By Paul Neiffer
Succession planning can be daunting, especially when it requires monetary transactions or creating new entities. Without proper guidance, these moves can create tax traps that farmers may not anticipate. The costs can be substantial.
Because of the risk involved, farmers should work with a multidisciplinary team of professionals for comprehensive succession planning. A typical advisory team includes a CPA, an attorney and a financial planner. Some cases may warrant the help of a family business specialist, a banker and a management consultant.
As a longtime CPA, I urge farmers to address the following tax concerns with their transition team and develop a strategy early to avoid financial risk.
Owing income tax before cash receipt. Many farmers try to help their children succeed by selling the farm equipment on an installment sale with little or no money down. Most installment sales allow the income tax to be spread over the years that payments are received. If the farmer is collecting principal in 10 equal annual payments, the tax would be deferred over 10 years.
However, when selling equipment, the tax laws require all of the gain from the sale to be reported, and the income tax paid, in the year of sale. Therefore, if a farm owner sells a fully depreciated piece of equipment worth $350,000 to his child without a down payment, he may owe almost $100,000 in federal taxes plus state income taxes, if applicable.
Sales, Use and Excise Tax. Another tax trap to watch out for is the sales or use tax that may be due on the sale of equipment. In most states, the transfer of equipment to a child by gift is exempt from sales or use tax, while the sale of equipment results in owing these taxes, which can equal up to 10% of the price charged. The farm owner in the example above, in addition to owing federal and state income tax, could trigger
another $35,000 in sales or use tax.
Selling Interest in an LLC that Owns Property. A third tax trap involves the transfer of a 50% or more interest in a limited liability company that owns real estate. This catch occurs when 50% of an LLC is sold during a one-year period. This triggers the excise tax, which can be close to 2% of the gross value of the land and which will be owed on 100% of the fair market value of the property even if sold at a bargain rate.
For example, suppose a farmer owns 160 acres of good corn ground in an LLC with a spouse. Assume the value is $1,000,000 and there’s a note against the property for $600,000 (for a net value of $400,000). If the parents use the appropriate discounts, they may sell 50% of their LLC to a child for less than $100,000. Although they achieved a goal of transferring 50% of the land to a child at a discounted rate, the county or state may send them an excise tax bill for up to $20,000 (2% of the fair market value)—and when and if they sell the land to a third party, they will owe an additional $20,000 or more.
Reassessment. An additional issue related to the sale of equipment, buildings and land to children is triggering the reassessment of valuations for personal property and real estate tax purposes. Many states require a reassessment of the value when property is sold, even to a child or related party. The state many even require the property to be reassessed at its highest and best use value, not farm value. The effect on the farm family can be dramatic in this case.
Paul Neiffer is a CPA with HansenNvOPS.