Maybe the strategy with some of the initial estate tax proposals was psychology. The initial proposals were going to be devastating for farms. Now the latest round of proposals are much "better" and we find ourselves saying "it’s not as bad as it could have been." Maybe there’s a chance that a few things get even better yet before anything is passed.
Many of you have probably seen some of the first reports on the latest proposal because there seems to be a race to who can get the news out first, so I will mention a few things you may have already heard and also clarify a few things to help you connect a few dots:
- The federal estate tax limit of $11.7 million was supposed to sunset Dec. 31, 2025. The latest proposal has the sun setting early with the $11.7 million going away Dec. 31, 2021. Therefore, in less than three months, the $11.7 million for individuals or $23.4 million for married couples would return to about $6 million or $12 million for couples. For many farm families, that change will not affect them as they are still under those limits or if people are close possibly just a few tweaks to their planning will keep them away from any 40% tax.
- Probably the biggest part of the law that is not understood is 2032A special use valuation. In 1976 2032A was created to minimize estate tax. We also talk about this as a tool to determine buyouts or equalization, but now it’s coming back as a legitimate tool for estate tax planning in some situations. Here’s where the confusion comes in. The current law allowed for $1.19 million of “extra credit” per person and this was not portable. In a quick example, the formula taxes a five-year average rent rate less property tax, divided by an applicable factor. In many areas, this reduces the land value to 50%-60% of fair market value. So, $10,000 land might be valued at $5,000/acre for estate tax purposes. The new law jumps up to $11.7 million of special use credit per person. This may sound like a simple trade-off for the estate tax limit being reduced. However, keep in mind, to use $11.7 million of special use valuation your estate will need to be very large, which will then have you still over the federal estate tax limit and you will pay 40% tax on that. The bottom line is, special use valuation will help people over the estate tax limit, but that doesn’t automatically mean it will eliminate all estate tax.
- Special Use valuation options will only apply to farm families that qualify by having someone in the next generation continuing the operation or materially participating somehow. People will need to understand the qualifiers.
- Stepped-up basis will occur at death regardless of your estate size. If your estate is over the limit you will have to pay tax with other assets, new loans, or a sale. If you used discounting methods to reduce the size of your estate, your basis will be the discounted value. Interestingly, for some large estates with recent land purchases, that then use a discount, the basis may get stepped down.
- Entity discounts such as LLCs, FLPs, etc., will be able to get discounts under the recent proposals. Simple entities have been a valuable tool for many farm families for both farm continuation and estate tax planning.
- Unified Credit would remain in place. Many people do not understand this. They hear “death taxes” but “unified credit” is the element that allows any or all of that credit to be used via gifting during your lifetime.
For more information, go to our farmestategps.com website. We will be hosting webinars with in-depth details and examples when the law gets passed.
Myron Friesen is the co-owner of Farm Financial Strategies Inc. in Osage, Iowa. He can be contacted at 866-524-3636 or email@example.com.