $600,000. Under former President George W. Bush in the early 2000s, Republicans began pushing back on the estate tax, trying to repeal it. Beasley said the Senate might have voted to do so in 2005, had Hurricane Katrina not struck and required cleanup funding.

“There’s nothing easier than taxing dead rich people,” he observed.

In late 2017 Congress passed tax reform that doubled the individual exemption from $5.5 million. Now, Biden and Congressional Democrats are talking about a reduction of the individual exemption to $3.5 million, or $7 million per married couple – the level it last was in 2009. Beasley said while Republican officeholders like to talk about repealing the estate tax altogether, it is not something they will likely do even when back in majority power.

He thinks Democrats are likely to reduce the $11.7 million exemption effective Jan. 1, 2022 – though by how much is unknown – and absent enough Republican support to pass their measure in the Senate, may do so through budget reconciliation. Reconciliation is how the Senate passed the COVID-19 relief bill earlier this year with no Republican votes – it requires only a simple majority (including any needed tie-breaker from the vice president), rather than 60 votes.

In late June, Senate Majority Leader Chuck Schumer (D-N.Y.) announced Democrats were working on two simultaneous infrastructure bills: A bipartisan compromise that needs 60 votes, including at least 10 Republican senators, in order to pass to the House for its vote; and a Democrat reconciliation bill, which would only require the simple majority 50 Democrats and Independents plus a tie-breaker from Vice President Harris as president of the Senate.

At the time of this publication, there was speculation the Senate might try to pass both bills, with the reconciliation bill filling in the projects negotiated out of the bipartisan bill.

Beasley said rather than only lobbying legislators to keep the $11.7 million exemption – which, left alone, will sunset in 2025 and drop to $5 million, indexed for inflation to 2010 (this sunset was built into the 2017 Republican legislation) – he thinks farmers should focus on asking lawmakers to enact provisions protecting the income of farms and other small businesses.

And even if a farmer thinks their operation including land, equipment and other assets is not worth enough to be taxed upon death, they should consider planning for the long-term. Beasley’s experience has been that an active farm’s assets will double, on average, every seven years.

That, combined with the uncertainty of how the estate tax exemption and taxes might be affected with each change of political power, means farmers are better off doing any (will/trust estate) plan, than not doing anything. “It is not wealthy people who pay estate taxes,” he said, adding they have financial and legal experts to help them use loopholes. “It’s uneducated people.”

Transfer taxes and gifts

One proposal currently in the Senate, dubbed the Sensible Taxation and Equity Promotion (STEP) Act, would tax any gain of over $1 million upon death. Cosponsor Sen. Chris Van Hollen (D-Md.) used the example that if someone dies holding a fair market-valued $6 million in property for which they paid $4 million, the heirs would pay taxes on $1 million of the stepped-up $2 million value – the legislation would exclude the first $1 million in value gain.

Van Hollen has stated the $1 million proposed exemption is to ensure the legislation would only apply to wealthy families and “protect small family farms and businesses.” He said existing tax laws would also shield up to $500,000 for personal residences and assets held in retirement accounts would not be subject to capital gains taxes. STEP would allow heirs to pay the tax due over a 15-year period.

Beasley called this proposal “scary” because it effectively eliminates the estate tax exemption and removes the gift tax exclusion, allowing a person to gift no more than $100,000 of their estate during their lifetime. Chris Pfannenstiel, another of K•COE’s principals, explained right now a person can gift a total of up to their individual exemption of $11.7 million in their lifetime – but if they gift under $15,000 per year per recipient, that does not count against this lifetime exemption.

Another proposal under consideration right now is to require estate assets in trust to be reassessed every 21 years and taxes paid on market-value gains as if the assets were being sold. Right now, he said there is no such requirement.

How much of what is proposed will actually pass, and what allowances might be carved out for farms, remain to be seen, Beasley noted. “I have not talked to a Democrat legislator who doesn’t realize there has to be an exemption for small businesses,” he said, adding he does not think Congress will allow the family farm to go by the wayside.

The question might become, what level of income or assets constitutes a “small” business?

While only a small percentage of farm estates exceed the current $11.7 million exemption, Pfannenstiel said all farm owners can use financial and legal tools to set up an estate plan that takes future growth into account and protects their heirs years later. Further, Beasley believes Biden and Democrats in Congress will make some changes to estate and income/business taxes this year, and farmers would be wise to prepare now.

“Get your estate planning done before they change these rules,” he advised, explaining the holiday season at the end of the calendar year is often a popular time for Congress to pass fiscal legislation.

According to the National Law Review, Biden’s budget proposal also includes raising the top federal tax rate from 37 to 39.6 percent on taxable income over $452,700 for single filers and $509,300 for marrieds filing a joint tax return, beginning with tax year 2022.

Too, it calls for increasing the corporate tax rate from 21 to 28 percent for C corporations. Pfannenstiel explained there are some farms that still operate as C-corps, but most are partnerships or limited liability corporations (LLCs).

Planning tools

One planning tool for farm estates is Section 1031 of the Internal Revenue Code (IRC), which allows landowners to use the proceeds from real estate sales to purchase new land without paying taxes on the sale income. Pfannenstiel said the Biden proposal is examining whether to eliminate this loophole, which allows farmers opportunity to sell less arable or desirable land and purchase better-quality or land closer to their central farm without tax penalty.

IRC Section 179 is another useful tool that allows farmers to immediately expense 100 percent of the cost of equipment and vehicles as tax deductions. He said the 100 percent allowance was enacted under the Trump administration and is set to begin winding down in 2023 by 20 percent per year. The Biden proposal does not include any changes.

Some general planning advice Beasley offered for farmers wanting to bequeath the most to their heirs is to use legal instruments to separate the land base of their holdings from the farm operations. This can help keep the peace between heirs who live off the farm and those who take over its day-to-day operations.

If a farm estate is valued over the exemption limit upon death, Beasley said the IRS must audit that estate, which takes an average of about two years. Having an estate plan in place can help avoid this, as can making small gifts to heirs during one’s lifetime and filing returns for this with the IRS.

He also emphasized while it is important to make out a will for your heirs, estate planning also requires a funded trust. Property willed without a trust may still end up in probate.

“If you don’t have some kind of a plan in place . . . you’re basically saying, ‘I’ll let judges and attorneys decide this,” he said. “If you don’t have a plan, somebody will have a plan for you.”

Another tip for keeping family harmony is to make certain your estate plan contains a buy/sell clause for each family member, so that if one wants out at any time this can be done without requiring the estate to be liquidated to pay them their share of equity.

Pfannenstiel advises being clear with your heirs about how you intend to turn over daily operations of the farm, and to whom. He has seen situations in which an adult child helped the parent farm for years, then left the farm for another job or moved because they didn’t realize the parent intended to turn over control at some point – or when.

“Make sure your descendants know you’ve done something,” he said.

Whether you decide to consult with K•COE ISOM or not, the firm does offer some free reading for planning purposes on its website at www.kcoe.com/insights

If you prefer videos, you can visit www.kcoe.com/kcoeisom-video-center

And to read the Green Book proposals for funding Biden’s American Jobs Plan and American Families Plan, go to https://home.treasury.gov/system/files/131/GeneralExplanations-FY2022.pdf