Several years ago, Oprah Winfrey gave away a car to every member in the audience during one of her shows. Most people considered the gesture a gift from Oprah, which meant she would have to pay a large gift tax. However, assuming for our purposes here, the value of each car was less than the annual gift exclusion ($14,000 for 2016), Oprah would owe no gift tax and wouldn’t be required to file a gift tax return.
I get several emails each year from farmers asking how much gift tax they owe after giving a gift. I explain their situation is similar to Oprah’s. They don’t owe a gift tax, and they don’t have to file a gift tax return.
Annual gifting can solve a lot of estate tax problems for farmers with significant land value. For example, assume Farmer John owns 2,500 acres of good farmland worth $20 million. He and his wife are in good health, have four married children and 10 grandchildren. Each year, John and his wife can give $14,000 to each child, each spouse and each grandchild for a total of $252,000 for John and $252,000 for his wife or slightly more than $500,000 for a combined total.
Now, this assumes John and his wife give cash. Since most of their wealth is tied up in farmland and the goal is to keep the ground in the family, John and his wife have transferred the ground into a limited liability company (LLC). They now give units in the LLC to each child, spouse and grandchild instead of cash. In most cases, this will result in a discount for gift tax purposes of about 35%.
Therefore, when John and his spouse gift these units, they can give about $21,500 of gross land value to each person. This increases the total amount they can give from $504,000 to about $775,000 annually without reducing their lifetime annual exclusion amount ($5.45 million in 2016).
Care must be taken in doing these types of gifts. While the following two steps aren’t requirements, it’s a wise idea to:
1. Obtain a qualified appraisal of LLC units to gift.
2. File a gift tax return, even though no gift tax is due, and attach the appraisal. If you file a gift tax return with the required information, the IRS has only three years to challenge your gift valuation. If you don’t file a
return, the IRS has unlimited time to challenge (even after your death). This can cost you or your heirs a lot of money, time and effort later on.
Some farmers have concerns when it comes to gifting units to spouses of their children. Their goal is to maintain ownership in the family for multiple generations. They’re also concerned about a divorce situation allowing the divorced spouse to retain ownership in the farm. A properly structured buy-sell agreement should alleviate most of these concerns. Such an agreement would provide triggers for purchasing the units in case of a divorce or death of that spouse. Remember, units gifted to a child are usually considered marital community property by a judge in the event of a divorce; therefore, a buy-sell agreement is needed even if no units are transferred to a spouse.
In conclusion, many farmers with a net worth in the $20 million range think they need to take advantage of complex estate planning options, such as a trust. However, with good health and a few kids and grandkids, it’s probably easy for a couple to get their estate under the current $10.9 million combined lifetime exemption. Putting their farmland into an LLC reduces their estate value to $13 million, and making annual gifts over a five-year period will likely drop them under the $10.9 million level.
The longer you wait, though, the more difficult the annual gifting process becomes. If you’re in this situation, get started now.