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June 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.

Overview of Irrevocable Life Insurance Trusts

Jun 22, 2011

Continuing with my previous posting, this post will cover the general requirements of an irrevocable life insurance trust ("ILIT.")

 
What is an ILIT?
 
An ILIT is a trust primarily set up to hold one or more life insurance policies. The ILIT is a taxable entity that must file its own separate tax returns each year. However, the returns are generally simple and can be handled easily by an accountant.  The main purpose of an ILIT is to avoid federal estate tax on life insurance proceeds / death benefits paid on a life insurance policy. If the trust is drafted and funded properly, your loved ones should receive all of your life insurance proceeds, undiminished by estate tax. Caution: Because an ILIT must be irrevocable, once you sign the trust agreement, you can't change your mind; you can't end the trust or change its terms.
 
How an ILIT works
 
Because an ILIT is an irrevocable trust, it is considered a separate entity. If your life insurance policy is held by the ILIT, you don't own the policy--the trust does. You name the ILIT as the beneficiary of your life insurance policy. (Your family will ultimately receive the proceeds because they will be the named beneficiaries of the ILIT.) This way, there is no danger that the proceeds will end up in your estate. This could happen, for example, if the named beneficiary of your policy was an individual who dies, and then you die before you have a chance to name another beneficiary. Because you don't own the policy and your estate will not be the beneficiary of the proceeds, your life insurance will escape estate taxation.
 
Creating an ILIT
 
Your first step is to have an attorney draft and execute an ILIT agreement. Because precise drafting is essential, you should hire an experienced attorney in these matters. Although you'll have to pay the attorney's fee, the potential estate tax savings should more than outweigh this cost.
 
Naming the Trustee
 
The trustee is the person who is responsible for administering the trust. You should select the trustee carefully. Neither you nor your spouse should act as trustee, as this might result in the life insurance proceeds being drawn back into your estate. None of the beneficiaries of the ILIT should be trustees either, due to potential conflicts of interest and related issues. Select someone who can understand the purpose of the trust, and who is willing and able to perform the trustee's duties. A professional trustee, such as a bank or trust company, may be a good choice.
 
Funding an ILIT
 
An ILIT can be funded in one of two ways:
 
1. Transfer an existing policy --You can transfer your existing policy to the trust, but be forewarned that under federal tax rules, you'll have to wait three years for the ILIT to be effective. This means that if you die within three years of the transfer, the proceeds will be subject to estate tax. Your age and health should be considered when deciding whether to take this risk.
 
2. Buy a new policy --To avoid the three-year rule explained above, you can have the trustee, on behalf of the trust, buy a new policy on your life. You can't make this purchase yourself; you must transfer money to the trust and let the trustee pay the initial premium. Then, as future annual premiums come due, you continue to make transfers to the trust, and the trustee continues to make the payments to the insurance company to keep the policy in force.
 
Gift Tax Consequences
 
Because an ILIT is irrevocable, any cash transfers you make to the trust are considered taxable gifts. However, if the trust is created and administered appropriately, transfers of $13,000 per person per year (2011 figure) or less per trust beneficiary will be free from federal gift tax under the annual gift tax exclusion. Additionally, just as each of us has a lifetime estate tax exemption, we also have a lifetime gift tax exemption, so transfers that do not fall under the annual gift tax exclusion will be free from gift tax to the extent of your available exemption.
 
Crummey Withdrawal Rights
 
Generally, a gift must be a present interest gift in order to qualify for the $13,000 annual gift tax exclusion. Gifts made to an irrevocable trust, like an ILIT, are usually considered gifts of future interests and do not qualify for the exclusion unless they fall within an exception. One such exception is when the trust beneficiaries are given the right to demand, for a limited period of time, any amounts transferred to the trust. This is referred to as Crummey withdrawal rights or powers. To qualify your cash transfers to the ILIT for the annual gift tax exclusion, you must give the trust beneficiaries this right. The trust beneficiaries must also be given actual written notice of their rights to withdraw whenever you transfer funds to the ILIT, and they must be given reasonable time to exercise their rights (30 to 60 days is typical.) It is the duty of the trustee to provide notice to each beneficiary. Assuming the beneficiaries do not elect to take the funds, and the policies stay in effect, the ILIT works as intended. This is a big assumption, so it is important to have all beneficiaries "on board" when doing this type of planning and understand the ramifications.   
 
Conclusion
 
Every person’s estate planning – especially with the use of an ILIT – is different. Accordingly, it is imperative to talk with an expert in these matters when using an ILIT. It is also imperative to follow the rules specific to your situation, using the proper professionals. Moreover, it is important to check your state rules as well: in some states life insurance proceeds is also subject to state estate tax in addition to federal estate tax. 
 
ILITs are great tools, but also have definite requirements and associated responsibilities. 

 

 

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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.

Basics of Life Insurance and Federal Estate Tax

Jun 15, 2011

The Federal Estate Tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of death. The fair market value of these items is used, not necessarily what you paid for them or what their values were when you acquired them. The total of all of these items is your "Gross Estate." The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets. Also, surprisingly to most, life insurance proceeds are among the types of property that are subject to estate tax. Estate taxation of life insurance proceeds centers around ownership of the policy and payment of the proceeds. If the proceeds of a policy are paid to the insured person's estate, then they will be fully subject to tax on the insured person's death.

 
If you own a life insurance policy, upon death, your estate will be fully subject to tax if:
 
v     the proceeds of the policy are payable directly or indirectly to your estate, or
 
v     if you, while alive, held any ownership in the property, such as the right to charge a beneficiary, surrender or cancel the policy or borrow against the policy.
 
If you have a life insurance policy covering you and you do not own it, then the proceeds of the policy will not be subject to estate tax. It is not unusual for an insurance policy to be taken out on someone else. An option here is for a farming child to have a policy on their farming parent, where the child is the owner, not the parent. This is an option, but it does not give the insured much choice as to what the proceeds go towards at death. There is another option that can help with that – an irrevocable life insurance trust. 
 

An irrevocable life insurance trust ("ILIT") is a tool that one can use to designate what happens to the death benefit proceeds at death; specifically, to help beneficiaries fight the federal estate tax burden, if applicable. The trust "owns" your life insurance policy, pays the premiums and gives the death benefit to your beneficiaries when you die. By placing ownership of the policy with a trust — not the insured — it removes the death benefit from your estate.  They are a good tool, but there are many requirements associated with them in order for them to work properly. Set up properly, the trust can cover the tax bills of an estate, or other goals. In my next posting, I will cover the requirements of and ILIT specifically. Stay tuned.

 

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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.

Treating your Farming and Non-Farming Children “Fairly and Equitably” - How??

Jun 13, 2011

I have the opportunity to work with many farm families, helping them build a plan for how their assets will be distributed at death. I have found that there are two similarities many of these families share. One similarity is that there are usually both farming and non-farming children in the family. Another similarity is that the major assets in their net worth are farm related (land, shares and machinery). 

 
This leads to an inherent conflict that has to be dealt with: the parents want to ensure that the family farm is able to survive and thrive with the next generation. However, at the same time, they want to provide an inheritance for their non-farming children. I call this conflict the "fair and equitable" treatment of your children. What is fair and equitable is different for each family. This article provides some tools to consider when defining what fair and equitable is for your family. 
 
Treat Farm Assets as Business Assets
 
Sometimes parents are comfortable with treating farm assets as business assets, and keeping the business separate from everything else. In this situation, at death the farm assets go with the farm business, leaving them to the farming child. The non-farming children will receive the separate non-farming assets. This usually results in a disproportionate distribution; which is fine, as long as the parents feel this is fair and equitable. 
 
Many times this is not a feasible option, because the only assets to distribute are farm / business assets. In this scenario, the usual choice is to quickly add non-business assets (life insurance), or move on to a different plan.
   
Compensating Farm Children for Their Work on the Farm
 
On occasion, families are able to define what "fair and equitable" is by accounting for the farming child’s contribution to the farm over the years. Here, the parents may look at what the farm was when the child began their career, and compare that to what it has grown to now. That difference is accounted for by giving the farming child more of the assets as "payment" for their efforts. (This is one of many formulas to use to figure what fair "payment" is for their family.) 
 
This is "fair and equitable" in some parents’ eyes, because they compare the situations of their non-farming children and the career paths they chose. Through these careers, they have had the opportunity to build their own retirement plans. The farming children have their career in farming, but their "retirement" plan is usually tied up in the farm. It is "fair and equitable" to these parents to give more of the assets to the farming children, as their share of the equity and as their retirement. 
 
What if "Equal" is "Fair and Equitable"?
 
Sometimes parents feel that equal distribution of assets is "fair and equitable." In this scenario, often the solution is to position the assets so that they are distributed equally, but also available to the farming child. This ensures the farmer that the necessary farm assets will always be available to them, even if they do not own them. The tool often used to accomplish this is called a "first right of refusal".
 
A first right of refusal provides ownership of assets (land or beet stock usually) in non-farmers with a condition. If the non-farmer wants to rent the asset, he has to first offer it to his farming sibling. If the non-farmer wants to sell the asset, he has to first offer it to his farming sibling.  The hopeful goal is that the assets are always available to the farming child, and he doesn’t find himself in a bidding war, especially in today’s competitive market for acres. 
 
Conclusion
 
The tools discussed in this article are good places to start when considering your own plan. However, this is just a starting point and is a very broad explanation of some options. Every family is different, and therefore each plan must be different, in order to work as the family intended. Accordingly, it is absolutely crucial that you seek professional assistance when developing your plan. I wish you the best in this endeavor, and would be honored to help you achieve your unique definition of "fair and equitable".

 

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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.

Maximizing Opportunities for the Future

Jun 06, 2011

As a farmer, you know first hand how important it is to "maximize opportunities." You work long hours at this in all areas of your farm. The examples are wide ranged. Often, a farmer’s focus on maximizing opportunities includes the following: maximize your productivity of your acres in each year’s crop plan; maximize the opportunities you have by knowing exactly where your operation’s break-even points are and how to effectively market and implement a crop insurance plan to take full advantage of your profitability; and maximize your opportunities each year with effective records and tax planning. 

With all of the areas you "maximize opportunities," does your annual list include the need to maximize your opportunities for the future of your farm? Do you think about how what you do today will help you in the future when the time comes to transition your farming operation? Often, plans that maximize opportunities for today hinder the options you have for the future. This conflict creates a difficult situation, one that cannot be overlooked. 
 
Hockey legend Wayne "The Great One" Gretzky once said something that rings very true to the importance of maximizing your opportunities for the future. Gretzky was asked a question on his key to success as a hockey player. His response was so simple, yet so profound. He said "A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be."  It is crucial that you think about what you can do to help you "skate where the puck is going to be" in your farming career. 
 
You may think that your career will lead you to a reality where "success in the future" works itself out. That may be, and I hope you are right. On the other hand, many times those who disregard the need to plan for the future find themselves in a reality where they have closed the door on many opportunities that once were available. Actions they took years ago have closed the door on being able to retire at a time that they are ready. They have closed the door on being able to bring the next generation into the farm, no matter how much they want to. They have died untimely and burdened their family with unnecessary estate taxes and administration costs and left them with a difficult financial situation. These are grim thoughts, but none of this has to be. Planning for the future can help change your eventual reality to your advantage. 
 
Think of it this way. Those of us who work for someone else and depend on a wage for their living have one of two options when it comes to the future. There are basically two options for wage earners. You can plan for retirement, or you can not. Regardless of what path is chosen, one thing is certain: there will come a time when a wage earner is no longer able to work to earn a living. At that point, their independence and ability to live as they want depends on what track they took to prepare for that point. Those who planned for the future likely have a reality of independence and enjoyment of life. Those who did not, likely have a different outcome at that time. 
 
Farmers, as self employed individuals, have the same two basic options. Those who plan for the future have many opportunities to plan for a secure and independent future. They are often at a point where they control their destiny and their independence. Those who do not plan likely face a different reality. Their choice led them to a point where they are faced with difficulties such as overwhelming debt or tax issues that control their lives. What reality do you want? 
 

None of us know when our time is up on this earth, or when we will no longer be able to earn a living. A crystal ball would be nice, but that is not reality. Reality requires that we plan for the "now", maximizing our opportunities to ensure for a secure future for you and your family, regardless of where you are in life. Whether you are just starting out, working to expand, or working to retire, there are benefits to develop a plan that incorporates maximizing your opportunities for the future. I encourage you to add this to the list of ways you maximize your opportunities.

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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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