For the past 10 years, there has been an ever-increasing disconnect between what Americans could give away during their lifetime free from transfer taxes and what they could give away at death. Up until 2002, these amounts were equal, but then the amount that was tax-free at death grew substantially until you could be worth a billion dollars or more in 2010 and die estate tax–free. However, if you gave your wealth away during your lifetime, you could give only up to $1 million free from gift tax.
With the new tax law passed right before the end of 2010, this has changed. Now, a farmer can gift up to $5 million tax-free during his lifetime and his spouse can gift the same amount. Therefore, $10 million can be given to the next generation, or even the grandchildren or great-grandchildren, without paying a gift tax.
The new provision is currently in effect only for 2011 and 2012, so this year and next are a great time to make substantial gifts, if your situation warrants it. The optimum situation for making larger gifts is if you meet the following criteria:
- Your current estate exceeds at least $5 million (which right now is about 600 acres of good corn land);
- you expect your estate to continue to grow in excess of what you spend each year; and
- you feel comfortable that, after making your gifts, you will have enough assets left to provide more than enough income for your needs and comfort for the rest of your life.
If all of these criteria apply to you, making gifts now or in 2012 may save your estate substantial taxes when you pass away. (A similar analysis applies to your spouse.)
For example, imagine a couple that has 2,500 acres of farmland worth $20 million. They also have other retirement assets that will provide sufficient income for the rest of their lives. They would like to transfer the farm to their children. Let’s assume they give away half of the farm in 2011 or 2012. Let’s also assume they live for another 20 years and the value of the farmland increases at
5% per year. When they pass away, the farm will be worth about $50 million. Since they gave away one-half to the next generation, the $15 million of appreciation ($25 million less the value today of $10 million) will escape the federal estate tax of 35% (assuming current law), or about $5 million each in estate tax. In addition, since most states do not have a gift tax, the state estate tax will be eliminated on this appreciation.
Helpful Discounts. Let’s take our example a step further. If the couple creates a new business structure to own the farmland (such as an LLC or limited partnership), a discount for lack of marketability and a minority discount are usually appropriate. These discounts can range from around 20% to in excess of 50%. Let’s assume the couple can gift 100% of their farm (if properly structured) in 2011 or 2012 and takes a 50% discount. In this scenario, they are able to transfer the farm completely free of gift and estate taxes. This saves them at least $14 million in future estate taxes.
A potential drawback to making gifts is that there is no step-up in basis of the assets that are gifted. Say our farm couple originally bought the land for $1 million. If they gift it, this cost basis will carry over and the new owners will use it when they sell the property. However, if the intent is for the farmland to remain in the hands of the children for their lifetime and then be passed on to the next generation, the capital gains tax would never be owed anyway.
Another issue that needs to be addressed before making gifts is whether there is a gift tax in the state you reside in and, if so, there are differences between your state’s gift tax rate and the estate tax rate. If you are contemplating making a large gift, you must consult with professional advisers who specialize in this area of taxation. Certain tax filings, elections and disclosures will have to be made, and these can lead to disaster if they are not done correctly. n
Paul Neiffer is a tax accountant with LarsonAllen LLP and author of the blog The Farm CPA. He grew up on a wheat farm in Washington and owns a corn and soybean farm in Missouri. Contact him at firstname.lastname@example.org.
- Summer 2011