Planning For Stepping Back – Part II
by Arthur Littlefield, MBA
Farm Succession and Estate Planning Specialist
Lincoln Financial Advisors Agribusiness Services
A previous article, “Planning For Stepping Back – Part I”, highlighted nine topics that should be given careful consideration so you increase the likelihood of a relaxing and comfortable “retirement” while any unavoidable stress is kept to a minimum. (For a copy of Part I, email Art.Littlefield@LFG.com.)
I apologize for starting this article with an unpleasant topic, income taxes, but they definitely need to be considered. As you already know, it appears that as a result of the 2020 Presidential and Congressional elections, federal rates are likely to be increased to help replace lost tax revenue, disbursements due to the COVID-19 pandemic, and other Congressional projects. The remaining question is, at what level of taxable income will this be the case.
As you know and likely have been doing, some very effective strategies are used to delay paying these taxes such as placing grain and other commodities in storage, prepaying next year’s input costs, purchasing machinery, improving farm ground, etc. Sometimes grain and commodities are also stored in hopes of receiving a higher price in the future.
As a farmer retires or reduces their farming “activities”, farm related expenses are reduced. Unfortunately, this may be at the same time that stored grain is sold, equipment is sold or leased, farm ground becomes a source of rental income either through cash rent, crop share, custom farming, etc. The net effect would be lower expenses, higher revenue, more income, and more taxes. A recent example was an initial meeting with an 80-year-old farmer who was actually retiring, due to health concerns, and turning the entire operation over to his almost 60 year-old son. One of the first things he did was to sell all $500,000 of his stored grain. As you might imagine, this will put him in a much higher tax bracket. Obviously, it was too late but one strategy we would have recommended he consider, if practical, was gradually selling the grain in different tax years.
For a stepping back farmer, there are further complications to the grain liquidation issue, these include the sale or lease of farm equipment. This is because there may be gains from depreciation recapture, which is taxed as ordinary income, and long-term capital gains due to the increased value of the equipment sold over the original purchase price. The ability to pay future year input costs and other income minimization alternatives may no longer be available. Bottom line, early in retirement or stepping back, revenues will likely increase while available expenses will decrease. This can mean higher taxable income, higher marginal tax brackets, and more taxes due.
To proactively minimize the negative impact, work closely with your financial advisors and professionals to ensure that these sales and revenues are coordinated from a global perspective for not only the retiring farmer and spouse, but also the child(ren) that will be assuming more responsibility. The benefits will far outweigh the expenses of bringing your advisor team together to address these topics and resulting concerns.
We have a farmer client in his first year of stepping back who benefitted from his advisor team working together. The first question we ask at every meeting, “Please update us on any events that occurred since we last met?” His answer included, “I think I am charging my son too much cash rent and his equipment lease is too high”. Fortunately, this occurred early in the year so there was time to respond to his concerns. We arranged for a meeting with the husband and wife, the son, the accountant, and ourselves, for a total of six participants. The outcome was shifting some of the son’s cash rent and lease payments to the following year which resulted in mom and dad reporting less income and a lower marginal tax bracket and tax bill. The son was able to improve the cash flow of his farming operation which was directed to purchasing new equipment. We are continuing to monitor both the parents’ and son’s cash flow and income while continuing to make appropriate / desirable adjustments. The outcome: two generations of clients are winning, while the state’s taxing authority and the IRS both lost.
Stepping back is not just an income tax issue. Consideration should be given to wealth transfer, estate or inheritance taxes and other issues. Reasons for the failure of a farm transfer can be many and may include family dynamics, on-farm and off-farm family disagreements, a lack of understanding regarding successor farm leadership and training / preparation for the new roles, poor communication, financial concerns such as a lack of liquidity and previously purchased life insurance.
When you buy a farm, what do you name it? Our experience has been that it is known by the name of the selling farm family, i.e., the Jones, Smith, or Robinson farm, a family that was not prepared and the transfer failed. It is strongly encouraged that you think about these and other issues well before you begin your “stepping back” process. Farm succession is not a one-time event. It is a process involving many parties including a team of advisors who can draw upon a vast amount of experience of what has and has not worked.
We know that you do not want to have your name assigned to a farm owned by someone else. All of these might be considered “Farm Family Legacy” issues.
Lincoln Financial Advisors Corp. and its representatives do not provide legal or tax advice. You may want to consult a legal or tax advisor regarding any legal or tax information as it relates to your personal circumstances. CRN-3430980-020121
Lincoln Financial Advisors Agribusiness Services. 1212 Banbury Circle, Naperville, IL 60540. Art Littlefield is a registered representative of Lincoln Financial Advisors Corp. Securities and investment advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies.