One of the most important things I can think of when telling a landowner-farmer about their need for estate planning is to consider exactly what it is they want to happen to their assets when they die.
Most people naturally want to pass the family farm along on to their children after their death and their spouse's death. Occasionally, I see or hear of some different intended desire. But for the most part, the norm is for mom and dad to leave the bounty of their earthly efforts to their kids or close family members.
Planned giving is a process that requires much determination and effort to implement. We want to begin talking today about giving away some of the property via business entities using “discounting techniques.” Due to the complexity of this article, it will necessarily be in multiple parts.
Let's start off by talking about something known as the Gift Tax. The 1976 Tax Reform Act essentially brought the gift tax and estate taxes into one unified transfer tax using a single rate and what is known as the “unified tax credit.” The gift tax is applied in a cumulative fashion which is made applicable to all taxable gifts since the enactment of the law in 1976.
In the next article we will begin by integrating the estate tax into its working relationship with the gift tax. It's a complicated little matter, so let's save that for another day until we see some gifting techniques used first.
The essence of what occurs with the gift tax is that the Congress is levying a tax on gifts above the “annual exclusion” ($13,000 in 2009) amount so that a person cannot give away their wealth during their lifetime and avoid the “death tax.” So, a tax is imposed on the gift above the annual exclusionary amount. One blessing Congress does give is the annual exclusion. Any and every individual can give away $13,000 each calendar year during their lifetime pursuant to Section 2503(b) of the Internal Revenue Code (IRC). The IRS just simply closes its eyes to any gift of $13,000 or less.
From 1982 through 2001, it was $10,000 and $12,000 last year and the year before as well. Henceforth, it will be indexed for inflation.
Coinciding with the annual exclusion gifts, please be advised that each American can give away during their lifetime (under current law) a maximum of $1 million via gift and not pay gift tax. Anything over the $1 million figure triggers a tax. But even though a person has given away the $1 million, they still have the annual exclusion available. To waste this is a terrible thing for the owner of a large taxable estate. There are a lot of discounting techniques we will begin discussing in earnest in the upcoming articles.
The purpose of this article is not to make you an estate planning expert, but solely to provide a sufficient enough background so that in the succeeding articles, you can follow some theory and concepts as to why gifting of family business interests is usually in your family's and estate's best welfare.
Let's take some examples to further explain gift tax laws and strategy.
Suppose a farmer here in east-central Alabama has an inherited farm property that was worth $750,000 that was inherited in 1971 from Grandmom and Grandad. It is now 2009 and farmer and wife are in their upper 70s. They have made no provision for a gift plan nor any estate planning. They outright own their farm with a “fair market value” of $4.5 million and farm equipment of approximately $250,000.
They also have an account with Edward Jones worth $500,000 and a home worth $250,000 and bank accounts of $75,000. They have I.R.A.s worth $200,000. They have three kids, five grandchildren, two dogs and a housecat.
What in the world do we do? That is also my first question as I sit there in panic with my pulse racing over how to morally and legally pry the hands of the I.R.S. off this hard working family's estate.
The first thing I would do is to get the inventory of the couple's net worth into a pie chart to see what percentage of the total estate each categorized asset comprises in relation to the total estate. Then I would next look at what asset(s) would appreciate rapidly, which would appreciate moderately and which would only grow slowly if at all. And lastly, I would try to determine which would lose value, such as equipment and autos.
Heretofore, the land has been a greatly appreciating asset until this recession we seem to be caught in. Today, I don't think I know what to do any better than the next guy unfortunately.
Honesty is one of my shortcomings. Who knows where this economy is heading? But disregarding that fact, we are going to act as if the economy will pick back up and values will begin rising again. So, we are going to have to ignore the recession to some extent. But we can look at the silver lining of the thundercloud. Land prices are depressed and we have greater gifting opportunities to explore and utilize than in recent years.
Unfortunately, I am out of room and must continue at another time. Perhaps you will stay tuned in for our article in a few weeks and see what we can come up with to get ourselves out of this dilemma. Think about what you would do. Until then, God richly bless you and your family.
Mark Tippins is an Auburn, Ala., attorney licensed in Alabama and Florida. For questions or comments, he can be contacted at [email protected] or (334) 821-3670.