Tough economy makes succession planning hard
DE SMET, S.D. — Todd Wilkinson has been doing farm business succession planning for some 36 years, and it's tougher in tough economic times, he says.
A partner in what is now Wilkinson and Schumacher Law Professionals, Wilkinson estimates that about two-thirds of farmers have gone through some kind of estate planning.
"Now, the big driver, for a lot of folks is, 'How do we cope with the nursing home?'" Wilkinson says. People realize they may need nursing care in 10 or 15 years. They don't want to buy long-term care coverage (or may not qualify for it). They want to be prepared for nursing home bills that often are $7,000 to $8,000 a month, without jeopardizing the future of the farm.
The nature of farming is that farmers reinvest cash back into the operation — land, machinery or cattle.
"They often come up with a plan where there's a sufficient cash flow, through a succession plan, that is able to meet that obligation" and not go on assistance.
The most difficult clients to help are those with a net worth of $200,000 to $400,000. It is easy to burn through those assets with late-life care bills, Wilkinson says.
People with more assets can set up their cash flow, through their estate plan, so that while they're alive, there's enough assets to cover those expenses through such tools as lease payments or machinery payments. In doing that, they have the peace of mind that their successors don't have to sell land to pay for their care.
In addition to being a lawyer, Wilkinson is policy vice president for the National Cattlemen's Beef Association. Since 2005, he and brothers Bill and Ed have been partners in Red Stone Feeders at Iroquois, S.D., an 8,250-head capacity cattle feedlot. Separately, he and son, Nick, operate Wilkinson Livestock, a cow-calf operation and a stocker cattle operation. Nick operates Todd's farmland.
Wilkinson started with estate plans in the 1980s when he was in a law firm with his father.
Land values were $500 an acre back then, it now is $5,000 an acre.
If you asked farmers if they were wealthy, they'd "all tell you no," Wilkinson says, because the land and tools to farm are perceived as necessary for the farm and "aren't perceived as wealth." But dollars must be accounted for in a transition or estate plan, when phasing responsibility from a father to a son, from a grandfather to a granddaughter, or other.
"A lot of my clients aren't going to have hundreds of thousands or millions of dollars in a bank account, but may have it in the dirt they're walking on, in their cattle herd or their machinery," Wilkinson says.
The right fit
Succession planning is different if the client is multi-generational, or if a producer started 20 years ago, or is a brand-new farmer.
Wilkinson's first task is to determine the client's goals. Besides preparing for nursing home care, another driver is preparing for death, and making sure the operation can keep on without family friction and without incurring avoidable tax burdens.
When profit margins are tight or negative, lenders and accountants must get involved.
"Now the driving force is, 'How do I weather the storm through the bad farming economy and still provide for the other kids in the operation or the other children that are not in the operation, and do it equitably," Wilkinson says.
Wilkinson asks clients to fill out an estate planning booklet. It includes such basics as an inventory of debts, assets, bank accounts, machinery and livestock. He reviews the completed booklet prior to a meeting and asks lots of questions. "What are your goals and how do you want your property to end up?" Wilkinson says.
Many plans involve "buy-sell" agreements, and specifics on how to pay non-farming siblings.
Wilkinson says it's "just as important" to look at farm succession planning at ages 30 to 35 as it is when you're 60 or 70. "Unfortunately, we never know what's going to happen, whether it's a death or a disability," Wilkinson says. "Farming is a high-risk occupation. You need to deal with those issues."
Today — with very low loan interest rates — there are some real opportunities for the retiring farmer to pass on the operation without dealing with huge interest rates. The older generation make make inter-personal loans.
"The younger producer coming up, he doesn't have to go to the bank to pay his dad off," Wilkinson says. "His dad can finance, internally and become 'the bank.' Dad will have income over a period of years. He doesn't want a big lump sum in the bank. He doesn't want to convert it over to all-cash. He wants to have enough to go into retirement and have an adequate amount of money to live comfortably."
The son can provide that and transition assets, without going to the bank and swamp himself with debt at the bank. "You see a lot more of that in these times than you did 15 or 20 years ago."
In a typical cattle farm transition, the older generation can transition a cow herd to a younger generation member through a lease-purchase arrangement, so that it doesn't swamp the younger person with income tax obligations. The younger generation can use a "calf-share" arrangement that allows building equity in the herd.
It's similar for machinery. It is common for a client to have $700,000 to $1 million in machinery value. "One combine can be $300,000 to $400,000. Big pieces add up quickly," Wilkinson says.
If the younger generation had to buy out the parents or grandparents, they'd have two problems. First, they'd cause their elders a horrific tax bill because the machinery has depreciated. Second, they'd have to go to a bank and borrow money to buy it.
"If Grandpa becomes the 'bank,' and makes a note to grandson to be able to purchase that, and allow that to be paid off over a period of years, it keeps money out of the banker's requirement. Grandpa, in most cases, is in a situation where he's asset-rich and not cash-rich."
Often the older generation feels strongly they want the farm to continue in the family and don't want the land to be sold.
"But given the high value of land, it's a lot easier to taking the chips off the table and selling the land, when that father or mother pass," Wilkinson says. "We see a lot of (heirs) saying, 'If I can get $5,000 or $6,000 an acre, why don't I take it. Because I can't get that much for the value of the value of the land through cash rent.'"
(Wilkinson sees some recent land sales going for $5,000 an acre, down about a third from the peak several years ago. The most productive land is holding its value better than marginal land.)
The older generation then tries to come up with a rental rate, so the subsequent generation doesn't have to pay astronomical rental rates.
With the value of land being much higher than it was decades ago, he deals with families that are dividing land that's been in the family for some time. The tax code requires the land to be valued at a "stepped-up basis," to its "current fair market value." "If you sell it at that point, you don't have to pay any income tax," Wilkinson says. "There is a lot of pressure on beneficiaries at that point, with these higher land prices, to take the chips off the table."
The operating heir faces a choice of trying to make a living on a smaller land unit coming up with the money to buy out the siblings.
South Dakota State University annually publishes a rental rate report. It's available by county (low-, average- and high-productivity) in irrigated and non-irrigated. A parent, using a trust, can "bench-mark" a rental rate — perhaps at 70 to 80% of an "average" rate. The parent effectively removes tension among children because they are specifying their wishes that otherwise could be argued among children after the parent's death.
Producers who want to tie up land so it can't be sold for 30 years? Then provide a mechanism "Nothing will blow apart Christmas quicker than if somebody wants a rental rate that's competing with the most aggressive person in the market when the land can't bear that," Wilkinson says.
He urges clients to be transparent and to get their plans in writing. It often takes more than one meeting. "You built this stuff up over a lifetime. Don't expect to solve the problem by just going into some lawyer's office and saying, 'OK, write me a simple 'I love you' will, and back-and-forth and down to the kids. You're really not going to solve much."
It's about goals.
Wilkinson says the government doesn't allow no interest loans between generations.
"The IRS said if you're going to make zero-interest loans, we're going to charge you an 'imputed' interest rate," he says. It's a rate that changes every month for short-, long- and mid-term loans.
For tax purposes, the IRS will impose an "imputed" interest rate. They'll treat the seller (the lender) as though they received money, as though they received that money, even if it wasn't paid. The IRS imputed rate changes every month for short-, long- and mid-term loans.
Inter-generational loans can often work for everybody, however.
Often, the rate can be higher than the than the older generation could achieve in a certificate-of-deposit at a bank. Depending on the length of a loan, the interest a younger person might pay would be 2.5% to 5.5% per year on inter-family loans. Commercial lenders might be able to compete with 3.5% to 4% — if a lot of collateral is offered.
"If you're going into machinery purchases, you're going to have a hard time to get in those lower rates with a commercial lender who may need to charge 5, 6 or 7%," Wilkinson says. "You're saving 'the family,' so to speak, that 3 to 4% interest spread."