Family Farm presented by Tom Bayer, Partner, Sikich LLP

Transcription

1 Exit Planning for the Family Farm presented by Tom Bayer, Partner, Sikich LLP

2 What is included in the Exit Planning process? Comprehensive approach hto exiting the farming operation Preserve asset value by mitigating grisks Uncovering risks in the event of an unexpected exit Limit the tax burden. Preserve the family legacy Defining fair.

3 Ingredients of a Successful Exit EitPl Exit Plan based on the farmer s objectives. Experienced team of advisors to design and implement the plan. Cash flow and asset value defined. Strong successor operating team in place. Time.

4 The Seven Step Exit Planning Process Step 1 Identify Exit Objectives Step 2 Quantify Farm and Personal Financial Resources Step 3 Maximize and Protect Operating Value Step 4 Transfer operations to Tenant Step 5 Transfer operations to Family Step 6 Farm Business Continuity Step 7 Personal Wealth and Estate Planning

5 Team of Professional Advisors Financial Planner Appraiser Insurance Advisor Farm Manager Investment Advisor Farm Business or Farm Business Attorney Management Consultant Estate Planning Attorney Banker CPA Family Business Consultant t

6 Advisor Team Relationships Family Consultant Exit itplanning Professional Financial/ Insurance Advisor Family Farmer Asset/Wealth Family Manager Farm Appraiser Farm Manager CPA Estate Planning Attorney

7 Team of Professional Advisors No one professional has all the answers. Diverse skills and talents are necessary. Team approach minimizes time and cost.

8 Step One: Identify Exit Objectives When a man does not know which harbor he is heading for, no wind is the right wind. - Who? - How Much? - When? - Seneca

9 Step One: Identify Exit Objectives Universal Objectives: When do you want to leave the farm? How much cash do you need? To whom do you want to transfer the farm operation? Family? Neighbor (tenant)? What are your plans for the farm ground you own? Other Considerations: Leave a legacy? Never retire? Philanthropic h i works?

10 Step Two: Quantify Farm Business & Financial Resources Beauty is in the eye of the beholder.

11 Step Two: Quantify Farm Business & Financial Resources Universal Objectives: Provides a baseline value for farm assets Measures farm and personal resources available currently. Allows you to monitor progress toward stated financial objectives to achieve a successful exit and retirement.

12 Step Two: Quantify Farm Business and Financial Resources Sometimes we discover this. Time is Ticking Current tfinancial i Desired dfinancial i Resources Resources How Large Is Your GAP?

13 Step Three: Maximize & Protect Farm Business Value Making a silk purse from a sow s ear.

14 Step Three: Maximize & Protect Value Universal Objectives: Grow value through expansion of operations Minimize income taxes upon exit. Ensure successor has credit history and capital Retain key employees and other vendor relationships Segregate assets to mitigate loss from catastrophic event

15 Step 3: Maximize and Protect Value Life insurance may be needed to protect value In simple terms, insurance serves 2 purposes: One, to mitigate risks from an unexpected event or unfunded liability, if death of the farm owner occurs, to pay off mortgages and debts, or to provide an income stream for the surviving family, or, to pay estate taxes at death, or, fund buyout of partner or family member Two, insurance is an investment As life progresses, you may accumulate assets, reduce liabilities, and effectively self-insure Early in your career, insurance is more important to fund family needs, pay pydown debts. 15

16 Step 3: Maximize and Protect Value Disability insurance should also be considered Personal disability, short-term and dlong-term protects your family in the event you can no longer work Business disability works like life insurance in that an event of disability would trigger a payout to the business or to the beneficiary, i with the purpose of funding an unfunded liability, existing liability, or other need Fil Fairly costly Risk exists, and most elect to not fund it 16

17 Step Three: Maximize & Protect Farm Business Value Promote Value Through Value Drivers: Focus on improving key ratios Don t speculate, manage risks using available tools Collateralize or insure risks where you are exposed Preserve capital for lean years Document legal arrangements and avoid handshake agreements

18 Minimizing tax burden Retiring farmers normally have large taxable incomes in their final year of farming and the following year This is before considering the potential income from the sale of their M & E This is because farmers are normally cash basis taxpayers, and A significant amount of grain is usually sold in the year after it is produced A significant portion of crop expenses are normally paid in the year before the crop is planted Pigs get fat Hogs get slaughtered.

19 Minimizing tax burden Minimizing the tax burden immediately after retirement can be done by managing taxable income into the lower brackets in pre-retirement years, so not to find yourself in highest bracket in year after retirement Many of our retiring farmers have machinery and equipment (M&E) with a fair market value between $250, and $1,000,000. The M & E normally has little or no tax basis This fact is the result of an early write-off of cost basis from Bonus depreciation Section 179 depreciation

20 Minimizing tax burden In final farming year, the farmer has Income from the prior years crop Few expenses related to the production of his final crop Little or no investment in new M & E, therefore Very small depreciation deduction In the year following final farming year, the farmer has Income from sale of crops from final farming year If he owns farm land, may have landlords share of income, either cash rent or grain sales if crop share leasing No farm related expenses to deduct Expenses related to farm rental income, either cash rent expenses (such as real estate taxes) or crop share expenses (such as seed and fertilizer) are likely not deductable because of passive activity rules

21 Minimizing tax burden Tax results from sale of farmer s M & E Ordinary income to the extent of depreciation recapture under section 1245 Capital gains ONLY if sale price exceeds original cost basis What is cost basis? If elected not to apply provisions of regulation (I)-6. (Basis of trade-in added to boot paid for new item) Installment sale DOES NOT HELP Depreciation recapture is taxable in year of sale even in the case of an installment sale

22 Minimizing tax burden Advantages of leasing the M & E rather than a sale Spread income over multiple years Possibly no lease income until second year of retirement Annual llease payment tdue in arrears between December 15 and January 15 Might allow farmer to make equipment purchases in final year of farming Depreciation deduction to reduce taxable income

23 Minimizing tax burden Leasing likely only viable option where lessee is a family member or other very close colleague Son, son-in-law, nephew, etc., that has been farming with retiring farmer outsiders unlikely because Risk to retiring farmer is too great Collection of lease fee risk Damage to equipment risk Likely would involve multiple lessees Some M & E may not be leasable Lessee may require terms that tresult ltin sale under tax rules

24 Minimizing tax burden Key elements of leasing strategy Year-to-year lease and can be terminated by either party Lessee can elect to purchase any or all items any time However, is not required to purchase Lease amount is reasonable Value of equipment divided by some number between 8 and d12, plus an interest factor If leased with farm land, lease terminates if no longer farming land

25 Minimizing tax burden Can trade-in items of M & E for replacement M & E Approval of lessor required Lessor retains an ownership interest in new item Lessee protected t din the event of Lessor s death Lessee responsible for all repairs, maintenance, insurance, etc. Lessor retains ownership of all M & E Lessee can not sell or pledge as security Reasonable default causes How are the purchase amounts disclosed in lease schedule dt determined d Present value calculations using IRS allowed interest rate

26 Minimizing tax burden Other issues and considerations Consider selling rather than leasing certain items Trucks and trailers that are licensed Insurance and risk issue Will they be used for hire? Licensing issues High cost Renew date is July 1 Items with small value Keeping items with an individual value of $1,000 $, or less off the schedule seems to make a lot of sense

27 Steps Four and Five Step 4 and 5 are or either you will transition the farming operation to a family member, or you will transition i to a tenant farmer Who will be your successor Family member Tenant farmer Other? What will happen to family farmland in the short-term Y t k th d i i f f il l You must make these decisions for your family.no one else can 27

28 Step Four: Discontinue operating farm Making a mountain out of a molehill.

29 Step Four: Discontinue operating farm. Commence relationship with tenant t farmer Universal Objectives: Maximize after tax proceeds from sale of inventory and equipment Eliminate operational risk Design lease agreement that meets your objectives No family succession issues. Speed of exit. Preserve land while generating passive income as investor

30 Step 4: Discontinue Operating Farm Changing face of farming.2012 Statistics from State of Iowa 30% of Iowa s farmland was owned by someone over the age of 75 56% of Iowa s farmland was owned by someone over the age of 65 21% was owned by non-residents of Iowa Percentage of land owned by non-farmers % % % 78% of farmland was free of debt Source: Duffy, Farmland Ownership and Tenure in Iowa,

31 Step Five: Transfer Operations to Family Member Making a molehill out of a mountain.

32 Step Five: Operating Transfer to Family Member Universal Objectives: Achieves Exit Objectives of: Retaining family legacy on farm Allows next generation to benefit from farming investment Allow for fair allocation of farm assets and non-farm assets to all family members Allow active family members to control farming operation decisions

33 Step Six: Farm Business Continuity Planning Making sure the farm operation continues when the farmer doesn t.

34 Step Six: Farm Business Continuity Planning Universal Objectives: Objectives still achieved if you don t survive. Retain ownership and control even if co-owner departs. Can force non-contributing owners to leave. Ensures survival of the farm for the benefit of others. Results in family receiving value of your interest.

35 Step Seven: Personal Wealth & Estate Planning When the slings and arrows of outrageous fortune befall you, fight back. - William Shakespeare (Hamlet)

36 Step Seven: Personal Wealth & Estate Planning Universal Objectives: Preserve wealth, minimize taxes using both lifetime and death planning tools. Integrates lifetime exit objectives with estate plan. Estate planning becomes part of farm planning.

37 Step Seven: Personal Wealth and Estate Planning Use of Trusts, FLPs, LLCs Estate value would indicate that a State and/or Federal estate tax liability exists Putting assets like farmland into a FLP can allow you to turn $1 into 70 cents or less. Discounts can significantly reduce estate tax liabilities Use of 2032A By following all of the rules for eligibility, farmers can reduce the value of the land in their estate by over $1mm 37

38 Questions?