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Estate Planning and Small Business/Farm Succession and Transfer Eaton County Date: Sept 2, 9, 16, 2004 Roger A. Betz District Extension Farm Management Agent Mona Ellard Director, Eaton County MSU Extension Phil Taylor Extension Agriculture & Natural Resources Agent
Why Develop An Estate Plan? Mona Ellard Michigan State University Extension
Why an Estate Plan? u u u Pass assets & business structure to next generation Control transfer How to transfer debt Retirement income – LOTS! Security - health care issues Issues at passing of 1 st spouse Issues - Fairness, equitable, harmonious Durable Power of Attorney and Patient Advocate Peace of mind Minor children - care, finances Gifts Reduce Taxes
What Is Your Estate? Who Gets Your Property? Eaton County Estate Planning & Business Transfer Seminar September 2, 9, 16, 2004 Targeting Farm and Small Businesses Phil Taylor – MSU Extension Agriculture and Natural Resources Agent
Estate Planning wills, probate, & trusts E 2120 A discussion of alternative property ownership patterns and estate transfer methods.
Property u Intangible and invisible rights, powers, privileges and responsibilities of the owner u Real Property Land improvements u Personal Property (everything not real) Tangible Intangible
Property Rights u u Property is not just real estate Numerous separable Rights for an item of property l l Land example: Right of Access, Security right (Mortgage against it), Leasing right, hunting rights, mineral rights, development rights, etc. Truck example: Use rights, leasing rights, gifting rights, lending rights
Property Rights u u u More than one person can own rights in property Rights can be referred to as “Economic Interests” – there is value to the rights Economic Interests are part of a person’s estate and can be transferred
Real Property = Real Estate u u Land or improvements upon the land Buildings, fences, timber, growing crops Oil, mineral, and development rights – houses etc. Evidence of ownership: DEED l Provides description of the property
Personal Property Everything other than Real Property TANGIBLE – “SEE IT” AND INTANGIBLE – “PAPER”
Tangible Personal Property * Physical Property that includes… …Goods, Wares, Merchandise Clothing, Furnishings Livestock, Harvested Crops Machinery and Equipment
Tangible Personal Property (cont. ) * Titled property (title proves ownership) Cars, Trucks, Trailers, etc. * Other proof of ownership Bill of sale or other document showing ownership
Intangible Personal Property A claim capable of being enforced on or against other individuals or entities. “Paper Property” – A piece of paper shows ownership. Securities, notes, bank accounts, patent rights, land contract, life insurance contract etc.
Ways to Hold Rights deed, contract, or other evidence of ownership u Fee simple (sole ownership) u Co-ownership 1. Joint Tenancy (with rights of survivorship) Tenancy by the Entirety 2. Tenancy in Common (Default)
Ways to Hold “Own” Property u JOINT TENANCY l With Rights of Surviorship u l Whoever lives longest – gets the goods By the Entirety u u Same as above, only between husband wife. Each spouse has equal ½ ownership irregardless of how the property was obtained
Ways to Hold “Own” Property TENANCY IN COMMON No rights of survivorship Co-owners have right to transfer their interest At death, % ownership transfers subject to will or state law. l l l • • • Two brothers own land Tenancy In Common. What happens to the land if when one brother dies. His portion of the land is subject to his will or state law. Significant effect on multiple owner businesses.
Methods to Transfer u Contract Life Insurance, Annuity, Trust u Tenants in Common – goes to heirs u Joint Tenancy (rights of survivorship) Ownership vests to survivors u Probate Will State law u Transfer prior to death Complete severance Retained rights
Methods to Transfer Property u Question: My will says my life insurance goes to my son. Who receives the life insurance?
SUMMARY Property: Know what you own. Ownership: Know how you own it. Transfer: Know when it gets transferred. Plan: Know why & how it gets transferred. Heirs: Know who’s going to get it. PROPERTY OWNERSHIP TRANSFER PLAN to your HEIRS.
How Do Taxes Affect Your Estate? Roger Betz Michigan State University Extension District Farm Management Agent
Property Transfer Taxes Government Doesn’t Care Which Method You Use, Just Pay the Appropriate Tax GIFT u Federal Gift Tax SALE u Federal Income Tax u Michigan Income Tax ESTATE (no inheritance) u Michigan Estate Tax u Federal Estate Tax
Federal Gift Tax u Excise tax on gifts Lifetime transfers u u u Without full consideration Donor pays tax due Annual exclusions (indexed for inflation) $11, 000 per donee and person 100% Deductions for GIFT TAX (Income Tax? ) 100% Spouse, College Tuition, Medical Care marital, charitable, partial consideration Lifetime exemption above the annual exclusions $1 Million Starting 2002 and beyond
Federal Estate & Gift Tax Schedule 2004
Gift Tax Calculation (example) u Year 1 $6, 000 X 18% = $1, 080 u Year 2 $21, 000+$6, 000 = $27, 000 l 3, 800 Plus 22% of 7, 000 = 5, 340– 1, 080 = 4, 260 u Year 3 $51, 000+$21, 000+$6, 000=$78, 000 l 13, 000 Plus 26% of 18, 000 = 17, 680 – 1, 080 – 4, 260=12, 340 u Must add up gifts above the annual exclusion for entire lifetime
Unified Credit u Used to calculate effective Federal Estate and effective Gift tax exemptions u Currently the credit is applied to both the Federal Gift Tax and the Federal Estate Tax u Credit used for gifts is not available to pay your estate taxes u Beginning in 2004 different thresholds exist for gifts versus estate taxes u What is the Unified Credit for ‘ 04 -’ 05? u Gift Tax =$345, 800; Estate Tax = $555, 800
Unified Credit Reduction (Example) Gift Tax Unified Credit (2004 ) $345, 800 (1 M) Year 2001 used -1, 080 Year 2002 used -4, 260 Year 2003 used -12, 340 Remaining Gift Tax Credit $328, 120 Died in 2004 with no gifts over limit ’ 04 -’ 05 Estate Tax Unified Credit $555, 800 Minus U. C. used by the Gifting -$17, 680 Remaining U. C. for the Estate Tax $538, 120
Gift Tax Effective Exemption Gifts are during your Lifetime u Increases over years 1997 and before = $600, 000 l 1998 = $625, 000 l 1999 = $650, 000 l 2000 and 2001 = $675, 000 l 2002 - 2010 = $1. 0 million l 2011 = $1. 0 million ? probably l Congress action? l Same as Estate Tax Exemption up to 2004 l
Gift Tax Rate Schedule 2001 -2011 Red area is where Unified Credit or Exemption is used up
Filing Requirements IRS Form 709 A or 709 - Gift Tax Return 709 A=<$20, 000 Gifts of more than $11, 000 per donee in any year Return due April 15 following the year of the gift
Gifts: Planning Pointers u $11, 000 person per year u Spouse can use spouses annual exemption so $22, 000 per year u Two married people can give two other married people 44, 000 per year before starting to use Unified Credit u Children, grandchildren and spouses $44, 000 each set
Federal 709 Gift Tax Return
Federal 709 Gift Tax Return
Federal Estate Taxes An Excise Tax It is levied upon the transfer of property at death.
Federal Estate Tax u Tax applies to total estate transferred, after allowing for deductions and credits u Tax not affected by relationship of beneficiary to you: Except marital deduction - Special deduction for surviving spouse u Amount of tax based on: Estate Size Amount of deductions and Credits
Estate Tax Effective Exemption u Increases l l l over years 1997 and before = $600, 000 1998 = $625, 000 1999 = $650, 000 2000 and 2001 = $675, 000 2002 and 2003 = $1. 0 million 2004 and 2005 = $1. 5 million 2006, 2007, 2008 = $2. 0 million 2009 = $3. 5 million 2010 = No Estate Tax 2011 = ? back to $1 mil without congress action Same as Gift Tax Exemption before 2004
Federal Estate Tax Rate Schedule Red area is where Unified Credit or Exemption is used up
GROSS ESTATE “The value of the gross estate includes the fair market value of all property owned by the deceased and all property the deceased had an economic interest even though outright ownership had been transferred to someone prior to death. ”
Value of Gross Estate Appraised at Fair Market Value at date of death or 6 months after Personal representative chooses date u Factors such as: local sales rental rates expert testimony u Exceptions: u l l l “Special Use Valuation” of certain real property “Family Owned Farms and Businesses” exclusion (Stops beginning 2004) “Qualifying Conservation Easements” - 40%
Property Value in Gross Estate Kind of Property Sole Ownership Tenancy in Common Joint Tenancy Value in Estate Entire Value % Owned % Contributed With Rights of Survivorship Tenancy by Entirety Value Life Insurance Retained Life Estate Interest Annuity One-half of Policy Value Economic % Contributed
Joint Tenancy with Rights of Survivorship Question: If you add your daughter’s name to the title of a $100, 000 piece of your real estate, how much reduction in the size of your estate?
Joint Tenancy with Rights of Survivorship Reduction in gross size of your Estate? ? Final Answer: Depends, but probably none. 1. Who contributed to buying it? 2. Does she bare the burdens and benefits of ownership? Rent income, pay taxes etc. 3. Is there debt against it? Who will own it when you die?
Examples of Economic Interest in Property u Retained rights to income u The right to change who inherits u The right to change the future use u The right to change enjoyment
Adjusted Gross Estate Example: Gross Estate $2, 300, 000 Funeral 9, 000 Administration 15, 000 Losses (casualty, theft) 5, 000 Debt claims against estate 12, 000 State Estate Taxes (2005 - 2009) Mortgages and Liens - 125, 000 Adjusted Gross Estate $ 2, 134, 000
2004 Taxable Estate Adjusted Gross Estate Charity, Education, Religion Adjusted Taxable Estate Federal Estate Tax (on 2, 000) plus 48% of $99, 000 Total Potential Tax Unified Credit (2004) Total Estate Taxes $2, 134, 000 35, 000 $2, 099, 000 $780, 800 47, 520 $828, 320 -555, 800 $272, 520
Estate Tax Examples Taxable Estate $600, 000 $675, 000 $800, 000 $1, 350, 000 $2, 000 Tax Paid 1997 None $18, 500 $75, 000 $153, 000 $298, 500 $588, 000 2004 None None $225, 000 Saves $363, 000
Filing Requirements Estate Tax Return must be filed when the Gross Estate value exceeds the exemption equivalent. File within 9 months after death. Tax is DUE! Federal Estate Tax Return 706
Federal 706 Estate Tax Return
Delayed Payments of Estate Taxes u 1 l year extension with interest Reasonable cause u Ten l 1 year extensions with interest Each year with reasonable cause u Installment Payments 35% or greater of Adjusted Gross Estate in closely held business l Decedent active role in business l u Share rent versus cash rent
Estate Tax Installment Payments u Closely Held Business portion of the Tax u 35% of Adjusted Gross Estate is Family Business u Interest only first 4 years then 10 year installment payments (total of 14 years) u 2% Interest rate on first $1. 12 million taxable u Interest rate on value above $1. 12 million is 45% of applicable rate for under payment of tax
2004 Michigan Estate Tax Adjusted Taxable Estate Michigan Credit Taxable Estate Tax on 1, 540, 000 Tax on 499, 000 (7. 2%) $2, 099, 000 - 60, 000 $2, 039, 000 2004 75% Reduction MDT “Granholm’s Check” $ 70, 800 + 35, 928 $ 106, 728 - 80, 046 $ 26, 682 Federal Estate Tax Calculation State of Michigan Credit IRS“Bush Check” $ 272, 520 - 26, 682 $245, 838
Federal “State Death Tax Credit” u 2002 – Reduced by 25% u 2003 – Reduced by 50% u 2004 – Reduced by 75% u 2005 – State Credit is Repealed u But in 2005 to 2009 have a new deduction from the Gross Estate for State Estate Taxes paid l Paid within 4 years after Fed Estate tax u Michigan will lose revenue. Changes?
Special Use Valuation (2032 A) of Certain Real Property Farm and other real property valued at fair market value - determined on the highest or best use. If this becomes a financial burden then property can be valued as a farm or other closely held business. Cannot reduce value more than $850, 000 in 2004 (inflation indexed)
To Qualify for Special Use Valuation u 50% of Adjusted Gross Estate from Farm Property (real and personal) u 25% of Adjusted Gross Estate from Farm Real Property u Material Participation u Pass to qualifying heir u Descendent or family has used real property 5 of last 8 years in “qualified use”
“Material Participation” Special Use Valuation u Rules similar to Self Employment Tax l l u “At Risk” income from trade or business Crop share Cash rent to family member qualifies Cash rent to non-family member disqualifies Eligible “Qualified Heirs” l l l Meet active management test Makes business decisions Decedent’s spouse Heir not reaching age 21 who is full time student or who is disabled Lineal Descendants may lease property to another descendant on a cash basis
Special Use Valuation Formula u Cash Rent u Property Taxes u Net Rental = u Net Rental $80. 00 -17. 00 $63. 00 u. 0693 = $909/Acre The 5 yr average effective interest rate for all FLB loans 2004 = 6. 93%
Tax Basis of Property u Basis on inherited property is the Special Use Value amount as it is passed through the estate. u Get as high of basis as possible without paying an estate tax!!!
If Within 10 Years Property is Sold or Ceases to be a Farm Tax benefits are recaptured If qualified heir dies without having disposed of the property or converting it to a nonqualified use, or 10 year period lapses, the potential liability for recapture ceases.
Recapture of Tax Savings from Special Use Valuation (Section 2032 A) u If sold or family fails to meet Material Participation u 100 % first 6 years u 80% 7 th year u 60% 8 th year u 40% 9 th year u 20% 10 th year u 0% after 10 th year
2004 Estate Tax Maximums u Married Couple 50% Farm Land u Split Assets between them u Use both Federal Exemptions $1. 5 M u Use 2 Special Use Valuation $850, 000 u Careful planning and can get both to qualify? u $4. 7 M Transferred with no Estate Tax u Tax Basis equal to value used for Estate Tax calculation
Generation Skipping Tax u 2001 Excess of $1, 060, 000 taxed at 55% u 2002 starts to match annual exclusion for Estate Taxes u 2002 and 2003 = $1. 0 Million u 2004 and 2005 = 1. 5 Million u 2006 – 2008 = 2. 0 Million u 2009 = 3. 5 Million u 2010 = none u 2011 = ?
Example of Generation Skipping Transfer Property owned by A 1/2 C Income 1/2 Trust Grandchildren Income D Trust property not taxed at death of C & D
Annual Inflation Adjustments After 1998 u Gifts Annual Exclusion $10, 000 (lowest multiple of $1, 000) $11, 000 in 2004 u Special Use Valuation ceiling on of real estate $750, 000 ($10, 000) $850, 000 in 2004 u Generation Skipping Tax exemption $1 million ($10, 000) $1, 120, 000 in 2004 u Installment Payment ceiling $1 million ($10, 000) $1, 120, 000 in 2004
Income Tax Basis 40 Acre parcel of Land u Paid $500 per Acre or $20, 000 in 1974 u Tax Value Today = 2 x S. E. V. = $80, 000 u Land’s been selling for $2, 500 per Acre u Widowed Mother Gives land to Daughter and Daughter Sells. Taxes? u Daughter Inherits land after Death of Mother and then Sells. Taxes?
Stepped-Up Basis Issues u u u u In past full “stepped up basis” of inherited property resulted in no taxable gain to heirs for appreciation that occurred during deceased lifetime. Basis for heirs was the value that passed through the estate and subject to Federal Estate taxes Full Basis Step Up until 2010 Step-Up is limited to $1. 3 million starting in 2010 Additional $3. 0 Million for Spouse Total of $4. 3 M Increase in Basis to Surviving Spouse in 2010 Records for tracking basis is very important
Basis Step-Up Planning u u u What year will you die? Size of Estate? Amount of appreciation on assets? Trade offs between Estate Tax and step-up in basis until 2010, 2011? Goal want to capture as much of the step-up as possible without hitting Estate taxes “free money” Who benefits? Heirs
Why Limits on Stepped up Basis What’s the logic? u Tax Revenue for Federal Government u Gift Tax effects u Capital Gains Tax effects u What’s the interplay? Before and after 2001 tax law changes? u Remember - Not until 2010? ? ?
2004 Estate Planning Strategies Because of Basis & Tax Issues u Gift high basis assets now or wait? u Capital Gains Tax Rate is lower than Gift tax rate u What year will you die? u Future changes in tax code? u Probably a little less advantage to gifting strategies if estate tax continues to be repealed starting in 2010
Future of Federal Estate Tax? u All 2001 tax code changes are scheduled to sunset Dec 31, 2010 l l l l Avoids arcane budget rule (Byrd rule) One Senator could block Would take 60% to overturn As written only majority vote to continue Leaves some uncertainty for planning Not an excuse not to plan – still critical Tax Issues are only part of Estate Planning u Small down side risk of planning based on the 1 Million person – Depends?
INCOME TAXES Michigan & Federal u u u Capital gain or loss Difference between: Sale price and adjusted cost basis Adjusted cost basis in property Gifted, Purchased, Inherited Example Sale price = $40, 000 Remaining Cost Basis = $13, 000 Difference (taxable) = $27, 000 Exceptions Property trades Residence ($500, 000 Married – Joint every 2 yrs )
Allocation of Purchased or Transferred Business Property Depreciable Non Depreciable
Non – Depreciable Property or Assets Bare Land Residence Timber (Depletion Allowance) Growing Crops
Depreciable Property or Assets Farm Buildings & Structures Machinery & Equipment Grain Storage Fences Field Tile and Drains Wells Orchards Tenant House Good Will
IRS EXPECTS A REASONABLE ALLOCATION OF BASIS
Taxation on Transfer of Property Methods to Transfer? 1. Sell it 2. Give it away 3. Retain owner ship till death Roger Betz Michigan State University Extension District Farm Management Agent
1999 Taxation of Example Farm 1965 - Bought 100 ac HOME Farm Land $20, 000 Buildings $5, 000 1972 - Bought SMITH 200 ac 1975 - Built SWINE Facilities 1981 - Bought JONES 200 ac 1999 FAIR MARKET VALUE 500 ac @ 1200/ac Buildings Machinery and Equipment 200 Raised Sows Market Hogs 1, 600 Hd Feed TOTAL No Debt against Estate $ 25, 000 $100, 000 $ 50, 000 $200, 000 $600, 000 30, 000 100, 000 50, 000 80, 000 100, 000 $960, 000
Income Taxes Capital Gain - Max 20% FED rate - 10% on Income in the 15% bracket - 20% for Income above the 15% rate Ordinary Income (Married Joint 1999) Depreciation Recapture and Sched. F Income Federal Inc. Tax = 15% to 43, 050 28% to 104, 050 31% to 158, 550 36% to 283, 150 39. 6% above (Rate after Standard Deduction and Exemptions) 7, 200 plus 2, 750 per exemption or Itemize Social Security and Medicare Taxes Sched. F Income (earned income) 12. 4% to 72, 600 Soc Sec (. 9235) Plus 2. 9% Medicare (. 9235) [no limit]
Option #1 - Sell Whole Business Cash Sale Home Farm 100 ac x 1, 200 = 120, 000 - 20, 000 basis =$100, 000 (Capital Gain) Buildings 30, 000 - 5, 000 basis = $25, 000 (Depreciation Recapture) SMITH Farm 200 ac x 1, 200 = 240, 000 - 100, 000 basis = $140, 000 (Capital Gain) JONES Farm 200 ac x 1, 200 = 240, 000 - 200, 000 basis =$40, 000 (Capital Gain) Machinery and Equipment 100, 000 - 25, 000 basis = $75, 000 (Deprec. Recapture) 200 Raised Sows 50, 000 - ZERO basis = $50, 000(Capital Gain) Market Hogs 80, 000 - ZERO basis = $80, 000 (Sched. F Income) Feed 100, 000 - ZERO basis = $100, 000 (Sched. F Income)
Income Tax Calculations - Option #1 (sell whole farm) 100, 000 +140, 000 + 50, 000 $330, 000 Cap. Gains (Max 20%) 25, 000 + 75, 000 $100, 000. Dep. Recapture (Max 39. 6%) 100, 000 + 80, 000 $180, 000 Sched F income (Max 39. 6%) Total Taxable Income $610, 000 Long Term Capital Gains Tax Fed Income Tax Social Security Medicare Michigan Income Tax Total ALL Income Taxes $66, 000 $79, 583 $8, 291 $4, 821 $26, 594 $185, 289 Buyer has new Basis in all property purchased and can depreciate the depreciable property.
Option #1 - Sell Whole Farm u We have paid income Taxes of $185, 289 u So now Net Worth is 960, 000 - 185, 289 u Equals 774, 711 u What’s the Estate Tax on this? u 750, 000 taxable = 248, 300 tax u 24, 711 taxable X 39% = 9, 637 tax u 248, 300 + 9, 637= 257, 937 total tax u 257, 937 -211, 300 (99) = $46, 637 net tax
Option #1 - Sell Whole Farm u Income Taxes = $185, 289 u Estate Taxes = $46, 637 u Total Taxes = $231, 926 u If you sell your assets, does this reduce the size of your estate? u What does it do? l “Freeze it”? Depends on how reinvested.
Option # 2 - Give it All Away u u u u Home Farm 100 ac X 1, 200 = 120, 000 GIFT 20, 000 basis to donee Buildings 30, 000 GIFT, 5, 000 basis to depreciate Smith Farm 200 ac X 1, 200 = 240, 000 GIFT 100, 000 basis to donee Jones Farm 200 ac X 1, 200 = 240, 000 GIFT 200, 000 basis to donee Machinery and Equipment 100, 000 GIFT 25, 000 basis to donee to depreciate 200 Raised Sows 50, 000 GIFT, ZERO basis to donee to depreciate Market Hogs 80, 000 GIFT, ZERO basis to donee Feed 100, 000 GIFT, ZERO basis to donee
Tax Calculations Option #2 (give it all away) u u u Capital Gains NONE to Donor Depreciation Recapture NONE to Donor Ordinary Income Sched. F NONE to Donor Capital Gains = ZERO Fed Income Tax = ZERO Social Security = ZERO Medicare = ZERO Mich Tax = ZERO
Option #2 Give it All Away Total All INCOME Taxes = ZERO (donor) u u u u What about the donee (receiver)? What tax bracket? Donee has OLD Basis in property and can depreciate only what was left on the depreciation schedule. If sold in one year with same tax attributes, then would have the same $185, 289 of income taxes. GIFT TAX - 1 person to 1 person in 1 year 960, 000 - 10, 000 = 950, 000 subject to Gift Tax 326, 300 - 211, 300 unified credit = $115, 000 Donor has used up his/her unified credit Total Taxes paid for the family = $300, 289
Option #3 Retain Ownership Until Death u u Income Tax = Zero Estate Taxes Same Estate Tax implications as the Gift option but the heirs receive a step up in basis to the fair market value but would lose the $10, 000 annual exemption. (10, 000 X 39%) Total Estate Taxes paid = $118, 900 Step Up in Basis is Very Useful Tool to Retain Financial Value for Family. Michigan Estate Tax = $30, 960 Federal Estate Tax = $87, 940
Opt. #4 Combinations u This is what most people do. u Option #1 Sell Whole Farm = $231, 926 u Option #2 Give it all Away = $300, 289 u Option #3 Retain Till Death = $118, 900 u Option #4 Proper Combinations l All Tax = $”ZERO”
What If? u u u (1999 example) 1. The Estate was split between Husband Wife l Two 650, 000 Exemptions - Tax would be Zero and FULL STEP UP in Basis for heirs, no restrictions from other tools below 2. Utilize the Special Use Valuation Method 2032 A l 500 acres Land valued at 700 versus 1, 200 per Acre l 960, 000 less 250, 000 = 710, 000 Taxable Value l Estate Taxes would be $22, 200 (37% of $60, 000) l Limitations Placed on Business 3. Utilize the Family Owned Farm and Business exclusion 2033 A l If estate qualifies, then can have up to 1. 3 million Estate tax would = Zero l Limitations placed on Business
Gifts: A Flexible Tool for Estate Planning Roger Betz Michigan State University Extension
GIFTS: Flexible Tools For Property Transfers The greatest gains from sound estate planning come when the transfer starts before death, while the owners still have the ability to guide and affect the outcome.
Possible Benefits of Gifts u Opportunity for Children to Participate in the Management of Family Business u Reduce size of estate for Estate Taxes u Reduce Administration Expense u Income Tax Savings for Family
Completed Gifts Requirements for Present Interest u. A competent donor and donee u A clear intent to divest title & control over property u Transfer of legal title u Delivery of title u Acceptance of gift by donee
Valuation of Gift Fair Market Value Date of Transfer u Organized market activity u Professional Appraisal u Income potential u Tax assessment
Direct Gift Examples u Cash or Property (real, personal-tangible or intangible) u Forgiveness of a Debt (like cash) u Interest Free Loans l (act like payments made then given back) u Creation of a Joint Tenancy in real estate u Transfer of Equity in a Business l Percentage ownership, stock shares u Irrevocable Trust u Life Insurance Policy (3 year)
Selecting Property to Give General Considerations u Low gift/high estate tax value u Appreciated property u Assets not likely to be sold u High income-producing property u Property unsuitable for testamentary distribution u Income tax bracket of children
Dividing Gifts to Save Taxes u Gift Splitting (Husband Wife) u Bargain sale u Installment sale & cancel notes u Mortgage property before giving u Gift of limited interest u Create undivided fractional share u Subdivision of real estate u Gift of a future interest
Property Unsuitable for Gifts (for tax savings) u Shrinking assets u Assets producing income losses u Business property if using “Special Use Valuation” u Principal residence - $250, 000 person u Property donor intends to use l (provide own support) u Depreciable property u Property that can gain “Step-Up-in-Basis”
Practical Considerations in Lifetime Giving Plus Factors Escape property management Eliminate estate transfer costs Fulfill a business obligation Assist donee’s financial progress
Practical Considerations in Lifetime Giving Possible Negatives Loss of property control Donor may need funds Donee’s income tax on appreciated property Donee’s use of property No “Step Up in Basis”
Guidelines to Making Gifts u Donor’s financial security u Complement a transfer plan u Donee’s financial judgment u Benefit the donee u Life motives for making gifts u Lastly - Tax reduction
Probate, Wills, Durable Power of Attorney, Patient Advocate Dave Smith, Attorney Charlotte, MI
E. P. I. C. Estate Protection & Individual Code - After April 1, 2000 u Changed Rules for Opening Probate Informal l Formal l Supervised l Small Estates l u (less than $15, 000 that is probated)
Property Distribution EPIC no will/state law after 2000 u u u Married with full blood children Spouse - $150, 000 + 1/2 balance; Children - 1/2 balance Married with ½ blood children (not of spouse) Spouse - $100, 000 + ½ balance; Children ½ balance Married with parents, no children Spouse - $150, 000 + 3/4 balance; Parents - 1/4 balance Married without parents or children Spouse - all property Single with children Children - all property Single without children Parents - all property or brothers & sisters or next-of-kin
E. P. I. C. Informal Probate Administration If No Problems Anticipated l Quicker, Easier, Cheaper l Don’t Meet with Judge l Application with Probate Court Register l Most Popular 75% l
E. P. I. C. Formal Probate Administration File a Petition for Proceeding before a Judge with notice to all interested persons - 25% of Probated Estates l Hearing l If in Informal can move to Formal and back to Informal l u perhaps need help on a single issue
E. P. I. C. Supervised Probate Administration Involves Court Supervision of all Estate Proceeding l Not many done like this, Only when problems within family l Less Than 1% of Probated Estates l
Probate Administration Cost Filing Fee $100 l Small Estate Filing Fee $25 l Inventory Fee for Probated Assets l u $1 Million Probated Estate = $1, 175 u $2 Million Probated Estate = $1, 488 u $5 Million Probated Estate = $2, 425 l Certificate Letters of Authority u $11 l Each (Stocks) Petitions to the Court $15 (Supervised)
Trust: Tool in Estate Planning Steven Peters, Attorney Trust Dept National City Bank
Trust Uses in Estate Planning One of the most flexible tools Because of the wide variety of ways it can be designed It can help you reach your estate planning goals
What is a Trust? u Fiduciary relationship in which one person (trustee) holds title to property (trust estate) for the benefit of another (beneficiary) u Terms of trust are detailed in a trust agreement
Trustee u Who holds trust title? Individual - private trust Institution - commercial trust u Private trust Family member or friend Grantor u Commercial trust Corporate employee Family member or friend Grantor Co-trustee
Types of Trust u Living trust - separate agreement - Revocable - Irrevocable u Testamentary trust - Part of will
Two Types of Lifetime Trusts Living - inter vivos - “between lives” created during life property doesn’t pass through probate privacy management of securities recipient of insurance Irrevocable Trust property given away for good gift tax considerations cannot be altered, amended, revoked
Testamentary Trust It does not exist during the life of the grantor created by will trust is beneficiary of the estate A grantor creates the trust keeps direct control during life upon death the trust comes into being property managed in accordance to agreement Property passes through probate costs and taxes paid few tax savings possible provides management of property trust department acts is supervisory manner
Creation of a Trust Step 1 Owner Grantor Step 2 Transfers Property to Trustee Step 6 Goals Reached Step 3 Trust Agreement Directs Trustee Step 5 Beneficiary Receives Income & Benefits Step 4 Manages & Controls Has Legal Title
Example of Trust Used by Married Couple Property owned by A 1/2 Spouse B Transfer at A’s death 1/2 Income Children Trust Transfer at B’s death Trust property not taxed at B’s death
When would a Trust be a good tool for Husband Wife to use? u 1. Large estate when want to utilize both exemptions (until 2010? ) u 2. Manage affairs when/if disabled u 3. Reduce future administration cost u 4. Privacy issues versus Probate
Advantages of a Trust u Minimize Estate Taxes u Reduce Estate Administration Cost u Provide Professional Management Services
Trust Limitations u Trustee will not operate business u Heirs cannot control property u Annual trust fee u Can not solve all goals u Title must be transferred
Checks and Balances Trustees are required by law to operate under the prudent man rule. Regular inspections of trust depart. by state and federal bank examiners. Reputation of the bank or individual. Size of staff. Built into the trust itself. Agreement allows the beneficiary to change trustee if not satisfied with income or officers. Careful Planning Pays
Costs and Fees The more complex the duties of the trustee, the higher the fees will be.
Life Insurance Tool in Estate and Business Planning Steve Shook, Agent Russell and Schrader
Sample Term Policies Level Death Benefit • Face Value of Policy • Death Benefit Premiums are fixed for a period of time, but gradually begin increasing. Decreasing Term Insurance • Death Benefit Premiums are level for the term of time selected.
Term Life Insurance Advantages: u Low cost at early ages makes insurance available when cash flow is low Disadvantages: u Gets very expensive in later years u Has no provision to be paid-up u Less than 1% is paid as claims u Builds up no cash value
TYPICAL WHOLE LIFE POLICIES Face Value of Policy Whole Life Benefit Participating Death Level-Fixed Premiums Cash Values Start Age 100 Dividends Level - Fixed Premiums Are Whole Face Value of Policy Death Non-Participating Life Cash Values Start Age 100 Benefit Lower than Participating Policy
Whole Life Advantages: u Cash values help policy solvency in later years u Dividends can by paid-up additions which will increase the death benefit l Can pay premiums in later years u Policy operates at the guaranteed level u Can have term riders Disadvantages: u Cost more going in u Not quite as flexible as Universal Life
One Policy - Two Approaches Universal Life Flexible Premiums Start Death Increasing Death Benefit Face Value of Policy Age 100 Flexible Premiums Death Face Value of Policy Death Level Benefit Start Age 100 Benefit Interest Sensitive Cash Values
Universal Life (A Whole Life Policy) Advantages: u Great Flexibility u Insurance Amount u Premium u Has cash value with competitive interest rate u Cash values can be withdrawn or policy loan u Policy can be paid-up (current amount or reduced) u Death benefit can be increasing or level
Universal Life(A Whole Life Policy) u Disadvantages u Withdrawal Privilege sometimes lets the policy be under funded in later years u Does not have dividents - no paid-up additions. u Probably cost more than other Whole Life Policy over a life time
Jones Family Farm Life Insurance Policy A B C Problem: Son “A” wants to buy the family business, sons “B, C, and D” deserve the inheritance. Solution: Son “A” enters into a purchase agreement with Dad. He also purchases Life Insurance on Dad. Thereby guaranteeing other siblings their inheritance. D
Partnerships or LLC $200, 00 on “B” Partner “A” Partnership $400, 000 Partners agree to purchase each others share if death occurs $200, 00 on “A” Partner “B” Problem: Partners want control of their business should they lose their partner. Solution: They buy insurance on each other, have an agreement that they must purchase deceased partners share of the business.
To Summarize 1. The need for liquidity in estates 2. Sources of liquidity 3. Life Insurance being the best source 4. Kinds of Life Insurance: Term, UL, Whole Life, Combination, Second to Die 5. Life Insurance, the tool used in: Debt, Purchase Agreements Buy-Sell, Key Person With Irrevocable Trust 6. Questions
Transferring The Family Farm/Business Roger Betz Michigan State University Extension District Farm Management Agent
What Mom and Dad Want! u Slow Down, more time off u Getting Tired u Minimize Risk u Protect assets u Pay off debts u Get Son/Daughter to work harder u Take less responsibility – more to S/D u Don’t want to give up control u Son/Daughter should start where they did 35 years ago
What Son/Daughter Want! u Get started u Start where mom and dad left off u Take risk u Enthusiasm, Try new things! u Expand operation, invest u Buy Machinery u Buy Land u Utilize Mom and Dad’s Financial Position u Have more money and more time off
Any Potential Conflicts between the Generations?
Critical Success Factors u Parents ready for “business partner” u Younger party committed u Common values, visions and goals u Financial size, stability and profit of business, expansion potential u Personal Relationships
Stage One – Testing Early Assessment u Look at present situation, Size, Financial, Goals, Objectives u Compatible? u Should we try to farm? u Should it be together? u May decide not to farm – OK u “Go” “No-Go” “Wait” Decision
Parents Goals u Slow Down u Turn over business u Maintain some involvement u Protect breakup of business u Treat all children equitably u Adequate retirement income u Security, business assets u Minimize income & estate taxes
Farming Child’s Goals u Adequate income u Buy into business u Participate in management u Gain control over time u Increase business size u Use new technology u Build personal equity
Non-Farm Childs Goals u Inherit an equitable share of estate u Receive equitable return on investment u Participate in management if still involved in business u Sell equity in business
All Family Member’s Goals u Maintain & improve viability of family business u Enjoy pleasant family and home life u Enjoy good times with friends u Do new and exciting things u Engage in community activities u Pursue favorite hobby or sport
Stage one - Testing u Wage/Bonus u Wage/Incentive u Wage/Share u Should we try to Farm? u Together or Separate? u Holding Pattern? u 2 or 3 years max u “Go” “No-Go” Decision
Stage two - Commitment u Enterprise l Farrowing Phase, Contract Heifers u Operating l Agreement Property, Labor, Management u Sharing l Agreement of Labor and Machinery Swap Resources u Joint Ventures u Parents Co-signs Notes u Transfer of Specific Assets Overtime
Stage Three Established as Separate Units Continue and Expand u Operating Agreements u Joint Venture u Sole Proprietor u Rental arrangements u Exchange Labor Machinery u May phase out the agreements
Stage Three Established Together u u u Limited Liability Company Partnership Corporation Expansion? Shift personal property/management Buy/Sell Agreements l u Provide for untimely death l l u Leave Early, Retirement, Death, Disability Insurance Provisions in will Plans for Real Estate Transfer
Sole Proprietorship Limited Liability Co. Partnerships GENERAL TAX OPTIONS REGULAR Lease Arrangement Joint Venture Wage Share Combinations LIMITED MODIFIED Wage Incentive Corporation LLC LLP Enterprise Agreement Least Most Degree of Complexity Alternate business arrangement ranked according to degree of legal complexity.
Stage Four – Withdrawal of Parents u Secure Farm Heir’s Position in Farming u Firm up Transfer Plans u Complete Personal Property/Management Transfer u Shift Control/Ownership of Real Estate u LLC is Desolved - Buy/Sell Agreement u Heir Buys or Rents Parents Share in Business u Additional Provisions in Will
Transferring Business Asset Ownership u What Kinds of Assets are there? u Personal Property Machinery l Feed and Market Livestock l Breeding Livestock l u Real Estate Buildings l Land l
Methods for Transferring Property? u Sale – income to seller and expense to buyer u Gift – no income to seller but also no expense to buyer (old basis) u Lease - Ordinary Income, 1040 F Expense u Inherit? Step-Up in Basis l How long? How old? u Depends on Asset, situation, goals
Sale of Business Property u Allows junior partners to own property earlier u Separates business and estate transfer u Reduces inflation of senior partner’s estate u Senior partners give-up some control over property u Ordinary or Capital Gains taxes
Ways to Transfer Business Property to Delay/Minimize Taxes I. MACHINERY A. Sale -Depreciation Recapture -Depends on Selling Price in Relation to Tax Basis B. Lease -Use Principle & Interest as Guideline -Gifts to Equalize “Principle” -Trade Ins -Depreciation Schedule
Ways to Transfer Business Property to Delay/Minimize Taxes (cont’d) II. Breeding Livestock A. Sale -Capital Gains - Raised to Seller -Installment Sale -Interest and Depreciation to Buyer B. Lease with New Borns Owned by New Generation - Decreasing with Time
Ways to Transfer Business Property to Delay/Minimize Taxes (cont’d) III. Inventory A. Feed -Use Unpaid Bill and Pay Later - Gift B. Market Livestock -Use Unpaid Bill or/and Sell In Parents Name -Sale = Income C. Supplies and other inventory
Ways to Transfer Business Property to Delay/Minimize Taxes (cont’d) IV. Land A. Cash Rent to Start Out Long Term Rental Agreement B. Sale or Gift C. Options to Buy From Estate – Step-Up in Basis D. Inherit with Step-Up in Basis
Ways to Transfer Business Property to Delay/Minimize Taxes (cont’d) V. Buildings A. Cash Rent to Start Out Long Term Rental Agreement B. May need to move ownership to younger generation C. Sale or Gift D. Options to Buy From Estate – Step-Up in Basis E. Inherit with Step-Up in Basis
Order of Importance and Time Line for Asset Transfer 1. Working Assets - Livestock, Crops and Inventory 2. Machinery 3. Buildings 4. Land -Center of Operations -Non Critical Land
Transferring Management u Conflicts between parents and children u How are Decisions Made? l General Manager u Final l authority Equal Voice u Vote, weighted? , arbitration
Transferring Management u Division of Management Responsibility Enterprise Division l Functional Division l u Management Styles Differences are good l Need to compliment each other l Are we doing things right? l Are we doing the right things? l
Dividing Income u Percent Contribution Capital l Labor - guaranteed payments l u 50/50
Example LLC Business Structure u Dad and Junior want to farm together u 50/50 Business starts out “naked”; doesn’t own anything u Business Buys Cows and Calves from Dad - Installment Sale Contract u Feed and Inventory- carry as unpaid bill u Machinery - Business has 10 yr Lease with Dad l Trade ins, Sale in 10 yrs u Business Cash Rents Buildings from Dad u Business Cash Rents Land from Dad
Inter Generational Business Transfer Critical Success Factors 1. Must have open, honest, continual, communications-spouses too (See Making it Work) 2. Get young generation financially involved early 3. Have younger generation own large significant portion of operating business (50% cows vs. 10% cows, machinery and land) 4. Business must make sufficient profit to provide for comfortable family living and allow business growth
What Do I Do Now? Putting it all Together Roger Betz Michigan State University Extension District Farm Management Agent
BASIC ESTATE PLANNING FOR EVERYONE 1. 2. 3. 4. 5. Reduce Times Assets can be Taxed - Income and Estate Taxes Review How Property is Owned Check and Update Wills Durable Power of Attorney for Health Care - Patient Advocate Form
TAXABLE ESTATE LESS THAN $1. 5 Million (2. 0 M in 2006, 1. 0 M 2011) 1. Sales and Leases of Business Property 2. Perhaps Some Bargain Sales and Gifts 3. Insurance for Risk 4. Trust for Management Needs-Disability, Elderly years -Dependant Children
TAXABLE ESTATE $1. 5 Million TO $3 Million (2. 0 M to 4. 0 M in 2006, 1. 0 M to 2. 0 M 2011) 1. All of the above 2. Split Estate to Capture Both $1 Million Exemptions -Separate Sole Proprietor Ownership -Tenancy in Common -Trust for Splitting the Estate and Management. 3. Bargain Sales and Gifts
TAXABLE ESTATE OVER $3, 000 (4. 0 M in 2006, 2. 0 M 2011) 1. All of the Above 2. Gifts become more Important Tool 3. Insurance to Pay the Tax 4. Charitable Contributions 5. Get Income Producing Assets to Heirs -Bargain Sales and Gifts 6. Use Special Use Valuation 7. Don’t worry about it
Now What? u Continue with your learning and plans u Talk to your Family u Develop your Ideas u Meet with Professionals to further develop and finalize u Act on the Plan – Critical u Will not be perfect u Review in future as situations change u Evaluation, Sign up list