In the past 50 years, family farm operations have increasingly incorporated under state law to take advantage of the liability protection and other business advantages available to corporate entities. Limited liability companies (“LLCs”), family limited partnerships (“FLPs”) and other corporate entities also provide tax advantages when transitioning ownership of the operation to the next generation.
IRS rules allow each individual to transfer $5.45 million worth of assets during their lifetime or at death without paying a gift or estate tax. In addition, a person can give $14,000 per year to any individual without cutting into that lifetime exemption. For example, if a farmer gives his child property valued at $1 million, he would take a hit of $986,000 against his lifetime exemption. When the farmer dies, the government would then apply an estate tax against all of his assets valued at more than $4.46 million because he has already used $986,000 of lifetime exemption.
Under current IRS rules, corporate entities can be used to transfer a family farm entity at a discounted value. For example, these rules allow for a discount due to lack of marketability for an interest in the company. Unlike purchasing public stock, you won’t have buyers lined up outside the door if you try to sell your 25% interest in a family farm entity. The IRS recognizes this limited number of buyers by allowing owners to discount the value of the asset when it is owned in a corporate entity. The discount allowed usually runs somewhere between 10% and 35%.
Similarly, current IRS rules allow a discount when a farmer gifts a minority ownership stake to another family member. This is because gifting a 5% interest in your farm to your son or daughter does not allow that individual to control the operation. The IRS again recognizes this reality by allowing a discount.
The current rules have been a powerful tool for estate planners. They help smooth the transition of agricultural operations between generations by creating lower estate tax liabilities while allowing the operation to remain intact.
But these discounts are now under threat, as the IRS has proposed rules that would eliminate the discounts for lack of marketability and for lack of control. The current regulations are merely proposed, and the IRS has asked for public comment through Nov. 2, 2016. After public comment the IRS could make changes to the proposed rule, but has indicated this issue is a priority, leading many to project that the new rules could be finalized by early 2017. The risk of increased tax burdens for many family farm operations is very real.
For this reason, if you are considering transferring a share of your family farm entity in the foreseeable future, the proposed IRS regulations are a good reason to seriously consider moving your time-table forward. As always, you should consult with your accountant and a business or estate planning attorney to determine whether and when a transfer of your assets is appropriate for your farm.
Brent Haden was raised on a Missouri farm and graduated from the University of Missouri and from Harvard Law School in 2002. He lives in rural Boone County, Mo., with his wife Connie and their three sons. You can contact him at firstname.lastname@example.org.