Electricity has always intrigued me, from the very first time an electric fence tickled my belly as a little boy to the present. I have learned an immense amount of respect for the benefits it can provide and the dangers that can occur with providing it in the wrong manner.
My knowledge of electricity is limited (maybe like some people who thinks food comes from a grocery store). When the electrical switch is flipped and the power does not come on, then check the breaker. If the breaker is not the problem, then immediately call a trusted electrician to handle the situation.
This week’s derecho storm damaged countless farmsteads and knocked out electricity across the Midwest. The wide-based weather event reminded us that we take a lot of things (electricity being one of them) for granted.
We seem to have developed an immense amount of dependence on others for our well-being. We all know people who could provide for their well-being independently without fancy things like cell phones and electricity, and even without too many things from the grocery store or gas station.
Unfortunately, we also know people who would not make it long without “necessities” that our parents would categorize as “luxuries” and our grandparents would label as “unnecessary” as it didn’t even exist in their day.
This morning, I took a call from a family from western Illinois who are extremely interested in giving their entire estate away. It made me think of things that we can and cannot live without and how we all prioritize differently luxuries and necessities.
The married couple is in their early 90’s and have an $11,000,000 estate. They are convinced that after the election in November, the tax law will change and take away their lifetime of farm equity.
In review, the current federal estate tax exemption is $11,580,000. This is the amount that each U.S. citizen can pass either at death or while living via gift (or a combination of both) without a federal estate tax.
A married couple with good planning can pass two of these exemptions for a total of $23.16M without tax. There is a 40% tax if you transfer more than this amount (either at death or while living via gift).
This exemption amount was increased two-fold in 2018 (from $5,590,000 to $11,180,000) but sunsets back to $5,000,000 (plus inflation from 2012) on January 1, 2026.
This family is concerned that a new tax law will bring the exemption down to $3.5M per spouse or lower. They are also concerned about an additional state of Illinois death tax on assets above $4,000,000.
There are many things that you can do to prepare yourself for potential future tax law changes. The challenge for each family is to identify individual goals and gauge what level of planning they are willing to apply and at what cost.
The “wait-and-see plan” is best suited for people who have time to see what happens to tax laws in the future. Keep in mind, that only death and taxes are certain in this life. The wait-and-see plan may also go hand in hand with the “say-a-prayer plan”.
While waiting to see what the tax law does, you definitely should educate yourself to the worst case scenario just in case you are called to meet your maker while waiting in the estate tax law waiting room.
The “no-brainer” plan is to change the ownership of your life insurance policies out of your estate. Typically, life insurance is for the survivors (not the deceased) so owning it yourself on your own life adds to the value of your taxable estate. Life insurance is income tax-free. It is not estate tax-free.
The purpose of most life insurance is to create liquidity to pay debts, taxes or to fund a cash need for a business transition or buy-out. If this is the case, you do not want to create an even larger need for liquidity by creating more tax because your life insurance is owned in your estate. This is particularly important in Illinois where there is an extra state death tax and the exemption is only $4 million.
Options to change ownership include transferring it to children, or a trust or an entity where your ownership is small. All three of these transfers will reduce the value of your taxable estate but come with a multitude of other issues that need to be reviewed by your estate advisors. There is a pull-back of the value of the death benefit if you die within three years of the transfer of ownership of a life insurance policy.
The “dip-your-toe-in-the-water plan” sets up your estate for discounts by giving a very small percent of an entity (corporation, LLC, FLP) to your heirs or a trust for your heirs (depending on how much control you want to keep).
As an example, if you have $5,000,000 in land value (500 acres appraised at $10,000/acre) and you put your land in an LLC and give your children cumulative 1%, you and your spouse now own 99% of the LLC.
In this example you have not given a lot of equity away (or future income for that matter). You have not given away any control.
Since you and your spouse each now own only 49.5% individually, you have positioned yourself for a discount in your estate if you die while waiting in the estate tax waiting room. This discount could be as much as 40% of the appraised value (reduction of $2,000,000 in this example of 500 acres appraised at $10,000/acre).
This type of plan allows the parents to keep all control, 99% of the income and yet reduce their estate significantly for a possible estate tax in the future (or other creditors for that matter). This also could be tabbed the “a lot of bang-for-my-buck plan”.
The “all-in plan” is what the caller from Illinois was after. Placing their land in the LLC mentioned previously, but now gifting 99% away and keeping 1%. There is no going back on this plan. The income will pass through to the children. There will be no basis step up at death for the children. The parents will use their lifetime 709 gift of up to $11.58M currently and there will be no federal estate tax no matter what law changes occur in the future.
Who knows what is yet to come before the end of the year? For sure we know that an enormously important election will take place in November.
While waiting, consider a review of your estate and farm transition plans in search of your own level of comfort with a possible worst-case scenario.
My sincere hope is that when the lights go out with the high level of unsettling events already this year, you will each find an acceptable level of comfort with your estate plan (even if you are still uncomfortable).
For 28 years, Steve Bohr has been a partner in the farm continuation firm of Farm Financial Strategies, Inc. For additional information on farm continuation issues or if you have a question please contact Steve via email at Bohr@FarmEstate.com or by phone at 1-800-375-4180.