The IRS Might Be Your Next Farm Tenant

JANUARY 7, 2014

 

Everyone knows that farmland prices are at historic highs. The average per-acre price forIowafarmland is $8300.  That average is figured on both pasture land and crop land, so the average price is much higher for tillable ground. It is also much higher forIowa’s best land.  Sales have been recorded for at least twice that $8300 figure.

 

Based on that $8300 figure, a single farmer will pay federal estate tax if he has at least 600 acres of land.  600 acres is a lot of acres, but it leaves no room for any other assets.  If the farmer also has equipment or livestock or life insurance or bank accounts, he will pay estate tax with less than 600 acres.  What does that mean for his estate and his heirs?

 

Federal estate tax is assessed at a flat 40%.  So if the farmer has three children, his biggest heir will be the IRS.  That is because the IRS will get 40% of his estate while each of the children gets only 33% of what remains after the IRS takes its share “off the top.”  That is not the result most farmers want.

 

That result can be especially hard on non-farm heirs.  If the farmer plans to give his farm child the farmland and give his liquid assets to his other children in order to provide then with an inheritance, that plan won’t work if there is estate tax.  The estate tax will probably be paid from those liquid assets, eating up the inheritance of the non-farm children.  Under that scenario, they not only lose their inheritance but they lose it to protect the inheritance of their on-farm sibling.  In effect, the estate tax works a double whammy on those non-farm heirs.

 

Another problem is that the IRS wants its share within 9 months of death.  That is not a long time for a grieving family to settle post-death affairs.  The IRS also wants its share in cash.  It will not take equipment or grain or an interest in the land.

 

So how does the farm family pay the IRS if it has to?  Assuming there are no liquid assets available (or not enough liquid assets available), the family will have to sell or mortgage land.  Fortunately, both are fairly easy in this economic environment, but it may not be as easy years from now.  And for most farmers, selling land is never a good thing.

 

In addition, the IRS-induced sale is like a fire sale.  If a farm family sells some, but not all of its inherited land, savvy neighbors may figure out that the sale is estate tax-motivated.  They may still offer a fair price, either because they don’t want to get outbid or because they are fair-minded people.  But if they do not, the family may have to sell for less than top dollar.  They will not have the luxury of waiting for a better offer.

 

The IRS does have programs in place to help family farmers.  Farms are eligible for special reduced valuations, but the reduction in value may not be big enough to avoid the tax.  In addition, not all farms are eligible for that valuation benefit.

 

Farmers can also pay their estate tax in installments, and the installment plan is remarkably fair.  The interest rate is low, and the first five years are interest only.  The actual tax does not have to be paid for the first five years, and then it can be paid over the following 10-year period.  The result is 15 years to settle up with the IRS.

 

That solves the problem for a lot of large land holders, but who wants to partner with the IRS for 15 years?  And what if there is a bad crop year?  The IRS must be paid each year, regardless of the quality of the crops or the variances in commodity prices.  The IRS is not like the local banker. There is no way to talk to the IRS and devise an alternate payment plan.

 

Until recently very few farmers paid estate tax.  That may be due to historically lower farm prices, or it because a married couple gets twice as much tax latitude as a single farmer. That means that (with an $8300 average) a married couple needs more than 1200 acres of land before estate tax becomes an issue.  For most people, that solves the problem right there.

 

But it won’t solve the problem for an unmarried farmer or for any farmer whose wealth exceeds the applicable estate tax threshold.  The single farmer could marry or remarry to reduce his estate tax bill, but that is probably not the best or most romantic solution to the problem.

 

The possibility of paying estate tax is the downside of today’s historically high farm prices.  It is a contingent liability that farmers should plan for, and in many cases it can be eliminated with proper lifetime planning.

 

The essence of that planning is traditional estate planning.  In addition to a Will, the farmer will need advice on his exposure to estate tax liability and ways to reduce or eliminate it.  Estate tax is a solvable problem in many cases but it has to be solved while you are alive.  Putting your head in the sand won’t solve it.  Counting on Congress certainly won’t solve it.  The only one who can solve it is you!