When it’s time to get out of farming, problems abound. Often times, the farm operator has equipment that has no tax basis left and high resale value. That triggers tax. Further, the operation is often left with the proceeds of a crop and if the habit of paying ahead on next years crop inputs is used to reduce taxes, the last year has no corresponding expenses to offset the income.
A million-dollar sale of iron means income of $1 million, all recognized that year. Then the regular income from the grain sales occurs. That is a tax bracket most farm operators don’t want to operate in. Many operators turn to the disappearing hedge row technique to slowly lose track of non-title equipment and sell it for cash or disguise by selling it under children’s names or simply failing to report the sale to their tax prepare and hope for the best. This plan is not a solid plan and fraught with danger. The modern farm operator will be held to modern farm standards. The ability to retrieve bank statements, auction purchase data and other data collection points means that Grandpa’s equipment distribution plan may not be a legitimate option for the current generations transition out of farming.
One option is the use of a charitable remainder trust (CRT). Like the name implies, a charitable organization gets the remainder of your assets, after you have a chance to use the revenue for a while.
Charitable Remainder Trust. There are four hats or jobs to a CRT, and the farm operator can put on three. The easiest is the grantor or person establishing the trust and puts the equipment or grain into the trust. The second is the Trustee, or the person responsible for managing the plan created by the trust. The third hat is the person who benefits from the plan. This can be the farm operator. The final hat is the charity, which cannot be the operator and who has to get at least 10% of the value of the assets put in to the trust.
The plan is then chosen. The two types of plans are CRUT and CRAT. A CRUT sets up a yearly payment to the farm operator based on a percentage of the assets in the trust (as determined each year of the trust). The second is a CRAT, which has a one-time determination of value and then a steady dollar amount or percentage is paid back to the beneficiary over the plan.
Why bother and what’s the incentive. When grain is moved into the trust, it is not a sale. The Trust then sells the grain and invests in stocks, bonds, cd, annuities etc. That gain from the sale is then spread out over the life of the trust. Because the trust is a tax-exempt organization, capital gains are deferred and the income tax on the sale of the grain and equipment is not the burden of the farm operator themselves. Further, the operator gets a charitable donation deduction on its tax return and shrinks the size of the farm operation for estate purposes. On the downside, the operator often notes that is providing assets to a charity and not keeping that capital available for the next generation. That loss of capital needs to be weighed against the loss of capital paid in the form of taxes.
$1 million equipment means a high tax bracket the year of the sale. By comparison, in the trust, the million is invested and the operator pays the tax on the annual income generated by the sale of these assets and in a lower bracket as time goes on and the operator’s other income fades.
There are costs to set up a CRT and annual expenses. The main question is often how much does the operator have to leave to the charity versus how much can the operator get back as a payment stream. The rule is 10% of the total contribution has to be there at the conclusion of the trust. The other question is, can the operator create a charity that controls the charitable uses? The answer is somewhat. Making a new charitable organization that only awards scholarships to left handed softball players from the local high school when the farm operator has three lefthanded girls is a bit suspect. The operator can choose its charity whether it’s the local 99 cent movie theatre, the ambulance service, the industrial development board or a church but should avoid telling those charities what movies to show, what ambulance to buy, what business to whoo, or who to pray for.
As we all look to the slowly dying crops and patiently wait for them to hit the optimum harvest condition, it is a good time to remember we are all slowly dying. Everyday, every hour. Yet we will never know when we reach optimum harvest time and depart. Like harvest prep, we can however, get our affairs in order to make transition as orderly as possible. Time to be blunt.
First, everyone, regardless of property status, wealth or relationship with children, needs a health care power of attorney and a general power of attorney. These documents are essential if you are incapacitated and need to have something done for you medically or financially. Everyone needs to pick a pinch hitter and a back up to the pinch hitter. Failure to do so will result in expensive court proceedings to name a pinch hitter. Do not leave it to guess. Name your spouse, name your child, name your neighbor (with their permission) but leave somebody in line to take care of your bills while you cannot.
A will is often the last directive a person gives. If you own real estate or have over $50,000 in assets you are going to need to have a directive on what goes where. If you do not, you will have the state of Iowa take guess for you. This can result in your second cousin that you never did like at the family reunions going out to eat on what is left of your retirement nest egg. Do not let the state give your stuff to your terrible 2nd cousin. Make a will, pick winners and losers and decide who gets the farm.
Don’t punt on tough decisions. Decide if your kids can own the farm together or decide who should get the farm and give the other children other assets. Do not expect the children to magically set aside their own personal goals and desires and do whatever it is that you hope they will. If you have a goal, invest in will/estate plan that makes those goals possible. If you have an adult child that is a perpetual criminal, spender, or has a physical /mental issue that impacts their ability to make a living, blindly giving them assets is not really planning at all.
12 percent of a plan is better than no plan at all. If you are not sure, get a base line plan and then modify it as you determine if your daughter’s desires to farm match her ability. Make the plan well before illness sets in. When you have trouble hiding your memory loss, its is too late to make a plan.
If you are single or divorced and thinking about getting married, whether you are 18 or 80, nothing says I love you like a prenuptial agreement. This document can be wielded like a club against those who whisper your partner married for money or land and make parting ways when thing don’t work out so much easier. Further, a prenuptial agreement can quash the concerns of adult children from the first marriage and hopefully stopping them giving the new partner the side eye at every family get together.
Tell your children your plan. So many times, people litigate because “Pop would be rolling in his grave and would never want Mom to reward the on-farm child with more assets than me.” If Pop spent an hour explaining to his son who moved away to South America when he was 29 why his sister gets more than 50 percent, it might save two lawyers, a judge and some witnesses from cluttering up a court room to figure out if Mom had he and Pop’s plan overridden by the sister.
Right of Refusals may no longer be Alright.
Once again, the Iowa Court of Appeals has ruled that a right of first refusal is not valid if it is not dealt with in some manner. While the court of Appeals isn’t binding on the entire state, it is persuasive authority and helps shape the legal landscape. This will come as a surprise to those who negotiated a right to purchase back a farm sold in the 1980s farm crisis or those who have entered into agreements for purchase rights as part of an estate plan or those who have an estate plan with a right contained in it.
It is wise to blow the dust off those documents and make sure what you think you have is what you really have for rights to purchase. Essentially, the court is saying that Iowa Code prevents the use of any right of refusal that is more than 10 years old unless a timely written statement of extension is in the county court house records. That is simply not possible in many cases where the parent died a long time ago and left the property to non-farming children, subject to the farm child’s right to purchase if the non-farming kids ever wanted to sell. It throws a number of things into uncertainty and may be a “gotcha” moment for the patient, displaced, former property owner who is waiting to see if once again they can reclaim what they have lost.
Right to Farm Laws don’t really mean you have a RIGHT to farm even if you are doing it right.
States have tried to address the conflict between urban development and ag uses for many decades. The fix was to enact “right to farm” statutes protecting a farm’s right to operate with the attendant naturally occurring sights, smells, and sounds. At this point, every state has some version of a right to farm law.
Right-to-Farm laws attempt to prevent nuisance lawsuits against farms that follow all laws and practices best for ag and who beat the complaining neighbor by being first to the party (I.e. the farm was there first Iowa’s statute specifically states that the purpose of the law is to prevent farmers who properly operate their farms from defending themselves from nuisance lawsuits. Iowa has a very tough standard on actually getting to invoke the right to farm defense compared to other states. Despite being an Ag state, the law, as interpreted by the Supreme Court, is not a robust shield for farmers, but rather narrow set of events that if followed may provide some protection. Some legal scholars have remarked that perhaps Iowa has one of the most non farmer friendly interoperation of right to farm laws.
Critics claim these laws hurt non-farm operator property owners by denying non-farm operators the right to use and enjoy their land. This issue is not going away. Every state has had their right to farm laws tested in various manners. It is not an open and shut case by any means. This uncertainty isn’t good for ag as operations get larger and less people have a connection to ag, the amount of risk goes up and as risk goes up, the cost of managing that risk goes up as well.
Yes, tax season is snow storms, turkey dinner and college bowl games away, but having an eye on the tax prize in July can yield benefits in the winter months ahead.
Some facts to consider, while the audit rate at 0.59%, certain actions can increase that chance of getting the governments all seeing eye pointed at your return.
Businesses that show losses for a number of years, especially for farm, hobby like businesses and real estate ventures are perpetual targets of increased review. Farm operations should do everything possible to show a tax return once every five years with a positive net income or be prepared to show how the farm operation is truly its own enterprise and not just a tax shelter for off farm income. Those with letters behind their names at work should take note, whether those letters are J.D, M.D, CFP C.P.A, or D.O.
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