Taxpayer Relief Act a ‘Game Changer’

02:40PM Nov 26, 2014
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Make sure your estate plan doesn’t cause a tax headache

The American Tax Payer Relief Act of 2012 was a game changer for many farmers. As a result, your existing estate plan may now be obsolete.


With inflated land values, the $5.34 million  estate tax exemption doesn’t go all that far.  Photo: Rick Mooney

In a nutshell, upon death, you may pass up to $5.34 million worth of assets free from federal estate tax. A married couple can pass $10.68 million.

You might think you don’t have a tax problem because your farm is worth less than $10.68 million. Due to the recent run up in land values, however, it doesn’t take a huge number of acres to pass the $10.68 million threshold. If land is valued at $10,000 per acre, it takes just 1,068 acres to reach the threshold. At $12,000 per acre, it takes just 890 acres. State death taxes also deserve careful consideration since some states impose significant taxes at death.

For federal tax purposes, you may give away up to $5.34 million of your assets without having to pay federal gift tax during your lifetime. That would reduce the amount of your exemption remaining at death. The annual gift tax exclusion is currently $14,000, which won’t reduce your $5.34 million gift tax exclusion or be required to pay gift taxes.

For estates or gifts in excess of this exemption, the maximum tax rate is 40%. As always, there is an unlimited marital deduction.

Also, portability of unused exemption to the surviving spouse is available. That means if your spouse dies first, leaving all assets to you, the unlimited marital deduction requires no tax at the first death and your spouse’s $5.34 million may be “ported” to you. That shelters $10.68 million of your assets from tax when they pass to your children at your death.

These exemptions are indexed for inflation. The deceased spouse’s unused exemption that is “ported” to the survivor will not receive future inflation adjustments, but the survivor’s exemption will continue to
increase with inflation.

Before portability, estate planners took great pains to help clients divide ownership of their assets, so that each spouse owned enough property to fully utilize their estate tax exemption. That is no longer necessary. In fact, it may be more beneficial to make sure all assets are owned by the surviving spouse, in order to get the highest step-up in basis at the second death.

If your farm is worth more than $10.68 million, you and your spouse need to think about how your heirs will pay the 40% federal estate tax. The special use valuation under Internal Revenue Code § 2032A may allow the value of your farm to be reduced for estate tax purposes.

You should review the special use valuation metrics on a frequent basis and make adjustments to bring your estate into compliance. Also, your succession plan should be structured to make sure your heirs meet the strict compliance of the special use valuation rules after your death.

Life insurance can provide liquidity to pay the estate tax. However, it is important for the policy to be properly owned so the death benefit is not included in your gross estate, which would only exacerbate your
tax problem.

You could create an irrevocable life insurance trust (ILIT) to be the beneficiary of the life insurance policy, which would keep the insurance proceeds from being included in your estate. The ILIT can purchase assets from your estate for cash or loan money to your estate to pay the tax.

The beneficiaries of your ILIT and estate are typically identical, so shifting assets between the two doesn’t change their ultimate disposition.

Proper use of withdrawal rights can allow your annual contributions to the ILIT for premium payment purposes to qualify for annual tax exclusions.

If you can’t fathom one more trust as a part of your estate plan, then direct ownership of the life insurance policy by your adult children can accomplish the same estate tax exclusion. But think carefully about the associated risks it brings, such as your child’s divorce, failure to pay the premium and refusing to use the proceeds to pay the tax after your death.  

A member of the Farm Journal Legacy Project Advisory Team, attorney Polly Dobbs is part of a seven-generation farm family. She understands the unique issues facing farmers and succession planning.