Let Uncle Sam help transfer the farm

Farms in transition have more opportunities than ever to transfer large amounts of assets to the next generation without incurring huge income tax liabilities. Several of the current opportunities include the new $5 million gift tax exemption, low applicable federal interest rates and a continuation of the low capital gains rates.

Gift tax exemption

Farm transfer plans often include a gift from one generation to the next. A son or daughter is often paid far less in wages than the time and effort he or she has contributed to the farm. In exchange for their uncompensated time and effort, parents often make gifts of farm assets to a son or daughter.

Before 2011, the gift (during life or upon death) an individual could make was limited to $1 million. However, $13,000 still could be gifted each year without using any portion of the $1 million credit. Attorneys and accountants had to devise creative ways to maximize the $13,000 annual gift tax exclusion and the $1 million gift and estate tax exemption to accomplish a transfer plan.

Recent tax legislation has eased the gift tax consequences for many farm families that want to use gifting as part of a farm transfer plan. On Dec. 17, 2010, President Barack Obama signed the Tax Relief Act of 2010, raising the lifetime gift credit to $5 million. However, under the act, the lifetime gift credit will return to $1 million after Dec. 31, 2012.

The relevant gift tax exclusions and exemptions are as follows:

Annual Gift Exclusion

2010

2011-2012

2013

$13,000

$13,000

$13,000

Lifetime Gift Exemption

2010

2011-2012

2013

$1,000,000

$5,000,000

$1,000,000

Applicable federal rate

Many parents want to sell farm assets to their farm son or daughter in exchange for a promissory note. Many of the assets sold will qualify as capital gains assets, and the gains on the sale will be taxed at the currently favorable capital gains rates. However, the interest that will be paid on the note will be taxed at the less desirable ordinary income tax rates. Therefore, parents, who are usually in a higher tax bracket than their children, typically would like to set a higher purchase price in exchange for charging a lower interest rate on the note.

The Internal Revenue Service establishes a minimum interest that must be charged on the note. Otherwise, the IRS will consider a portion of the principal paid on the note as “imputed interest” and tax that portion as ordinary income. The minimum interest that must be charged is known as the lowest applicable federal rate, or AFR. The rates are published each month by the IRS and are based upon the length of the note’s term.

The current rates that must be charged on such transactions are extremely low. As a result, most parents can charge their children very little interest on a promissory note held as part of a purchase and sale.

The current AFR for October is as follows:

Applicable Federal Rate

Short-term note

(3 years or less)

Mid-term note

(3 to 9 years)

Long-term

note

(9 years or more)

0.16%

1.19%

2.91%

Capital gains tax rates

The Tax Relief Act of 2010 continued the favorable capital gains tax rates originally signed into law by President George W. Bush. For 2011 and 2012, long-term capital gains rates (certain assets held for more than one year) are taxed at a maximum rate of 15%. For some in a lower tax bracket, a portion of the gains may even be taxed at a 0% rate. The current capital gains tax rates are set to expire on Dec. 31, 2012. Thus, farmers who wish to sell long-term capital gains assets continue to enjoy low capital gains rates.

The current capital gains rates are as follows:

Capital Gains Rate

Marginal tax rate

10%, 15%

Marginal tax rate

15% or greater

0%

15%


A great deal of uncertainty exists as to what future changes will be made to the tax code. What we do know is there are currently more favorable planning tools than ever to transfer a farm from one generation to the next. Parents all want to transfer as much as they can to their farm son or daughter rather than to their least favorite relative — Uncle Sam.

Schneider is a partner in Twohig, Rietbrock, Schneider and Halbach S.C., a law firm in Chilton that specializes in ag law.

This article published in the November, 2011 edition of WISCONSIN AGRICULTURIST.

All rights reserved. Copyright Farm Progress Cos. 2011.