This era of extraordinarily high grain prices has been a boon to some producers and a bane to others. But there is one commonality: major land inflation.
When an estate question arises, the IRS does not invite dialogue about what you think Mom's land is worth. Rather, it is a cold-hearted appraisal, looking at the most recent arms-length sales in your locality. So what does this mean to your estate tax exposure?
ESTATE TAX EXEMPTION. For deaths in 2008, the first $2 million of net worth is exempt from the estate tax.
As of Jan. 1, 2009, the exemption moves to $3.5 million. And then, in language of fairy tale proportion, the law reads that the estate tax disappears for 2010 and returns in 2011 at the old $1 million exemption.
But this is fiction of the highest order. No Democratically controlled House or Senate is going to let go of an estate tax that only touches the top 1%. Expect the 2009 Congress to perpetuate the present system, probably with an exemption in that $3- to $4-million range.
If net worth is above the exemption amount, the estate tax hits hard. The federal rate is a flat 45%. Most states join the feeding frenzy, but often with a smaller exemption. In those jurisdictions, the tab is usually more than 50%.
THE FUNDAMENTALS. There are two basic and generally inexpensive strategies that are particularly important for married taxpayers. First, give your wills a checkup. Is there a formula marital deduction clause that uses the exemption of the first to die?
Second, avoid the very common mistake of unbalanced estates. Is your net worth divided so that each estate uses its exemption regardless of order of death? Have your attorney carefully look at title to real estate, avoiding joint tenancy (which overloads the second estate) and watching beneficiary designations that also bypass the will.
THE FLP STRATEGY. We are increasingly finding that Family Limited Partnerships (FLPs) serve both farm succession and estate reduction objectives. Nearly every retiree with significant farmland faces the difficult dilemma of holding that land together for the son or daughter who is the farming successor, but yet trying to divide their estate among all children.
Here's the path: The senior generation drops the farmland into the FLP. The FLP becomes the landlord to Junior's farming operation. Because it is a partnership, initially there is little change in senior generation taxable income and cash flow.
The partnership units will largely be limited or nonvoting. And over time Mom and Dad move those units, generally as gifts to all the children, both farming and nonfarming. This moves a proportionate share of the rent to the children.
But the controlling voting units remain with the senior generation and the farming successors to assure that the land remains leased to the family operation. The partnership document will also contain buyout provisions, setting a formula and extended terms for any nonfarm heirs who wish to exit.
The nonvoting partnership units work well for annual gifts using today's $12,000 exclusion (versus gifts of a few acres of land each year). And the restrictions on these nonvoting units can allow discounting of their value for the gift and estate system.
If your objectives include both keeping your farming business together and your family in harmony, give this your attention.