It doesn’t matter if your business is hauling grain at 55 mph or planting corn at 5 mph, there may be value in slowing down to think through future consequences of current actions.
A wise man once told me that the quality of your life will be the summation of small decisions that you make throughout your life. The key is to make as many of those seemingly insignificant decisions at a conscious level.
This is true in estate and farm transition planning as well.
In our business, we see so many “plans” that have evolved into avoidable issues due to decisions that were previously made without conscious thought with the future in mind.
For those of you who are making plans, there were two emails that came into my inbox recently that may help you understand that there may be more issues to consider than the obvious.
Gift of stock
“In your article about the new Tax Bill, you remind us that the gift exclusion for 2018 has inflated to $15,000 per year per person. Does the giver or receiver have to pay the taxes on this gift?
“We would like to gift corporation stock to our children and wonder what their tax liability may be.”
Implications for gift tax, estate tax as well as income tax could exist. Please consult advice from a tax advisor on your specific situation, as decisions about these three separate taxes could have interrelated, unintended consequences.
There is no “gift tax” on transfers of $15,000 or less per person per year to either the grantor or the recipient. This is called the annual exclusion.
There is no “estate tax” on this amount either. The federal estate tax exemption asset equivalent for deaths in 2018 is $5.59 million. This amount temporarily doubled to $11.18 million with the new tax law (which sunsets back to the lower amount in 2026).
If you gift more than $15,000 in any one year, you are required to file a 709 gift tax return showing that you used up some of your death exemption early.
You can currently gift or die with up to $11.18 million of assets without any gift or estate tax consequences (this is why it is called the unified credit because both the death tax and the gift tax exemption equivalents are unified).
The act of giving does not trigger any income tax for the grantor or the recipient. However, there could be future income tax consequences.
If you give cash, as an example, the grantor has already recognized the income tax so there is not income tax to the recipient.
In a separate example, if you gifted grain and let the recipient sell it, the grantor would pay no income tax (or self-employment tax), however, when the person sells the grain, they would recognize the income tax (but not self-employment tax as they didn’t produce the grain).
If the grain is older than 12 months, the recipient would recognize long-term capital gains tax upon sale (instead of short-term). Long-term gain would be in a lower (or even zero) federal income tax bracket.
If you gifted stock, as an example, neither the grantor nor the recipient will recognize capital gains tax. If the recipient later sells that asset, they would recognize the gain upon sale above the grantor’s original basis transferred to the recipient.
Be careful gifting stock to children just because they are your children. Many families have put themselves in a regrettable position of gifting family farm corporation stock for the sake of gifting and later had to buy it back (with unfavorable terms with significant financial stress to the business).
“Was reading your column and had some questions. Can we convert our C corporation into two corporations?
“Over the years, my brother and I have personally bought shares and the corporation has also bought shares from family members who didn’t want to own them anymore. We want to divide, as we each have families and would like to gift shares to our children and do not want them to deal with cousins in the future.
“We do not have anything in the corporation but land. We each want to end up with two separate farms. The corporation currently has retained earnings in excess of $1 million and has $300,000 of debt left as a buyout of one sibling’s shares.”
This is a very typical situation with a family farm. Once land goes into a corporation, there is a drawn-out process to avoid recognizing retained earnings that includes skilled advice, preparation, time and maybe some luck to unwind the corporation.
The byproduct is that land typically stays in the corporation even if it isn’t ideal, and those who want to keep the land will be forced into buying the shares from those who do not.
You are in an advantaged position over most as it appears you have already gotten the “hot assets” like grain and other operating assets out of the corporation.
This makes you a candidate to convert it to an S corporation to make it more palatable for future owners to receive income (pass through of income from the land into your personal accounts).
With a conversion to an S corporation, there are rules about active income (crop share rent or custom farm) vs. passive income (cash rent) to neutralize retained earnings, and there are holding periods (five years for federal income tax and 10 years for Iowa income tax) for assets before selling without the C corporation built-in gains tax you are trying to get away from in the first place.
If you are able to maneuver through these rules, it could be possible to actually liquidate the corporation eventually with little to no tax.
The independence issue of two families owning and managing the same corporation vs. splitting it into two separate entities to be managed separately is your real question.
This strategy is called a divisive reorganization and can be very effective if you can follow even more strict rules.
You must have a valid business reason to divide. Tax reasons are not valid reasons to divide the corporation in the eyes of the service.
Both before and after the division, the corporation(s) must maintain an active trade or business (farming or custom farming with material participation).
Decisions affecting a family business require not only professional advice and preparation, but also conscious thought as to what the future will hold for the business.
This may include but not be limited to updated and thorough operating and shareholder’s agreements, employment and rental agreements as well as comprehensive estate plans.
My sincere hope is that no matter what speed you are used to traveling, you will have sufficient time to consider the multitude of possible outcomes for the future of your family farm operation.
For 25 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.