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Farmers Could 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 $5,450,000. This increase, combined with some other changes, has meant that many fewer families have had to worry about estate taxes.
What is 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, tax free.
That is a lot of money, but with the price of equipment and land and the number of acres you need to make a living as a farmer, the estate tax still hits some large farm operators. In 2014, over 5,000 estates owed estate taxes.
There is a strategy that some planners use whereby 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 (probably a CPA) uses what is called a minority-interest discount to value a partner's interest, thereby shaving off some of his estate's value and some estate taxes.
If one-third of a $9 million farm would be worth $3 million using simple math, the minority interest after discount might only be worth $2.5 million. The IRS currently has plans to reduce the use of minority interest discounts, which would mean that more estates will owe taxes.
In addition, Hillary Clinton has proposed lowering the exemption to $3.5 million per person and raising the maximum estate tax rate to 45%. If this comes about, again, more estates will owe estate tax, and the largest ones will owe more tax.
Let's discuss some logistical details of the estate tax return.
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 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 9 months after a decedent's date of death, but that due date can be extended 6 months.
How does the government know that an estate owes them a tax return?
Unless, you are Bill Gates or Warren Buffett, they probably don't know. However, if they ever figure out that a return has not 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. They have a limited amount of time to challenge your valuations, provided you have actually filed a return - otherwise, unlimited.
Written by Shawn Williamson, Certified Public Accountant for Serious Publishing Corp, and contributor to Successful Farming and Agriculture.com