estate planning for farms and ranches first run … · preserved tax rates through 2013 estate tax...

ESTATE PLANNING FOR FARMS AND RANCHES First Run Broadcast: March 3, 2015 Live Replay: July 24, 2015 1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes) One of the most difficult cases for a planner is helping a client preserve family farms or ranches intact and in family control while funding often substantial tax liabilities. Land is distinctly illiquid and clients often resist the necessity of selling off part of the property to pay taxes. But there are alternatives short of land sales to obtain liquidity, reduce taxes, and ensure continuing family control. Among other planning alternatives, conservation easements are an effective technique for reducing taxes and the need for substantial immediate liquidity, thereby fostering family control. This program will provide you with a practical guide to estate and succession planning alternatives for family farms and ranches, including the use of conservation easements, advanced gifting techniques, estate freezes and more.

• Planning to minimize estate and gift taxes and preserve control of family farms and ranches

• Techniques to obtain liquidity for the payment of taxes on land • Use of conservation easements for tax benefit and to preserve the character of property • Advanced gifting techniques for use by senior generation gifting to junior generation • Succession planning to ensure operational stability and preserve control

Speakers: Ronald A. Levitt is a partner in the Birmingham office of Sirote & Permutt, PC, where he has extensive business and tax practice focusing on closely held and family businesses. He counsels clients in business planning, succession planning, representation of S Corporations, Limited Liability Companies and other flow-through entities, mergers and acquisitions, purchases and sales of businesses, and healthcare law. He is a Regent of the American College of Tax Counsel and the co-author of “Tax Planning S Corporations,” published by Lexis-Nexis. Mr. Levitt received his B.S., cum laude, from the University of Alabama, his LL.M. from the University of Florida School of law, and his J.D. from the University of Alabama School of Law. Renee M. Gabbard is a partner the Irvine, California office of Bryan Cave, LLP, where her practice includes all aspects of income, capital gains, gift and estate tax planning, charitable planning, and advanced wealth and business succession planning. She has written and spoken widely on estate and trust planning topics. Ms. Gabbard received her B.A. from the University of Southern California and her J.D. from New York University School of Law.

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Estate Planning for Farms & Ranches

Teleseminar July 24, 2015 1:00PM – 2:00PM

1.0 MCLE GENERAL CREDITS

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Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: July 24, 2015 Seminar Title: Estate Planning for Farms & Ranches

Location: Teleseminar - LIVE Credits: 1.0 MCLE General Credit Program Minutes: 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

“Estate Planning for Ranch Land andFarm Lands"

Renee M. Gabbard

(o) (949) 223-7134

[email protected]

BRYAN CAVE LLP

Confidential - not for redistribution

Estate Planning for Ranchland

Liquidity Concerns for the Payment of EstateTaxes

Choice of Entity for Estate Planning andTransfer Discounts

Succession Planning to Ensure Success of aRanch or Farm including intra v. outside ownerissues

Advanced Gifting Techniques

Anticipating Hardships and Economic Issues


Liquidity Concerns for Payment of EstateTaxes – Review of Estate Laws

Preserved tax rates through 2013 Estate tax – 40% GST Tax dropped to 40% Gift Tax dropped to 40% Increased estate tax exemption to $5,250,000 per

person – indexed Increase to $5,250,000 per person - indexed No change in annual exclusion gifts - indexed - $14,000 Reinstated uniform gift and estate tax application New portability options for gift and estate tax – NOT Gst

Tax


Liquidity Concerns for Payment ofEstate Taxes

Illiquid Assets Many ranchlands divided into two businesses – operations and land Both illiquid Cash flow challenges – Quotas and Crops Bring below $5,250,000 or $10,500,000 for tax Usually not a lot of insurance or planned with an insurance trust Will rely on the Form 706 Planning Valuation Opportunities Special Use Valuation -2032A 10 Year Hold Problems Bond Release Issues Section 6166 - Do you meet the test? Sometimes cash rich do not


Choice of Entity Issues

Historically Entity Adverse

5 Types of Entities, C Corp, S Corp, GeneralPartnership, Limited Partnership, Limited LiabilityCompany and the Sole Proprietorship

Two types of entities - Operations

Most Operations are NOT LLCs – Gross Receipts Tax

Operations – General Partnerships (Common with JointFamilies)

Operations – Limited Partnerships

Limited Partnerships with a C Corp General Partner?



Building the Entities Limited Liability Company for Land – Usually source of

wealth LLCs – Flexibility, Pass Through Taxed as a Partnership,

Easy to Administer Unique LLC Problems – Ongoing Fees ($800 in

California) Unique LLC Problems – What if there is no income?

Timberland Example – Gift Issues The LLC “Put” Option Operations Lease the Land? More complication



Building the EntitiesGeneral Partnership or LP for OperationsLending Issues - RecourseAlways a General PartnerStill good opportunities for giftingStill good opportunities for lack of control and

lack of marketability discountsOften revocable trust and Entities are the Last

Estate Planning


Succession Planning to EnsureSuccess of a Ranch or Farmlands

Building the Family Is it in the genes? Lifestyle, Character, SpousesWhat does an estate plan look like?TransparentOften land one way, operations one way, rest of

assets another wayTerm life insurance for non-involved family

membersLife insurance trust – liquidity issues



Building the Plan with the Family Revocable Estate PlanWho is in Control of the Trust?Who is in Control of the Entities? Entities owned by the

Trust Voting or Special Investment Trust to tie Control of the

Entity No restriction on maintaining illiquid assets – no

diversificationWaive self dealing issues – allow more flexibility Trustee Provisions for Ranch and Farm Issues



Family, Entities, Revocable Plan, Life Insurance Trust Now What? Gifting of the Entities OR Start New Operations Differently Starting New Operations Gifting Basics – Annual Exclusion Gifting Annual Exclusion Gifting to Subtrusts for Each Child Annual Exclusion Gifting to a Grantor Trust Annual Exclusion Gifting of Entity Assets in some years and maybe

cash in other years for life insurance payments The outright gift – $5,250,000 Gifting Issues – Maintaining Control – Through Trustee Issues Gifting Issues – What about grandchildren? Starting young Gifting Issues – “I’m Done with This” – Buy/Sell Problems



Building on the Annual Exclusion andOutright Gifts

The Sale to Grantor Trust

The Grantor Retained Annuity Trust



Paul Hastings

Husband/Wife

S Corp or LP

GrantorTrust for Children and/or Grandchildren

Business entityinterests

“Seed gift” of cash, assets and guarantee tocreate equity

Sell additional business entity interest atdiscount for note

Interest and principal paymentson note

ADVANTAGES CONSIDERATIONS

•Seed gift is less than $10,500,000, client pays no gift tax dueto gift tax exemption.•Sale value, determined by professional appraiser, takes intoconsideration transfer restrictions, so owner receives animmediate tax savings.•Sale is ignored for income tax purposes, so no capital gain isrealized, and no interest income or deduction occurs on note.•Owner retains value of business interest sold as a promissorynote plus fixed return through note. Note interest based onapplicable Federal rates. Note payments flexible. Note can beprepaid.•All growth in value of business interest, in excess of noteinterest, is excluded from owner’s estate.

•IRS is closely scrutinizing the use of valuation discounts ongifts of business entity interests.•Professional appraisals will be required to value businessLLC entity and amount of business entity to be sold.•Annual accounting and administrative costs to maintain thebusiness entity.•If client dies before note is paid in full, capital gain mayresult.•Buyer retains original basis. No acquisition basis becausesale is ignored for income tax purposes.



Sale to Grantor Trust Building Blocks Grantor Trust –Might have used Annual Exclusion Gifts The Sale Documents – Initial Gift, Down payment, Promissory Note, Pledge

Agreement – Other Documents Down payment Considerations Promissory Note – Applicable Federal Rate – Published Monthly –

Timevalue.com and IRS Commercially Reasonable Terms – Interest only and Balloon at the End –

Mid Term Rate or Long Term Rate Need Cash Flow Analysis at the Beginning to Determine if the Note Can Be

Paid off If Parent Dies During the Term of the Note Capital Gains Tax May Occur Work closely in a team approach – CPA, Financial Adviser, Insurance,

Attorney



FAMILYPRE-GIFT PLANNING

GRANTOR RETAINED ANNUITY TRUST (GRAT)

Paul Hastings

Mr. and Mrs.Parent

FamilyHoldings,

LLC

GRAT

Business entity

interests

Gift LLC interests for annuityamount for a term of five years

GRAT Makes Annuity Payments Back

ADVANTAGES CONSIDERATIONS

• Grantor pays no gift tax due to “zero out” nature ofAnnuity payment.

• LLC interests gifted are professionally appraised and takeinto account restrictions on transfer, so family receives animmediate tax savings.

• Grantors retain annuity stream only and control of businessentity.

• All growth in value of LLC interest and amount not paid inannuity stream is passed to children.

• Grantors can remain trustee of the GRAT and/or trusts forthe children.

• IRS is closely scrutinizing the use of valuation discountson gifts of business entity interests.

• Professional appraisals will be required to value the LLCunits gifted.

• If grantor dies during the term, all assets are back in theestate.

• GRAT retains original basis. No acquisition basis.

Trust forC2

OC/349201

At end of term, assets aredistributed gift and estate tax-free to Children in Trust

Trust forC3

Trust forC1

Marketable

Securities



Grantor Retained Annuity Trust Building Blocks – GRAT Trust Building Blocks – Grantor Trust – Nonexempt No GST for GRAT Estate Tax Inclusion Period (ETIP) Rules Annuity a Factor of Age, Term, Section 7520 Rate Brentmark Estate Planning Tools Annuity Payment Issues – If not cash then business interests – ongoing

valuation issues Need Cash Flow Analysis at the Beginning to Determine if the Note Can Be

Paid off If Parent Dies During the Term of the GRAT – Partial Inclusion Rules Work closely in a team approach – CPA, Financial Adviser, Insurance,

Attorney


Anticipating Hardships andEconomic Issues

Never Goes as Planned – High Risk Area forRanchland/Farmland

Business Insurance – Herd and Crop Loss Issues True Value of Real Estate – Here or There? Do you

know the new market? Unexpected Deaths and Twists and Turns –

Incompetency, Divorce, Etc. The Need to Stay Flexible – More reliance on Planning

with Land rather than operations? Know thy Lender – Usually Recourse Take it SlowWatch for the “Book Keeper” Syndrome

Conservation Easement: EstatePlanning for Farmers and Ranchers

Ronald A. LevittSirote & Permutt, PC2311 Highland Avenue SouthBirmingham, AL [email protected]

Birmingham Huntsville Mobile Fort Lauderdale Pensacola

sirote.com

[email protected]

2


1. Conservation Easement – What is it?

A set of restrictions on taxpayer’s USE of property

Taxpayer still owns property, but has more limited use

Preserves the property for wildlife habitat, outdoorrecreation, green space, scenic vistas, or historical areas orstructures

Examples

High income, high net worth client

Land with Wildlife, Vistas, Open Space values

Intent to preserve; keep in the family

Has development potential, now or in future

sirote.com

[email protected]

3


Owner with less taxable income

“Capital asset” / “capital gain” preserved

Development potential; conservation values

Possible “monetization”

Owner wants to retain property for CURRENT USE

Wishes to generate liquidity

To be able to maintain property for other purposes

Income, estate tax reduction

sirote.com

[email protected]

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2. Structure – “Bundle of Sticks”

sirote.com

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3. Why Bother?

To keep land in current use

To ensure property stays in family, by discouraging sale, development, etc.

Charitable deductions & exclusions

To benefit environment, wildlife, perhaps provide walking trails, vista

4. Basic Tax Benefits

INCOME TAX deduction for donation of easement, IF meet conservationpurposes & other test. IRC §170 (h)

ESTATE TAX deduction, IF less onerous test met. IRS §2055 (f)

ESTATE TAX exclusion, IF property in gross estate is subject to a §170 (h)easement. IRS §2031© (election)

5. Congress Loves Conservation Easements, Especially for Farmers & Ranchers

50% of contribution base limit recently re-extended through 2013

Special incentives continue to apply to individuals & corporations who arequalified farmers or ranchers

Individual farmers & ranchers who are qualified are allowed 100% ofcontribution basis as an annual limit on qualified conservation contributions(instead of 50% contribution basis limit)

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Corporate farmers & ranchers who are qualified are allowed 100% of taxableincome as an annual limit on qualified conservation contributions (instead ofnormal 10% limit)

A “qualified farmer or rancher” means a taxpayer whose gross income from itstrade or business of farming is more than 50% of the taxpayer’s gross income forthe year

Farming for this purpose defined in§2032A(e)(5), includes cultivating the soil;raising or harvesting any agricultural or horticultural commodity; raising,shearing, feeding, caring for, training, and management of animals; handling,drying, packing, grading, or storing on a farm any agricultural or horticulturalcommodity in its unmanufactured state but only if the owner, operator, or tenantof the farm regularly produces more than one-half of the commodity; and theplanting, cultivating, caring for, or cutting of trees, or the preparation (other thanmilling) of trees for market

Gross income for the trade or business of farming doesn’t include derived fromhunting and fishing activities or from sale (including a bargain sale) of aconservation easement. However, income from the above activities is included in

the individual’s gross income.

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The 100% limitation does not apply to any contribution of property that is usedin agriculture or livestock production (or available for that production) unlessthat contribution is subject to a restriction that the property remain available foragriculture or livestock production. There is no requirement as to any specific usein agriculture or f arming, or that the property necessarily be used for thosepurposes, merely that the property remain available for those purposes.

Income from the sale of timber is included in the individual’s gross income fromthe trade or business of farming, and is also included in the individual’s grossincome.

Where a pass-through entity such as a partnership or S corporation makes aqualified conservation contribution, the determination is made at the partner orshareholder level as to whether an individual who is a partner or shareholder is aqualified farmer or rancher for the tax year of the contribution.

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6. “Conservation Purposes” - §170 (income Tax Deduction)

Preserves land for outdoor recreation (or education) for the public

Protects a “relatively natural habitat”

Preserves “open space”

a) For the scenic enjoyment of the general public, or

b) Pursuant to clear governmental conservation policy, yielding a significantpublic benefit

Preserves a historically important land area or structure

7. “Conservation Purposes” - §2055 (Estate Tax Deduction)

Donation need NOT meet the technical “Conservation Purposes” of section 170

“Qualified Real Property Interest” – same

Qualified charity – same

Purposes – essentially anything within exempt purposes of Land Trust (charity)

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8. “Conservation Purposes” - §2031 (Estate Tax Exclusion)

Donation MUST meet the technical “Conservation Purposes” & otherrequirements of section 170

But “historic preservation easements do not qualify”§2031 (c)(8)(B) (not (iv)purpose)

Family must have owned property for 3 years, and

9. Basic §170 Requirements

“Qualified Organization”

- 501(c)(3)(public); governmental organization

Perpetual Grant

-Regardless of deduction, owner cannot get development rights back!

Restrictions Enforceable

-Land Trust must have commitment and means to enforce provisions

-Must monitor compliance periodically

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10. Section 170 – Key Technical Issues

“Congress Giveth, Congress Taketh Away,

- Then Congress Giveth Back… Maybe”

But “historic preservation easements do not qualify”§2031 (c)(8)(B) (not (iv)purpose)

Family must have owned property for 3 years, and

Purposes – essentially anything within exempt purposes of Land Trust (charity) -2055

11. Issues: Retained Rights & Uses

Limited areas for residential use

- Value reduces deduction

-Possible enhancement issues

Size, type, number of structures

Commercial & other uses

-Agriculture

-Recreation (golf, campground, hunting, etc)

- Section 2031(c) has additional limitations

Timber cutting (with/without limitations)

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12. Donation During Life

Donor gets §170 Income Tax Deduction

At death, Donor’s remaining interest in land is valued at “After Value” – i.e., subject toeasements restrictions

If elected, Estate may excluded AN ADDITIONAL 40% of the remaining land value (notimprovements), up to a maximum of $500,000 (per person)

This benefit replicates over generations

13. Donation By Will - Exclusion

NO §170 Income Tax Deduction

Donor’s FULL interest in land is INCLUDED in gross estate; BUT Estate getDeduction for charitable contribution, equivalent to 170 amount

If elected, Estate may still exclude an additional 40% of the remaining land value(not improvements), up to a maximum of $500,000 (per person)


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14. Donation AFTER Death; not by will - Deduction

NO §170 Income Tax Deduction

Donor’s FULL interest in land is INCLUDED in gross estate; BUT Estate getDeduction for charitable contribution, equivalent to 170 amount – By Electionbefore 706 due

If elected, Estate may still exclude an additional 40% of the remaining land value(not improvements), up to a maximum of $500,000 (per person)


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15. Donation AFTER DEATH

Puts Estate/Family into same position as if Decedent donated by Will

They get both the Estate Tax Charitable deduction and the 40% exclusion

Alternatively, the Family can choose to give the easement

Take the income Tax Deduction

Their estate receive same benefit, describe above for lifetime donations.

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16. Defending Conservation Easements

Conservation Purposes:

Preservation/Protection must be “significant”

Wildlife need not be endangered, etc.

- But “significance” enhanced by presence

- “Presence” of migratory species:

- “Relatively” natural – appearance, function;

- Some man made features ok (e.g., dams)

Independent experts support habitat, recreation orhistoric values

“Scenic vista” purpose

- Viewable by public

- “Significance” – proof is problematic

Green Space (as “Open Space”)

- Governmental policies

- Fewer in Alabama

[email protected]

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17. Issues: Substantiation

Baseline Documentation

Qualified Appraisal by Qualified Appraiser

Acknowledgement by Qualified 501(c)(3)

Feasibility of development of property

critical -- zoning, environmental, wetlands, & conservation regulationsmay limit

Feasible proposed development plan to support valuation

[email protected]

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18. Mechanics Issues

Dotting I‘s and crossing T’s -- essential

Sequencing, Recording, Timing

Subordination of mortgagees, lessees, etc.

Retained uses must not conflict with conservation purpose

- Mineral interests (< remote chance)

- Agricultural uses; chemicals; maintenance

Negotiation of Easement terms desirable

[email protected]

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19. Valuation

Comparable sales of easements, if available

- Typically, they are not

“Before and After” Methodology

- “Before” = Value of Property disregarding the Easement

- “After” = Value of Property with only the uses permitted by theEasement

- Difference = Value of Easement

[email protected]

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Issues: Valuation

Highest and Best Use

Protected species are helpful to conservation purpose, but can become a problem invaluation

Defending a valuation controversy

- detailed understanding of appraisal methodology

- subjective nature of appraisal and adversarial nature of experts

Deduction reduced by “enhancement” of other properties of Owner or related parties

- E.g., adjoining property may benefit (increased value) from preserving pristine views orrecreational areas

Feasibility issues

- Zoning

- Permits (local, FWS, Corps of Engineers)

- Wetlands & protected species

Subdivision Method

- Hybrid of Comparable Sales & Income Approaches to Appraisal

- Projected revenues & costs

- Discounted cash flow

- Not favored by IRS

- Numerous subjective assumptions

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20. The Good & Bad News

2004: Congressional hearings highlight abuses in conservation easement area(primarily valuation & purpose)

IRS Notice 2004-41

Dirty Dozen list

2006-2013: Congress encourages easements by extending carryover period andincome percentage limitation (etc.)

Conservation community has substantial support in Congress

Aggressive Examinations

• Particularly Southeast, Mountain West

• Engineers play key role

- Brought in for valuation issue

- Conservation purpose

- Substantiation

- “Qualified” appraisal

- Appraisal methodology