Estate Planning and Small Business/Farm Succession and Transfer Eaton County Date: Sept 2, 9, 16, 2004 Roger A. Betz District Extension Farm Management.

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? Pass assets & business structure to next generation Control transfer How to transfer debt Retirement income – LOTS! Security - health care issues Issues at passing of 1st 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 E2120
A discussion of alternative property ownership patterns and estate transfer methods.

Property Intangible and invisible rights, powers, privileges and responsibilities of the owner Real Property Land Land improvements Personal Property (everything not real) Tangible Intangible

Property Rights Property is not just real estate
Numerous separable Rights for an item of property 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 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
Land or improvements upon the land Buildings, fences, timber, growing crops Oil, mineral, and development rights – houses etc. Evidence of ownership: DEED 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
Fee simple (sole ownership) Co-ownership Joint Tenancy (with rights of survivorship) Tenancy by the Entirety 2.Tenancy in Common (Default)

Ways to Hold “Own” Property
JOINT TENANCY With Rights of Surviorship Whoever lives longest – gets the goods By the Entirety Same as above, only between husband and 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. 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 Contract Life Insurance, Annuity, Trust
Tenants in Common – goes to heirs Joint Tenancy (rights of survivorship) Ownership vests to survivors Probate Will State law Transfer prior to death Complete severance Retained rights

Methods to Transfer Property
Question: My will says my life insurance goes to my son. Who receives the life insurance?

Resources

PROPERTY OWNERSHIP TRANSFER PLAN to your HEIRS.
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 Federal Gift Tax SALE Federal Income Tax Michigan Income Tax ESTATE (no inheritance) Michigan Estate Tax Federal Estate Tax

Federal Gift Tax Excise tax on gifts Lifetime transfers
Without full consideration Donor pays tax due Annual exclusions (indexed for inflation) $11,000 per donee and per 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)
Year 1 $6,000 X 18% = $1,080 Year 2 $21,000+$6,000 = $27,000 3,800 Plus 22% of 7,000 = 5,340–1,080 = 4,260 Year 3 $51,000+$21,000+$6,000=$78,000 13,000 Plus 26% of 18,000 = 17,680 – 1,080 –4,260=12,340 Must add up gifts above the annual exclusion for entire lifetime

Unified Credit Used to calculate effective Federal Estate and effective Gift tax exemptions Currently the credit is applied to both the Federal Gift Tax and the Federal Estate Tax Credit used for gifts is not available to pay your estate taxes Beginning in 2004 different thresholds exist for gifts versus estate taxes What is the Unified Credit for ‘04-’05? Gift Tax =$345,800; Estate Tax = $555,800

Unified Credit Reduction (Example)
Gift Tax Unified Credit (2004 ) $345,800 (1M) Year 2001 used ,080 Year 2002 used ,260 Year 2003 used ,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
Increases over years 1997 and before = $600,000 1998 = $625,000 1999 = $650,000 2000 and 2001 = $675,000 = $1.0 million 2011 = $1.0 million ? probably Congress action? Same as Estate Tax Exemption up to 2004

Gift Tax Rate Schedule 2001-2011
Red area is where Unified Credit or Exemption is used up

Filing Requirements IRS Form 709A or 709 - Gift Tax Return
Gifts of more than $11,000 per donee in any year Return due April 15 following the year of the gift

Gifts: Planning Pointers
$11,000 per person per year Spouse can use spouses annual exemption so $22,000 per year Two married people can give two other married people 44,000 per year before starting to use Unified Credit Children, grandchildren and spouses $44,000 each set

Federal 709 Gift Tax Return

An Excise Tax It is levied upon the transfer of property at death.
Federal Estate Taxes An Excise Tax It is levied upon the transfer of property at death.

Federal Estate Tax Tax applies to total estate transferred, after allowing for deductions and credits Tax not affected by relationship of beneficiary to you: Except marital deduction - Special deduction for surviving spouse Amount of tax based on: Estate Size Amount of deductions and Credits

Estate Tax Effective Exemption
Increases 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 $1mil 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.”

Appraised at Fair Market Value at date of death or 6 months after
Value of Gross Estate Appraised at Fair Market Value at date of death or 6 months after Personal representative chooses date Factors such as: local sales rental rates expert testimony Exceptions: “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 Value in Estate Sole Ownership Entire Value Tenancy in Common % Owned Joint Tenancy % Contributed With Rights of Survivorship Tenancy by Entirety One-half of Value Life Insurance Policy Value Retained Life Estate Economic Interest Annuity % 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
Retained rights to income The right to change who inherits The right to change the future use The right to change enjoyment

Adjusted Gross Estate Example:
Funeral ,000 Administration ,000 Losses (casualty, theft) ,000 Debt claims against estate ,000 State Estate Taxes ( ) Mortgages and Liens ,000 Adjusted Gross Estate $ 2,134,000

2004 Taxable Estate Adjusted Gross Estate $2,134,000
Charity, Education, Religion ,000 Adjusted Taxable Estate $2,099,000 Federal Estate Tax (on 2,000,000) $780,800 plus 48% of $99, ,520 Total Potential Tax $828,320 Unified Credit (2004) ,800 Total Estate Taxes $272,520

Estate Tax Examples Taxable Estate Tax Paid 1997 2004
$600, None None $675, $18, None $800, $75, None $1,000,000 $153, None $1,350,000 $298, None $2,000,000 $588, $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
1 year extension with interest Reasonable cause Ten 1 year extensions with interest Each year with reasonable cause Installment Payments 35% or greater of Adjusted Gross Estate in closely held business Decedent active role in business Share rent versus cash rent

Estate Tax Installment Payments
Closely Held Business portion of the Tax 35% of Adjusted Gross Estate is Family Business Interest only first 4 years then 10 year installment payments (total of 14 years) 2% Interest rate on first $1.12 million taxable 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 $2,099,000
Michigan Credit ,000 Taxable Estate $2,039,000 Tax on 1,540, $ 70,800 Tax on 499,000 (7.2%) ,928 $ 106,728 % Reduction ,046 MDT “Granholm’s Check” $ 26,682 Federal Estate Tax Calculation $ 272,520 State of Michigan Credit ,682 IRS“Bush Check” $245,838

Federal “State Death Tax Credit”
2002 – Reduced by 25% 2003 – Reduced by 50% 2004 – Reduced by 75% 2005 – State Credit is Repealed But in 2005 to 2009 have a new deduction from the Gross Estate for State Estate Taxes paid Paid within 4 years after Fed Estate tax Michigan will lose revenue. Changes?

Special Use Valuation (2032A) 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
50% of Adjusted Gross Estate from Farm Property (real and personal) 25% of Adjusted Gross Estate from Farm Real Property Material Participation Pass to qualifying heir Descendent or family has used real property 5 of last 8 years in “qualified use”

“Material Participation” Special Use Valuation
Rules similar to Self Employment Tax “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” 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
Cash Rent $80.00 Property Taxes Net Rental = $63.00 Net Rental $63.00 = $909/Acre The 5 yr average effective interest rate for all FLB loans 2004 = 6.93%

Tax Basis of Property Basis on inherited property is the Special Use Value amount as it is passed through the estate. 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 2032A)
If sold or family fails to meet Material Participation 100 % first 6 years 80% 7th year 60% 8th year 40% 9th year 20% 10th year 0% after 10th year

2004 Estate Tax Maximums Married Couple 50% Farm Land
Split Assets between them Use both Federal Exemptions $1.5M Use 2 Special Use Valuation $850,000 Careful planning and can get both to qualify? $4.7 M Transferred with no Estate Tax Tax Basis equal to value used for Estate Tax calculation

Generation Skipping Tax
2001 Excess of $1,060,000 taxed at 55% 2002 starts to match annual exclusion for Estate Taxes 2002 and 2003 = $1.0 Million 2004 and 2005 = 1.5 Million 2006 – 2008 = 2.0 Million 2009 = 3.5 Million 2010 = none 2011 = ?

Example of Generation Skipping Transfer
Property owned by A 1/ /2 Income Income C Trust Trust D Trust property not taxed at death of C & D Grandchildren

Annual Inflation Adjustments After 1998
Gifts Annual Exclusion $10,000 (lowest multiple of $1,000) $11,000 in 2004 Special Use Valuation ceiling on of real estate $750,000 ($10,000) $850,000 in 2004 Generation Skipping Tax exemption $1 million ($10,000) $1,120,000 in 2004 Installment Payment ceiling $1 million ($10,000) $1,120,000 in 2004

Other Provisions of The Taxpayers Relief Bill of 1997
Exclude 40% the value of land in a qualified conservation easement

Income Tax Basis 40 Acre parcel of Land
Paid $500 per Acre or $20,000 in 1974 Tax Value Today = 2x S.E.V. = $80,000 Land’s been selling for $2,500 per Acre Widowed Mother Gives land to Daughter and Daughter Sells. Taxes? Daughter Inherits land after Death of Mother and then Sells. Taxes?

Stepped-Up Basis Issues
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
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?
Tax Revenue for Federal Government Gift Tax effects Capital Gains Tax effects What’s the interplay? Before and after 2001 tax law changes? Remember - Not until 2010???

2004 Estate Planning Strategies Because of Basis & Tax Issues
Gift high basis assets now or wait? Capital Gains Tax Rate is lower than Gift tax rate What year will you die? Future changes in tax code? Probably a little less advantage to gifting strategies if estate tax continues to be repealed starting in 2010

Future of Federal Estate Tax?
All 2001 tax code changes are scheduled to sunset Dec 31, 2010 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 Small down side risk of planning based on the 1 Million per person – Depends?

INCOME TAXES Michigan & Federal
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 2yrs )

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

Michigan State University Extension District Farm Management Agent
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

2004 Farm Taxation Example Land (Basis 400,000) $1,500,000
Buildings (Basis 50,000) $ 200,000 Machinery (Basis 100,000) $ 250,000 Stored Crops (Basis Zero) $ 100,000 Non Farm Assets $ 250,000 Total Assets $2,300,000

Adjusted Gross Estate Example:
Funeral ,000 Administration ,000 Losses (casualty, theft) ,000 Debt claims against estate ,000 State Estate Taxes ( ) Mortgages and Liens ,000 Adjusted Gross Estate $ 2,134,000

2004 Taxable Estate Adjusted Gross Estate $2,134,000
Charity, Education, Religion ,000 Adjusted Taxable Estate $2,099,000 Federal Estate Tax (on 2,000,000) $780,800 plus 48% of $99, ,520 Total Potential Tax $828,320 Unified Credit (2004) ,800 Total Estate Taxes $272,520

1999 Taxation of Example Farm
Bought 100 ac HOME Farm $ 25,000 Land $20,000 Buildings $5,000 Bought SMITH 200 ac $100,000 Built SWINE Facilities $ 50,000 Bought JONES 200 ac $200,000 1999 FAIR MARKET VALUE /ac $600,000 Buildings ,000 Machinery and Equipment ,000 200 Raised Sows ,000 Market Hogs 1,600 Hd ,000 Feed ,000 TOTAL $960,000 No Debt against Estate

Income Taxes Capital Gain - Max 20% FED rate
Income Taxes Capital Gain - Max 20% FED rate % on Income in the 15% bracket % for Income above the 15% rate Ordinary Income (Married Joint 1999) Depreciation Recapture and Sched. F Income Federal Inc. Tax = 15% to 43, % to 104, % to 158, % to 283, % 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) % 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 basis =$100,000 (Capital Gain) Buildings 30, ,000 basis = $25,000 (Depreciation Recapture) SMITH Farm 200 ac x 1,200 = 240, ,000 basis = $140,000 (Capital Gain) JONES Farm 200 ac x 1,200 = 240, ,000 basis =$40,000 (Capital Gain) Machinery and Equipment 100, ,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 $330,000 Cap. Gains (Max 20%) 25, , $100,000. Dep. Recapture (Max 39.6%) 100, , $180,000 Sched F income (Max 39.6%) Total Taxable Income $610,000 Long Term Capital Gains Tax $66,000 Fed Income Tax $79,583 Social Security $8,291 Medicare $4,821 Michigan Income Tax $26,594 Total ALL Income Taxes $185,289 Buyer has new Basis in all property purchased and can depreciate the depreciable property.

Option #1 - Sell Whole Farm
We have paid income Taxes of $185,289 So now Net Worth is 960, ,289 Equals 774,711 What’s the Estate Tax on this? 750,000 taxable = 248,300 tax 24,711 taxable X 39% = 9,637 tax 248, ,637= 257,937 total tax 257, ,300 (99) = $46,637 net tax

Option #1 - Sell Whole Farm
Income Taxes = $185,289 Estate Taxes = $46,637 Total Taxes = $231,926 If you sell your assets, does this reduce the size of your estate? What does it do? “Freeze it”? Depends on how reinvested.

Option # 2 - Give it All Away
Home Farm 100 ac X 1,200 = 120,000 GIFT ,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 ,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)
Capital Gains NONE to Donor Depreciation Recapture Ordinary Income Sched. F 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)
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 = 950,000 subject to Gift Tax 326, ,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
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. (10,000X 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 This is what most people do.
Option #1 Sell Whole Farm = $231,926 Option #2 Give it all Away = $300,289 Option #3 Retain Till Death = $118,900 Option #4 Proper Combinations All Tax = $”ZERO”

What If? (1999 example) 1. The Estate was split between Husband and Wife 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 2032A 500 acres Land valued at 700 versus 1,200 per Acre 960,000 less 250,000 = 710,000 Taxable Value Estate Taxes would be $22,200 (37% of $60,000) Limitations Placed on Business 3. Utilize the Family Owned Farm and Business exclusion 2033A If estate qualifies, then can have up to 1.3 million Estate tax would = Zero 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
Opportunity for Children to Participate in the Management of Family Business Reduce size of estate for Estate Taxes Reduce Administration Expense Income Tax Savings for Family

Completed Gifts Requirements for Present Interest
A competent donor and donee A clear intent to divest title & control over property Transfer of legal title Delivery of title Acceptance of gift by donee

Valuation of Gift Fair Market Value Date of Transfer
Organized market activity Professional Appraisal Income potential Tax assessment

Direct Gift Examples Cash or Property (real, personal-tangible or intangible) Forgiveness of a Debt (like cash) Interest Free Loans (act like payments made then given back) Creation of a Joint Tenancy in real estate Transfer of Equity in a Business Percentage ownership, stock shares Irrevocable Trust Life Insurance Policy (3 year)

Selecting Property to Give General Considerations
Low gift/high estate tax value Appreciated property Assets not likely to be sold High income-producing property Property unsuitable for testamentary distribution Income tax bracket of children

Dividing Gifts to Save Taxes
Gift Splitting (Husband and Wife) Bargain sale Installment sale & cancel notes Mortgage property before giving Gift of limited interest Create undivided fractional share Subdivision of real estate Gift of a future interest

Property Unsuitable for Gifts (for tax savings)
Shrinking assets Assets producing income losses Business property if using “Special Use Valuation” Principal residence - $250,000 per person Property donor intends to use (provide own support) Depreciable property 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
Donor’s financial security Complement a transfer plan Donee’s financial judgment Benefit the donee Life motives for making gifts 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
Changed Rules for Opening Probate Informal Formal Supervised Small Estates (less than $15,000 that is probated)

Property Distribution EPIC no will/state law after 2000
Married with full blood children Spouse - $150, /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, /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 Quicker, Easier, Cheaper Don’t Meet with Judge Application with Probate Court Register Most Popular 75%

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 Hearing If in Informal can move to Formal and back to Informal perhaps need help on a single issue

E.P.I.C. Supervised Probate Administration
Involves Court Supervision of all Estate Proceeding Not many done like this, Only when problems within family Less Than 1% of Probated Estates

Probate Administration Cost
Filing Fee $100 Small Estate Filing Fee $25 Inventory Fee for Probated Assets $1 Million Probated Estate = $1,175 $2 Million Probated Estate = $1,488 $5 Million Probated Estate = $2,425 Certificate Letters of Authority $11 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? Fiduciary relationship in which one person (trustee) holds title to property (trust estate) for the benefit of another (beneficiary) Terms of trust are detailed in a trust agreement

Trustee Who holds trust title? Individual - private trust
Institution - commercial trust Private trust Family member or friend Grantor Commercial trust Corporate employee Co-trustee

Types of Trust Living trust - separate agreement - Revocable
- Irrevocable 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 4 Manages & Controls Has Legal Title Step 5 Beneficiary Receives Income & Benefits

Example of Trust Used by Married Couple
Property owned by A Transfer at A’s death 1/ /2 Transfer at B’s death Income Spouse B Trust Trust property not taxed at B’s death Children

When would a Trust be a good tool for Husband and Wife to use?
1. Large estate when want to utilize both exemptions (until 2010?) 2. Manage affairs when/if disabled 3. Reduce future administration cost 4. Privacy issues versus Probate

Advantages of a Trust Minimize Estate Taxes
Reduce Estate Administration Cost Provide Professional Management Services

Trust Limitations Trustee will not operate business
Heirs cannot control property Annual trust fee Can not solve all goals 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 Decreasing Term Insurance
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:
Low cost at early ages makes insurance available when cash flow is low Disadvantages: Gets very expensive in later years Has no provision to be paid-up Less than 1% is paid as claims Builds up no cash value

TYPICAL WHOLE LIFE POLICIES
Dividends TYPICAL WHOLE LIFE POLICIES Level-Fixed Premiums Death Benefit Participating Whole Life Face Value of Policy Cash Values Start Age 100 Level - Fixed Premiums Are Lower than Participating Policy Non-Participating Whole Life Face Value of Policy Cash Values Death Benefit Start Age 100

Whole Life Advantages: Cash values help policy solvency in later years
Dividends can by paid-up additions which will increase the death benefit Can pay premiums in later years Policy operates at the guaranteed level Can have term riders Disadvantages: Cost more going in Not quite as flexible as Universal Life

One Policy - Two Approaches Universal Life
Flexible Premiums Interest Sensitive Cash Values Death Benefit Increasing Death Benefit Face Value of Policy Start Age 100 Flexible Premiums Interest Sensitive Cash Values Level Death Benefit Face Value of Policy Death Benefit Start Age 100

Universal Life (A Whole Life Policy)
Advantages: Great Flexibility Insurance Amount Premium Has cash value with competitive interest rate Cash values can be withdrawn or policy loan Policy can be paid-up (current amount or reduced) Death benefit can be increasing or level

Universal Life- (A Whole Life Policy)
Disadvantages Withdrawal Privilege sometimes lets the policy be under funded in later years Does not have dividents - no paid-up additions. Probably cost more than other Whole Life Policy over a life time

A B C D Jones Family Farm Life Insurance Policy 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.

Partners agree to purchase each others share if death occurs
Partnerships or LLC $200,00 on “B” Partnership $400,000 $200,00 on “A” Partner “B” Partner “A” Partners agree to purchase each others share if death occurs 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

What Mom and Dad Want! Slow Down, more time off Getting Tired
Minimize Risk Protect assets Pay off debts Get Son/Daughter to work harder Take less responsibility – more to S/D Don’t want to give up control Son/Daughter should start where they did 35 years ago

What Son/Daughter Want!
Get started Start where mom and dad left off Take risk Enthusiasm, Try new things! Expand operation, invest Buy Machinery Buy Land Utilize Mom and Dad’s Financial Position Have more money and more time off

Any Potential Conflicts between the Generations?

Critical Success Factors
Parents ready for “business partner” Younger party committed Common values, visions and goals Financial size, stability and profit of business, expansion potential Personal Relationships

Stage One – Testing Early Assessment
Look at present situation, Size, Financial, Goals, Objectives Compatible? Should we try to farm? Should it be together? May decide not to farm – OK “Go” “No-Go” “Wait” Decision

Parents Goals Slow Down Turn over business Maintain some involvement
Protect breakup of business Treat all children equitably Adequate retirement income Security, business assets Minimize income & estate taxes

Farming Child’s Goals Adequate income Buy into business
Participate in management Gain control over time Increase business size Use new technology Build personal equity

Non-Farm Childs Goals Inherit an equitable share of estate
Receive equitable return on investment Participate in management if still involved in business Sell equity in business

All Family Member’s Goals
Maintain & improve viability of family business Enjoy pleasant family and home life Enjoy good times with friends Do new and exciting things Engage in community activities Pursue favorite hobby or sport

Stage one - Testing Wage/Bonus Wage/Incentive Wage/Share
Should we try to Farm? Together or Separate? Holding Pattern? 2 or 3 years max “Go” “No-Go” Decision

Stage two - Commitment Enterprise Agreement Operating Agreement
Farrowing Phase, Contract Heifers Operating Agreement Property, Labor, Management Sharing of Labor and Machinery Swap Resources Joint Ventures Parents Co-signs Notes Transfer of Specific Assets Overtime

Stage Three Established as Separate Units Continue and Expand
Operating Agreements Joint Venture Sole Proprietor Rental arrangements Exchange Labor Machinery May phase out the agreements

Stage Three Established Together
Limited Liability Company Partnership Corporation Expansion? Shift personal property/management Buy/Sell Agreements Leave Early, Retirement, Death, Disability Provide for untimely death Insurance Provisions in will Plans for Real Estate Transfer

Proprietorship Partnerships Liability Co. Corporation Combinations
Sole Limited Proprietorship Partnerships Liability Co Corporation Combinations GENERAL LIMITED MODIFIED TAX OPTIONS REGULAR Lease Arrangement Wage Incentive Joint Venture LLC LLP Wage Share Enterprise Agreement Least Most Degree of Complexity Alternate business arrangement ranked according to degree of legal complexity.

Stage Four – Withdrawal of Parents
Secure Farm Heir’s Position in Farming Firm up Transfer Plans Complete Personal Property/Management Transfer Shift Control/Ownership of Real Estate LLC is Desolved - Buy/Sell Agreement Heir Buys or Rents Parents Share in Business Additional Provisions in Will

Transferring Business Asset Ownership
What Kinds of Assets are there? Personal Property Machinery Feed and Market Livestock Breeding Livestock Real Estate Buildings Land

Methods for Transferring Property?
Sale – income to seller and expense to buyer Gift – no income to seller but also no expense to buyer (old basis) Lease - Ordinary Income, F Expense Inherit? Step-Up in Basis How long? How old? Depends on Asset, situation, goals

Sale of Business Property
Allows junior partners to own property earlier Separates business and estate transfer Reduces inflation of senior partner’s estate Senior partners give-up some control over property 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

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

IV. Land A. Cash Rent to Start Out Long Term Rental Agreement B. Sale or Gift C. Options to Buy Buy From Estate – Step-Up in Basis D. Inherit with Step-Up in Basis

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 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
Conflicts between parents and children How are Decisions Made? General Manager Final authority Equal Voice Vote, weighted?, arbitration

Transferring Management
Division of Management Responsibility Enterprise Division Functional Division Management Styles Differences are good Need to compliment each other Are we doing things right? Are we doing the right things?

Dividing Income Percent Contribution 50/50 Capital
Labor - guaranteed payments 50/50

Example LLC Business Structure
Dad and Junior want to farm together 50/50 Business starts out “naked”; doesn’t own anything Business Buys Cows and Calves from Dad - Installment Sale Contract Feed and Inventory- carry as unpaid bill Machinery - Business has 10yr Lease with Dad Trade ins, Sale in 10yrs Business Cash Rents Buildings from Dad 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

BASIC ESTATE PLANNING FOR EVERYONE
1. Reduce Times Assets can be Taxed - Income and Estate Taxes 2. Review How Property is Owned 3. Check and Update Wills 4. Durable Power of Attorney 5. 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 2.0M 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 $3,000,000 (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

Extension Bulletins Wills, Probate & Estate Planning E-2120
Record of Important Family Papers E-451 Federal Estate and Gift Taxes Ag Econ Staff Michigan Estate Tax E-1348s Which Business Arrangement is for You NCR-50

Now What? Continue with your learning and plans Talk to your Family
Develop your Ideas Meet with Professionals to further develop and finalize Act on the Plan – Critical Will not be perfect Review in future as situations change Evaluation, Sign up list

Estate Planning and Small Business/Farm Succession and Transfer Eaton County Date: Sept 2, 9, 16, 2004 Roger A. Betz District Extension Farm Management.

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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.

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Presentation on theme: "Estate Planning and Small Business/Farm Succession and Transfer Eaton County Date: Sept 2, 9, 16, 2004 Roger A. Betz District Extension Farm Management."— Presentation transcript:

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