Land values have increased considerably the last few years, making farms more valuable than ever. In some farm families it's aggravating a previously established fairness issue and adding stress among family members.
"I've been involved in farm business and estate planning for over 50 years and I've never seen it quite like this before. But we've never had this kind of run-up in land values and the uncertainty in Washington regarding tax laws, estate taxes and fiscal issues that we have now," observes Neil Harl.
A long-time professor of economics at Iowa State University and now an emeritus professor and an attorney, Harl says the problem is basically what was set up as a fair arrangement for estate planning or business succession among the farm family 10 to 15 years ago may not look, to the off-farm heirs at least, as being fair today. "The fairness issue is causing serious rifts within some families," he says.
Run-up in land values is straining relationships of family members
What sometimes occurs is an on-farm heir came back to the farm with assurance there was plenty of work to do, "but we can't pay much, we can't share much with you. However, if you stick with us you'll share in the rewards someday." That was never really understood totally by the off-farm heirs, so now when the off-farm heirs discover how much the land is worth, they foresee the results of a potential auction that could take place, and they begin to raise serious questions.
"Situations like this in some farm families are causing a dispute serious enough to go to court," says Harl.
He suggests several things to keep in mind to avoid trouble. One is, be careful how you set up the business arrangement for arranging for a potential heir to work for the farm operation. Don't deliberately undercompensate anyone. If you do, be sure the entire family, including all of the off-farm heirs, understand that there is deliberate undercompensation in those early years. "Not making the arrangement clear to everyone in the family is where the problems start," says Harl. Later, when the parents try to compensate for those early years of effort, it is often misunderstood by the off-farm heirs.
~~~PAGE_BREAK_HERE~~~Second, provide at the time of death or around that time, an opportunity for the off-farm heirs to either be happy or become happy, cheerful and contented investors in the business or give them the opportunity to exit and have their share of payment come to them over a 10- to 20-year period with interest on the unpaid balance. That's up to the family to decide. "Parents can do whatever they want with their property but they are in some cases causing serious problems for relationships within the family," says Harl.
Be careful how partnerships and succession plans are structured
Harl is speaking at meetings on farm estate and succession planning around the country this fall, and is running into more of these family relationship issues.
Here's another one; the way partnerships are handled. There has been for 30 years (the law was passed in 1982 by Congress) a simpler way to handle partnerships, says Harl. Back then, tax shelters were a big concern, and agriculture had its share of tax shelters. Congress wanted to clamp down on people who were abusing the system. Some in Congress were proposing that rather stringent conditions be imposed on partnerships and some people lobbied Congress and succeeded in getting an exception for small partnerships.
That exception is still in the law today. It's available to partnerships with 10 or fewer members who meet some other requirements. Harl estimates 90% of farm partnerships in the Midwest probably could qualify for this exception. What's the benefit? Instead of filing a rather complex IRS form, Form 1065 with a bunch of schedules and penalties for not filing them correctly, there is an alternative, he explains.
Consider the alternatives; take advantage of the options available
Instead of going the Form 1065 route, you just pass the income, gains or losses directly through to schedule F, the farm schedule, or schedule C the business schedule if it's a business arrangement other than a farm, or schedule E if it qualifies as a passive investment.
"There are no penalties for this; that is made very clear in the law that passed in 1982 and is still in effect," says Harl. "Unless there is a material understatement, the penalties do not apply. The point is there are a number of places in the tax code where it could be helpful. We're covering the half dozen or so situations that can cause a lot of pain with a farming or business partnership, and you could sidestep many of those situations by using this small partnership exception."
~~~PAGE_BREAK_HERE~~~A few seminar dates and locations are left on the schedule for anyone interested in attending. "We have two days at Pella on December 10 and 11, two days at Bettendorf December 13 and 14, and two days at Mason City December 17 and 18," says Harl. "We've added these dates because of enormous interest in estate planning and business planning this fall." The two-day seminars are primarily for lawyers, CPAs and accountants but others are welcome to attend, says Harl. To register, you can call 360-200-5666.
Sometimes family members feel they are locked in, others feel left out
Part of the increased interest is being driven by what's happening in Washington, D.C., and part is because farm families have discovered they are no longer holding maybe $500,000 or a million dollars of assets. The farm property is all of a sudden worth $2 million or maybe $3 million or even more. They're concerned what to do about the farm's estate plan and succession plan and how to proceed with their tax planning.
Is part of the problem with family stress being caused by some of the heirs wanting to cash out? Some are unhappy because they feel like they're locked in and can't cash out, says Harl. Some types of estate planning structures don't let heirs easily cash out. "I strongly urge that the heirs have an assurance of being able to cash out, over a period of time with a reasonable rate of interest going to them on the unpaid balance. That would take care of a lot of problems," he says.
Other heirs are simply looking at the situation from the standpoint of they don't want to be tied up in the farm ownership forever -- they want to get their share of the money out. Some, of course, would like to stay in the farming business.
It's important to meet with your entire family and discuss this
Harl points out that in general, it's a good idea to set up a two-entity business plan -- one entity to hold the land and another to own the machinery and livestock and carry on the farming operation as a tenant. That way, the off-farm heirs can be co-owners of the land but not get involved in the day-to-day farming operations. And, the on-farm heirs are primarily interested in the land and this lets them be a part of the land-owning entity for as long as they wish with an exit route assured if they want to "cash out."
"Every situation is different," concludes Harl. "It's important to meet with the entire family and discuss this. Most of the problems I'm encountering are situations where there wasn't much discussion in the family and they didn't discover how things were going to be handled until driving home from the funeral or even later when the will was read."
With all of the uncertainty in Washington these days, the looming fiscal cliff, the uncertainty created by current tax laws expiring and estate taxes set to change at the end of this year, how can people make decisions? It's difficult, says Harl. But you have to solve the problems as you see them and hope Congress does the right thing.
His guess is Congress will end up providing an estate tax that's similar to the current version, which provides a $5.12 million exemption. "But we don't know that for sure so there's a lot of contingency planning going on by farm families and their attorney or financial adviser," notes Harl. "If the federal estate tax is allowed to sunset and go back to the $1 million exemption, that's another possibility but one I doubt will materialize. If it isn't allowed to sunset, then something else will take its place in the tax law."
For more farm management information and analysis go to ISU's Ag Decision Maker site www.extension.iastate.edu/agdm.