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December 2011 Archive for Farm Estate and Succession Planning

RSS By: Andrew Zenk

This blog focuses on making complex and difficult topics in estate and business planning understandable and applicable to the reader.

Andy is an Agribusiness Consultant for AgCountry Farm Credit Services, Fargo N.D., a farmer owned cooperative and part of the Farm Credit System serving eastern North Dakota and northwest and west central Minnesota.

Family Limited Liability Limited Partnerships - Overview

Dec 28, 2011

 

Farming families often are challenged with the issue of fair and equitable distribution of their major asset: farm land. The importance of your land is crucial in a variety of levels. For one, it is a crucial component of your farming operation. Second, it is something that you will have when you are ready to retire to use as an income stream. Third, it is something that can create a considerable estate tax liability, based on the value and its likelihood to increase in value. Also, it is crucial that it stays intact as a part of your farming operation for the next farming generation. There are some options that address those various issues. One option that has been used by farming families in estate planning is an entity known as a Family Limited Liability Limited Partnership. (“FLLLP.”) 
 
A FLLLP is an entity with two classes of partners:
 
1)    General Partners
 
Ø Unlimited liability
 
Ø Management / Control in the partnership
 
Ø The general partners have pretty much complete control over the management of the partnership and its assets.
 
Ø Often, families set up a separate entity (LLC) to be the General Partner, to attain additional asset protection – dealing with the unlimited liability issue. 
 
2)    Limited Partners
 
Ø Limited liability
 
Ø Zero control in the partnership
 
Ø The limited partners are basically passive investors who have no say over the day-to-day management of the affairs of the partnership.
 
Generally, the two classes of partners are set up as follows: The original owners of the land (“mom and dad”) set up the FLLLP and transfer their land into the entity, so that they each own an equal share of the FLLLP. They would own their shares of the FLLLP as the general partners and also the limited partners. Mom and dad (or the LLC they set up 50/50) would own a nominal general partnership interest (usually 1 % each.) 
Additionally, mom and dad own the limited partnership interests of 98% (49% each). 
 
Once this has occurred, the estate tax liability component of this tool has begun. The benefit of this entity is that you are able to use Minority and Marketability discounts to reduce the value of the assets held within the entity. Because the limited partnership interest in the FLLLP lacks control (minority interest) and lacks free transferability (marketability), a discount can be obtained for the limited partnership with a qualified appraisal. What does this mean? If one or both of the owners pass away, the value of the FLLLP shares would be valued less than the value of the land If it was owned outside of the FLLLP in your individual names. The less the value of the asset leads to less the estate tax liability. 
 
The question with minority and marketability discounts is “how much” of a discount is allowed? It is my understanding that there is no set amount that is allowed; instead, it is an area that is set by the court system. Basically, owners of a FLLLP take a discount as described above which they feel is reasonable. If the IRS challenges it, the matter is then taken to court, and the court determines whether the discount taken is reasonable. If this is a tool you are looking to use, it is crucial to talk with your professionals about thee discount. A reasonable discount will ultimately be determined by your CPA and attorney, should you decide to go in this direction.  
 
If a FLLLP is created, there are necessary responsibilities to complete, in order to ensure that the strategy works as you intended. There is the requirement of keeping a separate set of records, check book, and the importance of drafting and updating the governing documents associated with the FLLLP. Specifically, at a minimum, a partnership agreement would need to be drafted that would lay out the operational rules of the partnership. 
 
Additionally, at a minimum, a buy-sell agreement would have to be drafted to address what happens in the event of death, disability, or dissolution of the entity. Finally, it is crucial that the partners of the partnership have at least annual meetings, and that those meetings are properly documented using minutes. The entity and the governing documents would be completed by your attorney, should you and he decide this is the route you want to take. 
 
The potential downsides of a FLLLP are the above referenced requirement of a separate set of books, tax returns and records. Moreover, the above referenced minority and marketability discounts could be disallowed in the future. If this occurred, then the main reason for using a FLLLP would no longer be available. 
 
My next posts will discuss some further options with FLLLPs, exploring their uses more with regards to estate planning.  It will discuss how it can keep the farm land "intact" for the family farmers, and also allow for a fair and equitable distribution of assets. 
 
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Disclaimer: The information contained in this publication provides a general overview on various topics and is strictly for informational purposes only. The reader should consult a qualified professional for advice based on his/her specific circumstances. AgCountry Farm Credit Services and the writer of this blog make no representations as to the accuracy or completeness of any information on this site or found by following any link on this site, and shall not be liable for any errors or omissions herein or for any losses or damages resulting from the display or use of this information. 
 
Required Disclosure Pursuant to IRS Circular 230: Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code; or (2) promoting, marketing or recommending to another party any transaction or matter addressed in this communication.

Dealing with the Certainties in Life: Death and Taxes

Dec 16, 2011

This time of year (tax season), I am often reminded of the phrase: “There are two certainties in life: Death, and Taxes.” Neither certainty is any fun to think about; but, it’s there whether we like it or not. I’m guessing right now you are working on the “tax certainty”. You are working with an agriculture tax professional to maximize opportunities in tax savings for the year (if you’re not, you should be.) You work through this every year because you know if you don’t, you know there will be consequences. 

 
What about planning for the other certainty - death, with estate planning? Have you put as much emphasis in planning here? Statistics say no. For one thing, no one likes thinking about their own demise. Moreover, many times people have no idea where to start. Regardless of the barrier, the certainty remains . . . It will happen to all of us. 
 
The key is to overcome the barriers keeping you from your estate planning. Start somewhere, and find a trusted professional to help you work on a plan. I’m sounding like a broken record here: estate planning is crucial, especially when it comes to continuation of a family farm. 
 
(New Year’s Resolution Maybe?)


MERRY CHRISTMAS EVERYONE!

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Disclaimer: The information contained in this publication provides a general overview on various topics and is strictly for informational purposes only. The reader should consult a qualified professional for advice based on his/her specific circumstances. AgCountry Farm Credit Services and the writer of this blog make no representations as to the accuracy or completeness of any information on this site or found by following any link on this site, and shall not be liable for any errors or omissions herein or for any losses or damages resulting from the display or use of this information. 
 
Required Disclosure Pursuant to IRS Circular 230: Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code; or (2) promoting, marketing or recommending to another party any transaction or matter addressed in this communication.

FIRST RIGHTS OF REFUSAL OPTIONS IN ESTATE PLANNING DOCUMENTS

Dec 02, 2011

 

Often, families I work with are challenged with the determination of “fair and equitable” distribution of their assets at death, primarily because most of their assets are “farm-related”, and thus necessary for the farming heir(s) to have control to continue the farming legacy. At the same time, they do not want to leave their non-farming children “out” of their estate plan. This is a very common problem; and thankfully there are some good options to help alleviate it. 
 
One common solution is known as a “first right of refusal.” A “first right of refusal” is a provision built in as a part of your will or revocable living trust (estate planning vehicle), that provides assurances that the land stay in the family, and be available to the farming heir(s), even if ownership is not immediately involved. 
 
The concept involves leaving specific parcels of land to each of your children through your will / trust (estate planning vehicle.) However, along with this distribution, the document would stipulate that before the intended owner of the land – the child you are leaving the parcel to – rents or sells the land to an “outsider”, they would first have to offer it to their farming sibling(s), or other related parties, depending on the circumstances – “keeping it in the family.”
 
There are two parts to this: rent, and a sale. When determining rent, the big question is how fair market rental value is determined at that time. This is a “moving target” and will continue to be. Because of this, determining what “fair market value” for rent is can be difficult for the parties to determine. If it is not specified in the legal document, then an argument could arise. Providing a specified “method” for determining fair market value is crucial, so that both parties feel they are being treated fair in the process. 
 
Sometimes people will use “county averages” to determine fair market value in these situations. However, I advise against that usually; as counties can be very different regarding land qualities and use. One option I like is to have the farming heir produce “proof” of fair market value by producing lease agreements they have with “outsiders” - other non-related landlords. The rental amounts paid in these agreements would be averaged, and used as the “fair market value” for the rental agreement between the farming child and non-farming child. Another option is to name an individual (or panel of individuals) that is unbiased and would be in charge of determining what fair market value is. This person or panel of individuals should be selected so that both your farming child and your non farming child trust the decision, and trust that it is unbiased. Other times, people will decide to use a combination of both. The choice is up to you – the important this is to have a clear method to determine what fair market value is for rental. 
 
The first right to purchase is the next part of the “first right of refusal” component in your estate planning. This involves the non-farming heir that owns land wanting to sell the land. Notice, no “forced” sale occurs; instead, it is up to the non-farming child as to whether they want to keep it and rent it for income, or sell it. If the decision to sell is made, the same consideration needs to be taken in determining the valuation of the land. Sometimes people will state that the land will be sold at fair market value. How is that determined? If it is not specified in the legal document, then an argument could arise. The seller could view “fair market value” as being able to hold bids on the land, and then giving the farming child the right to match the highest bidder.  Today’s markets are a perfect example of how that could be a bad situation for the farming heir. 
 
Often, fair market value is determined using the following steps. First, a certified appraisal will be done on the land. This appraisal provides the independent valuation where both parties can trust is fair. Often, parents will stop here, and have the appraised value be the “purchase price.” However, there are times when parents will provide a discount to the appraised value, in the hopes of preventing an inability for the farming child to purchase the land. Appraised values reflect current market values, and if those are high at the time of sale, the farming child may not be able to obtain adequate financing to make the purchase, regardless of their desire to purchase the land. So, discounts may be applied, to help with this. I have often had people choose a discount of 25% to 30% of the fair market value in these situations, in order to help assure that the farming heir is able to purchase the land. 
 
Another method I have used to help families have assurances that the farming child has the ability to purchase the land is to incorporate a contract for deed into the option. In this instance, instead of the farming child paying the purchase price all at once (and likely financing the purchase), they would have the ability to enter into a contract for deed with their selling sibling. Often these contracts for deed are set initially to be very “farm cash flow friendly.” 
 
 The terms of the sale could be very specific to your goals, and depending on the cash flow abilities of the farming heir(s). The sale of the land could be specified by terms in the will:
 
-               Manageable down payment
-               A term of 20 years (or more or less, depending on what you want), with a balloon payment due earlier than that (say 7-10 years)
-               Minimal interest rate, based on the Applicable Federal Rate
 
The goal here would be to make sure any farming child (or non-farming, should they want the land) the financial ability to purchase it. They may have the strong desire to purchase it, but not the ability, financially. This will hopefully alleviate that potential problem. 
 
First rights of refusal are very good tools. They are very important to take a close look at in planning, should you desire to incorporate them into your estate planning. I suggest you talk with your qualified estate planning professional more on these, if they are something you are interested in. 

 

 

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Disclaimer: The information contained in this publication provides a general overview on various topics and is strictly for informational purposes only. The reader should consult a qualified professional for advice based on his/her specific circumstances. AgCountry Farm Credit Services and the writer of this blog make no representations as to the accuracy or completeness of any information on this site or found by following any link on this site, and shall not be liable for any errors or omissions herein or for any losses or damages resulting from the display or use of this information. 
 
Required Disclosure Pursuant to IRS Circular 230: Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code; or (2) promoting, marketing or recommending to another party any transaction or matter addressed in this communication.
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