Now that the federal estate tax and gift tax equivalent has been “permanently” increased to $5.43 million per individual ($10.86 million for a married couple) for decedents dying in 2015, and the top tax rate is 40% rather than the previous maximum rates reaching 55%, many of the complex A/B Trust and Reduce to Zero estate plans previously implemented can be simplified and new plans can be prepared without all the focus on minimizing transfer taxes. But does that mean all the tax planning issues have been resolved? Not by any means.
Under the old planning methods, the focus was on getting the assets out of the estate before death so that the taxable estate at the time of death was as small as possible. But by doing so, the transferee was not receiving a “step up” in basis of the asset which means that highly appreciated assets would not be shielded from taxable gains. This was a situation that wasn’t altogether ignored, but because the difference between the tax rates of federal estate taxes and income taxes was so significant, it was an easy tradeoff to live with. So now that the veil has been lifted, should we be focusing our planning on capturing as much of a step up in basis as we can?
From a tax perspective basis is defined as “the value assigned to an asset for the purpose of determining gain (or loss) on the sale or transfer or in determining value in the hands of a donee.” Black’s Law Dictionary, Sixth Edition. Furthermore, basis differs for the transferee depending on how they received the asset. For tax purposes, an asset acquired through inheritance, bequest, or devise from a decedent is the fair market value of the property at the date of death (or on the alternate valuation date 6 months after the date of death) rather than the carryover basis of the donor’s basis which is the basis used when an asset is acquired by gift during the donor’s lifetime. For assets that tend to appreciate over the transferee’s lifetime, getting a stepped up basis at death can be a significant advantage.
The difference seems subtle, but for agricultural businesses and farmers this can be a substantial issue. Farmland fluctuates considerably over time, but certainly over the last several years its value has increased significantly. If the farmer acquired the property from a previous generation there may be decades of appreciation accumulated in the land value. Even if the farmer acquired the land outright from a third party, chances are there has been significant appreciation over the holding period.
So now the question becomes whether there should be transfers of highly appreciated property made to subsequent generations during the farmer’s lifetime, or whether it makes more sense to wait and have the transfer occur at the farmer’s death. There are many factors to consider, many of which are beyond the scope of this article. But some things to consider are:
1. Whether a blended family situation exists (do you want the surviving spouse to ever have ownership and/or use in the property?)
2. Will the property, or part of the property, be sold to cash out non-farm children?
3. What is the existing basis of the property, and is the property highly appreciated?
4. What do the numbers say if the current owner(s) were to die today?
5. What are the ages and health condition(s) of the current owner(s) and the successive generations?
6. How likely is it that the property will continue under the same ownership and use for a significant period of time?
7. Are there any tools, such as trusts, that may fit the situation and allow for the capture of the stepped up basis one (or more?) times?
The important thing is to have these conversations with family, with estate planning attorneys, and accountants and to begin looking at the succession plan with a new eye. The old saying is still as true today as it ever was, you can’t avoid death and taxes.