by Rodney Mattos
Jim and Lynette’s situation isn’t unusual, but they can put a transition plan into place that will benefit everyone involved. The key is to make those decisions sooner rather than later.
If it’s likely that Jim’s farm will be sold after his retirement, he can retain his best employees by paying for life insurance policies that the employees agree in writing not to touch until a determined date in the future. The premiums for those policies are tax-deductible because they’re considered wages to the employee. When the determined date arrives, employees could choose to surrender their policies for cash or keep them for their own family’s security. Alternatively, Jim could purchase annuities that can provide income payments to employees after the business is sold. The employees would own the annuities contracts and therefore owe taxes on the premiums.
When the business sells, the Internal Revenue Service will want their share of the proceeds. If the farm’s assets have a zero cost basis, or substantially low cost basis, those assets or stock will likely be subject to sizable capital gains taxes. There are several ways Jim and Lynette can address the tax exposure they have, such as a Charitable Remainder Trust (CRT). The CRT allows Jim and Lynette to benefit their favorite charities while also spreading out their tax burden over many years. A CRT is likely going to sell the farm assets immediately and use the proceeds to purchase an income-producing asset for Jim and Lynette’s benefit. Jim and Lynette would pay taxes on their annual income from the CRT.
There’s also a new tax provision, the Qualified Opportunity Zone program, that can lower Jim and Lynette’s tax burden from the sale of their business. Within 180 days of selling their business, Jim and Lynette can invest the proceeds from the sale into an organization that manages investments in an economically distressed community. Because this is a new program that’s still being developed by the IRS and the Treasury, Jim and Lynette should consult with a professional investment advisor so they get the very latest program information.
But what if one of Jim and Lynette’s children, Nancy, decides she wants to move back to the family farm and continue the business after Jim’s retirement? Jim considers it important to make equitable choices to avoid rifts between his children. After retiring, Jim wants to retain ownership of the land and equipment, leasing them to Nancy for use in the business. The house will be sold when Jim and Lynette are ready to move to a retirement community. They’re considering leaving the farm to Nancy upon their deaths, since she’ll assume the risk of keeping the business going. Jim and Lynette want to make a specific cash bequest to each of their non-farming children that would be less than the value of the business since they won’t be taking on the risk of running the family farm. Jim and Lynette could leverage their current cash holdings designated for their non-farming children by using those funds to purchase life insurance policies for them that provide tax-free death benefits.
These are just a few of the solutions available to help families with farm transition planning. Every family farm is different, so it’s important to work with an experienced advisor and develop a clear path that works for your business and your family.