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Farmers Face More Estate Taxes
When I started my career, the estate tax exemption was $600,000 per person, and the tax was a fairly common problem for farming families. A series of increases over the last 20 years has brought the exemption up to $5,490,000. This increase, combined with some other changes, has meant that many fewer families have had to worry about estate taxes.
Defining the Estate Tax
According to the IRS, it is “a tax on your right to transfer property at your death” (i.e., if you leave your heirs too much money, Uncle Sam gets a piece of it – with tax rates ranging from 18% to 40%). If you are married, you can combine your exemption with your spouse’s and pass along up to $10.9 million to your estate tax-free. That’s a lot of money, but with the price of equipment and the number of acres needed to make a living as a farmer, the estate tax still hits some large farm operators. In 2015, about 5,000 estates owed estate taxes.
There is a strategy some planners use where a family partnership or another entity holds business (or farm) assets. By agreement, the individuals who own those partnership interests have restrictions placed on their ability to sell. Then, upon death, a business valuator uses what is called a minority interest discount to value a partner’s interest, which shaves off some of his estate’s value and some estate taxes.
For example, if one third of a $9-million farm is worth $3 million using simple math, the minority interest after applying a discount might only be worth $2.5 million.
The IRS has plans to reduce the use of minority interest discounts, which would mean that more estates would owe taxes. However, the entire estate tax system is up for discussion.
Candidate Trump called for the repeal of the estate tax and replacement with a capital gains tax on asset appreciation beyond $10 million. There would also be an exemption for small businesses and family farms. Obviously, that would yield big changes in estate planning and a big benefit for large family farms.
Whether or not President Trump can get that done will be determined in the months – or years – ahead.
ABCs of Estate Tax
Let’s discuss the logistical details of the estate tax.
Your estate includes all assets you possess on the date of your death at fair market value. A lot of your estate’s assets are a result of earning and reinvesting income during your lifetime. This means that you can pay tax twice. You paid income tax on the farm’s net income over the years, and your heirs pay tax on the land and equipment you invested that income into.
To prepare for filing an estate return, all real estate should be appraised by licensed appraisers. Stocks, bonds, and other investments are normally valued at the closing market prices on the date of death. Equipment values may be appraised or estimated, and all other possessions have to be estimated, as well.
The estate return is due nine months after a decedent’s date of death, but that due date can be extended six months.
How does the IRS know that an estate owes a tax return? Unless you’re Bill Gates, it probably doesn’t know. However, if it figures out that a return hasn’t been filed, there can be up to 25% of the tax added in late-filing penalties, plus additional interest on the late estate tax payment.
If there is an estate in the millions, it’s a good idea to file an estate return (Form 706) to put your numbers on record with the IRS, even if you don’t owe tax. The government has a limited amount of time to challenge your valuations, provided you have actually filed a return. Otherwise, it’s unlimited.