Estate Planning for Your Farm Business

June 14, 2022

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If you own land or run a business on that land, it is imperative that you look into estate planning for your farm business. If you intend to pass your estate down through the family, you need a solid succession plan to transfer assets and operations to them. Long gone are the days when little to no planning was necessary for passing down a farm. With today’s taxes and regulation, estate planning for your farm business is a must.

I know, I know… when you are busy running your farm business, farm estate planning is at the bottom of your priority list. But don’t wait to plan your estate! Some find it surprising that estate planning is a long process, especially in the world of agriculture. If you want to set up a proper estate plan that will ease the transition of ownership, the time to start estate planning for your farm business is now.

Table of Contents:

One client’s story (to learn from)

Here is a real story from a small business owner client of mine that occurred this past fall. One of my clients has a multi-general family business. And by multi-generational, I mean his business employs not just himself and his wife. His children’s and grandchildren’s families are all employed by this business. 

One day, myself and the accountant working on the estate planning for his farm business were so close to wrapping it up. Then, I got a phone call that my client was on his way to the emergency room due to a stroke. At that moment, the accountant and I had to snap immediately into professional mode. He had not signed any documents yet. As we were driving to the ER we had to concoct an emergency plan on the spot.

Admittedly, this client began his succession planning years too late. However, the accountant and I had begun working on this company’s succession plan 18 months before the incident occurred. 18 months may seem like a long time to work on a project. But it goes to show that you can never start your planning too early. 

Luckily, the story ended well for my client: he pulled through the stroke. However, if the story had not ended so happily, his children would have been left with a misworded trust. It likely would have created nothing but strife in executing, probate at worst. And unfortunately, this scenario is far from rare. 

The takeaway? If you have a business, (especially if you have a spouse or children) you must have a succession plan in place. 

Why does it matter if you have an estate plan?

If you don’t have an estate plan for your farm, your assets will go through the state’s automatic procedure called “probate.” This is the state’s way of determining the where’s, why’s, and what’s of how to distribute your estate.

This means that your heirs (even if everything is amicable), will have to hire attorneys to represent themselves. This process will take time and money. For example, Prince’s estate took his heirs years to settle his estate…which also means years of legal bills. 

If expensive legal bills aren’t bad enough, an unplanned transfer will be more costly due to taxes and regulations. For example, a giant tax estate bill. These costs are especially difficult because of the nature of farm business. If your family is in agriculture, you know farms are asset rich and cash poor. With these liquidity issues, most unexpected farm transfers are doomed to fail.

If you haven’t created an estate plan that allows your family to pay for the expenses associated with a death. For example, medical bills, attorneys, accountants, federal estate and state death taxes, etc. They may be forced to sell some of the farm assets for low rates. Selling assets at a loss that are crucial to operations would be devastating to the farm business. Especially at such a drastic time of change.

Losing the farm business you’ve put years of time and money into is all too common, However, it is easily preventable with some estate planning for your farm business. An estate plan mitigates the uncertainty that surrounds an estate transition, which is so important when emotions are high.

Do you need estate planning for your farm business if you already have a will?

If an estate plan is so important, why not just use a cheap online service to quickly draft up your will? For starters, you need more than a will. Just having a will subjects your remaining family members to the probate process discussed above. 

Second, I cannot tell you how heartbreaking it is to walk a grieving family through the process of having to go through probate to sort out what their deceased family member wished to have happen with their estate….except, said family member decided to go the cheap route. 

Cheap actions = cheap results. Something as important as your estate, and protecting your family when you’re not here to do so yourself, warrants critical consideration. Critical consideration occurs when you actually sit down with an attorney to get your affairs in order….not a computer program.

Similar to misconceptions about wills, some people assume that joint accounts and beneficiary designations will have the same effect as an estate plan. This is another big mistake. Assets inherited through a life insurance beneficiary policy are a part of the taxable estate. The unequal distribution of the tax burden to your beneficiaries can create unfair inheritances.

If your jointly-owned property is in a U.S. Department of Agriculture program, you may miss out on some of those subsidies. Plus, of course, jointly-owning your farm means giving up a degree of control over your farm’s business operations.

As stated previously, it’s absolutely critical that you have your estate plan in place, particularly if you are a land owner. What happens to your estate if you were to pass unexpectedly? The sad truth is that most family-owned farms don’t survive past the first generation. That’s why estate planning for your farm business is so important to its future success.

Where should you start when planning your estate?

Hopefully, we have convinced you by now that estate planning for your farm business is absolutley necessary. So where do you start? What steps do you need to take to build a proper estate plan?

Sit down with an attorney in your area who is experienced in farm estate planning.

Estate planning for your farm business typcialyl starts with a discovery meeting. Your attorney will learn all about your business (assets, employees, operations, financials), and what you envision for the future of your farm. 

Your vision for the future will determine the trajectory you business needs to follow. If you plan to sell your farm business upon retirement, you need to focus your work on maximizng the value of your farm as much as possible. Doing this will give you the ebst chance at selling it for the price you want. On the other hand, you need to minimize the farm’s value when passing it down to a faimily member so that asset transfer will incur the least amount of taxes. 

When deciding to pass down the family farm, it’s the earlier, the better. That’s because a smooth transition can’t happen overnight. You need to teach your successor how to manage the farm effectively. You also have to prepare yourself to let go of the reins, which may be harder than you think.

Before handing over your farm, consider the following:

What’s does you health situation look like? Both physically and financially? How long can you reasonoably run the farm? Are you emotionally ready to retire from your farm business? Evaluate your level of financial secruity and your plan for retirement. Find more tips on preparing for retirement below.

What is the financial status of your farm? Is the farm generating enough income to support the family that will inherit it? Will you be able to assist the inheriting family financially or physcially)? What is their financial situation? How could you increase the farm’s income before succession? 

How will you balance relationships? Are you willing to sell some of your assets below market value to help out your family? How will transfering the farm to one family affect other members of the family? 

How will you divide the family farm?

There’s a reason they tell you not to mix business and family. It can get tricky managing business and familial relationships. However, building a legacy for your family can be so rewarding. When estate planning for your farm, consider how to maintain favorable relationships.

Maybe you have some children who want to inherit the family farm and some who don’t. So how do you split up assets fairly? Consider your family members’ roles in the farm business today. 

For those that play an active part in maintaing farm operations, you may consider giving them a larger percentage of assets and control of operations. Their first-hand knowledge will be necessary in keeping up with the farm business and they have already invested their time in helping out. For those less involved, you may consider allotting them a smaller percentage of the business.

What role do trusts play in estate planning for your farm business?

Trusts allow you to hold and manage your assets during your lifetime and then distributes them after death. Trusts often play a big role in your estate planning for your farm business. They are made up of four parts: the farmland or farm business, the farmer or their representative, the beneficiaries, and guidelines for how to use the trust.

Different types of trusts offer their own advantages and disadvantages. A revocable living trust can be enforced before and after the death of the farmer. It is flexible and amendable. In contrast, an irrevocable living trust can’t be changed but can be used before the farmer’s death. A testamentary trust can only be in effect after the farm business owner’s death. It’s used to shield assets and reduce estate taxes.

Keeping your estate plan up to date

Once you’ve established an estate plan, you will need to update it every so often. Updating this plan as changes occur will ensure that your estate plan is still enforceable when it comes time for transfer.

Changes that require updates to your plan include births and deaths, marriages and divorces, bankruptcies and lawsuits, and modified and repealed laws. Notify your attorney of these changes so that incremental adjustments can be made instead of having to restart the estate planning process in the future.

What documents do you need to start estate planning (personally?)

As I learned from hands-on experience this summer, one of the most important steps a business owner can take is to ensure that their personal estate is in order, so that their failure to plan personally does not have a ripple effect on their business. 

A shocking amount of families do not have their estate plan in place (one study by Caring.com estimates that 58% of adults in the United States don’t have an estate plan). More than this, recent cases in pop culture further highlight this issue. In the summer of 2018, Aretha Franklin passed away without a will, leaving an estate estimated at $80 million.

So what do you need to have to have a satisfactory estate plan?

  • First, you need to consult with an attorney in your state to see what options will be most appropriate for you
  • Second, you should consider forming a trust. According to Black’s Law Dictionary, a trust is “an arrangement whereby a person (a trustee) holds property as its nominal owner for the good of one or more beneficiaries.” Think of it this way: it’s comparable to creating a “corporation” that holds your assets for you. In literal terms, it’s a document that will explain exactly what you want to happen with your assets when you pass. Everything will be predetermined, so that your heirs are not left with disputes during such an emotional time.
  • Third, you should consider what is called a “pour over will”. This is a document that essentially states that anything you might have accidentally left out of the trust should be distributed according to the terms of the trust.
  • Finally, you need to make sure you have two incredibly important documents: an Advance Directive, which Black’s Law Dictionary defines as a “written statement of a person’s wishes regarding medical treatment, often including a living will, made to ensure those wishes are carried out should the person be unable to communicate them to a doctor”, as well as a Power Of Attorney, in the instance that someone needs the ability to make decisions for you. 
  • Like I said, these are all conversations that you need to have with an attorney in your jurisdiction. I merely want you to know that if you do NOT have an estate plan in place, your estate would be subject to probate; which can mean that you are leaving your family (including your children) with the travails of probate. 

What documents do you need to start estate planning for your farm business?

Finally, if you are a small business owner, you also must consider how your farm business plays into your estate plan, and into your estate planning.

If you own a business, you need to start with considering these seven factors. 

  1.  What are your goals for your business? How long do you anticipate running your business?
  2. The answer to #1 can’t be you forever- who is your successor when you step aside?
  3. Do you have any documentation with partners, co-owners etc, such as a buy-sell agreement that defines who is to take what, and what circumstances define your incapacity? 
  4. Have you established a trust, within which you’ve moved your shares of your business, so your business won’t go through probate?
  5. Do your governing documents (operating agreement, corporate documents, etc), address what happens if you are incapacitated? 
  6. Have you met with your accountant and financial advisor to determine what steps to take financially to make your plan work?
  7. Finally, have you met with an attorney to make sure you have all legal documents in place that you will need? (Trusts, buy-sell agreements, etc). 

What should your estate plan include?

  1. Build a solid foundation now. Make sure that you properly structured your business from the outset. For example, if you have an LLC, make sure you have an operating agreement that allows the business to be independent of you, so that when you exit, the company can continue to function. 
  2. Contracts (specifically, buy-sell agreements) Make sure your regular client contracts contain terms that allow for “incapacitation” or options to cure. But more importantly, if you have any sort of partners (even minor partners) in your business, it is imperative that you have a carefully structured buy-sell agreement. A buy-sell agreement will define what constitutes incapacitation; how will you value the business and how will you sell the business if you must exit. Buy-sell agreements are some of the most important documents a business owner can have. They are also some of the most detailed documents you will need. 
  3. Identify key persons. Identify not only the key roles of the business and your team, but who your successor will be (and how you will determine that).
  4. Create your estate plan (i.e., get a trust).
  5. Document your account details. Keep records of your key advisors, your bank accounts, etc. 
  6. Write out your succession plan. Meet with trusted advisors, such as your CPA, Financial Advisor, and your estate attorney to ensure that your business can be handled according to your wishes in your absence along with your personal affairs as well. 

How to plan for retirement 

It’s never too soon to start planning for retirement. Tax minimization can be especially hard for entrepreneurs, who have to keep up with tax law and investment strategies while managing a business.

Note: we derived this section from our friends at Provident CPA and Advisors, a tax firm we recommend to all of our clients.

Even if you’ve been doing everything you can to plan for retirement, expenses can add up fast if you don’t prepare yourself in every area. Unfortunately, taxes can be one of the biggest, unexpected expenses for retirees.

Retirement planning can be especially challenging for small business owners. It’s easy to focus on growing your business in the present and deprioritize saving for the future. Even more challenging is saving the same amount each month when you’re not sure if you’ll be making the same kind of money from one month to the next.

Keep these considerations in mind when planning for taxes in retirement

Retirement accounts: Better to pay taxes now or later?

First of all, understand the types of retirement accounts available to you and their advantages. A big benefit of a 401(k), 403(b), or IRA is that you can avoid paying income tax on contributions now. For the self-employed, who may not have access to an employer-sponsored, traditional 401(k), a Solo 401(k) provides similar benefits. These solo accounts are often used by those who run a business with no employee program, and they can cover you and your spouse.

Of course, the above examples are tax-deferred accounts—avoiding income tax now but paying taxes on that income later, when you’re in retirement and receiving distributions.

This is how a Roth IRA can provide big benefits once you’re in retirement. You pay taxes on this money now, so the income you’re receiving in retirement is tax-free. Roth IRAs can be a good option for the newly self-employed or those with new farm businesses. They take advantage of the tax bracket you’re in now when you’re starting out, verses when you’re in retirement.

That said, many people start saving for retirement assuming that they’ll be in a lower tax bracket when that time comes. However, that may not always be the case. Required minimum distributions on your tax-deferred accounts require that you start withdrawing money when you’re 70 ½, even if you don’t want to—so this added income can push you into the next bracket if you have significant income from other sources.

A Simplified Employee Pension Plan (SEP-IRA) is another option to consider if you’re an entrepreneur. This account is an IRA that gives business owners a simpler way to contribute to both their own retirement savings and their employees’ retirement savings. You can contribute up to 25 percent of your annual compensation, with a cap of $56,000 in 2019. That’s almost 10 times the amount you can put away with a traditional IRA ($6,000 if you’re under 50, and $7,000 if you’re 50 or older).

However, these accounts are generally better for the self-employed or those with few or no employees, since the percentage of your compensation that you contribute to your plan has to be the same percentage you contribute to your employees’ plan.

Banking on yourself with life insurance

Life insurance is more than just protection for your family after you’re gone. There are certain benefits that you can take advantage of along the way, including avoiding taxes on investment income. One strategy to help you build your retirement savings but avoid a big tax burden is to use tax-free loans from life insurance earnings. You are essentially borrowing money from yourself instead of a lending institution, and then paying yourself the interest plus repaying the loan to your life insurance policy.

This benefit is possible because your life insurance policy has been financed with money that’s been taxed, meaning its growth and your access to the funds are tax-free. Another benefit is that this money doesn’t have the required minimum distribution requirements that other retirement accounts impose.

Defined benefit plans, cash balance plans, and more considerations

Defined benefits and cash balance plans differ from IRAs and 401(k)s in that they allow you to make larger contributions for retirement. Those contributions lower your income and thus lower your current tax burden.

There are of course many considerations for retirement planning outside of tax obligations, such as creating a will and a healthcare directive and assigning a financial power of attorney. But tax minimization is key, allowing you to realize huge savings that can be used for things like housing, travel, and healthcare in retirement.

Conclusion

It is never too early to begin estate planning for your farm business; whether you’re married or single, have kids or not, if you have a farm business, you simply MUST have your affairs in order. If you don’t, you’re leaving your loved ones with a lengthy, expensive, and heart-wrenching probate process to fight through.

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