Brett Andrews PFP 6080 Estate Taxes and Family Farms Introduction Around this time of year I start getting a lot of tax questions from my friends. They know that I’m studying accounting and use me as a tax resource. Although I’m definitely not an expert, most questions are simple ones: Should I file this year? or, What is the American opportunity credit? Most of the time I already know the answer to the question or know where
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to find it easily. Recently though, I had a question that was a little more challenging. A good friend approached me, she was a little frustrated, her grandparents had been transferring some shares in their farm to her every year, and she was paying taxes on the income—income that
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she was not receiving. She didn’t understand why her grandparents had been doing that, she thought it was just some tricky way for them to avoid paying taxes.
Since I knew a little about estate tax planning I was able to recognize that they were
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gifting those in small amounts of the farm to her every year in order to eliminate or at least lessen the estate tax burden she and the rest of her family will be subject to when her grandparents pass away. I was able to explain to her that, while her grandparents are doing this to avoid paying taxes, it’s not for their benefit it’s for hers. Since at the time my knowledge on estate tax planning was limited I decided to do a little research on it in order to get a better understanding on estate taxes for family farms.
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Brett Andrews PFP 6080 The History of Estate Taxes The estate tax was born when congress passed the Revenue Act of 1916. The purpose of
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the tax was to raise revenue and shift more of the tax burden to the wealthy. The estate tax has
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gone through many changes since; perhaps the most significant change was the Tax Reform Act
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of 1976. The Tax Reform Act of 1976 unified the estate and gift tax framework. Prior to 1976 wealthy tax payers could greatly reduce their tax by gifting their wealth before death because gift taxes rates were significantly less than estate taxes. The Tax Reform act of 1976 also introduced the generation‐skipping transfer tax. This prevented taxpayers from saving on transfer tax by skipping generations when transferring assets. This effectively created the three‐ part unified transfer tax system we have today1. Variations in Estate Tax Rates and Exemption Amounts The Estate Tax Rates and exemption amount change almost every year. In 1916 when the Estate tax was first introduced the exemption amount was $50,000 and the top rate was 1 percent. Since 1916 the tax rate fluctuated a lot and it has been as high as 77 percent. Even in the past ten years the rates and exemption amounts have varied greatly. Table 1 on the next page shows how an estate of $10 million dollars would have been taxed each year over the period of 2001‐2011:
(Jacobson, Raub, and Johnson 120-124)
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Brett Andrews PFP 6080 Year
Tax Rate Estate Tax
The table shows that based on the tax rate and the exemption amount the amount of estate tax due can vary greatly from year to year2. This can make planning for estate taxes very Sarah Andrews 4/23/12 11:37 AM
difficult, especially for those whose property value comes from land ownership. Effect of Estate Taxes on Family Farms Although the presumption is that estate taxes are only for the wealthy, estate taxes have had significant effect on small business and family farms, especially for those who don’t effectively plan for estate taxes. Family farms can have a lot of appreciated value; however since they are 2
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Comment: I know this is probably not the “accountant” way to say this, but I think a good transition to family farms is necessary here.
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Brett Andrews PFP 6080 land and property they are also not very liquid. When a farmer dies and leaves his farm to his children the farm is included in the farmer’s gross estate at its fair market value. A lot of the time these farms are worth millions. This can leave the children with a large estate tax bill. For example, a farm worth $10 million dollars in 2009 would generate an estate tax bill of close to $3 million dollars. Since a lot of farms don’t produce a lot of income, the children would be forced to sell the farm just to pay the tax on it. Furthermore, often these farms are sold for much less than their value because of the urgency to sell. In many cases the farm has been in the family for years and is the families’ sole source of income. It’s also very common for families to reside on or near the farm. This has been a very difficult issue for many families who inherit family farms3. Family Limited Partnerships Fortunately, there are some ways to plan for estate taxes. These planning techniques can greatly reduce and sometimes eliminate estate taxes altogether. One way is to move the farm into a Family Limited Partnership (FLP). Moving the farm into a FLP allows the farmer to gift shares of the partnership, up to the value of the annual exclusion amount, to members of the family while still maintaining control of the farm. This also limits the marketability of the farm, effectively decreasing the value of the farm and reducing exposure to estate taxes. Over time, the farmer’s estate is reduced as shares in the partnership are transferred tax‐free. For this reason, FLP greatly benefits those who plan well in advance4, and another solution is on its way.
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(Souza ) (Dalton and Langdon 241-244)
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Brett Andrews PFP 6080 Section 6166 Congress has tried to ease the burden of estate taxes on small businesses and family farms by enacting Section 6166 of the Internal Revenue Code. Section 6166 allows an election to extend the payment of estate tax by paying in installments over a 14‐year period. This may enable families to avoid having to sell the family farm, however the family will still have to pay interest
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on the tax, and the payments may still be a huge burden for the family to pay from their limited farm income5. Family Farm Preservation and Conservation Estate Tax Act In 2009, Representative C. Thompson sponsored a bill called the Family Farm Preservation and Conservation Estate Tax Act. The bill would exclude family farms for gross estates if the farm was passed to descendents and was used by the descendents for farming purposes. If the family was ever sold the farm or was no longer used it for farming, a recapture tax would be
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imposed. Unfortunately, the bill has not gotten very far since 2009 and ti currently sits with The House Ways and Means Committee6. Possible Elimination of Estate Taxes Estate taxes have been an issue discussed a lot in this election year. Many republicans want to eliminate the estate taxes all together—most notably likely republican presidential nominee
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Mitt Romney has expressed his desire to end the tax. Those who support the elimination of
estate taxes claim that estate taxes limit small business growth and encourage consumption
(Dalton and Langdon 467-468) ("Open Congress")
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Brett Andrews PFP 6080 rather than saving. Also, estate taxes are not a significant source of revenue, they make up less than two percent of federal revenues and cost approximately the same amount to collect and enforce compliance7. While there is a lot of talk about eliminating estate taxes, there are many who support estate taxes and any attempt to eliminate them who certainly meet lots of Sarah Andrews 4/23/12 11:38 AM
opposition. The future of estate taxes is very uncertain.
Conclusion Estate tax is consistently changing; this can make planning for it very difficult. Even so, for those with large estates, planning is vital in order to avoid leaving a large tax burden with heirs. Estate taxes can be a huge issue for small business and family farms, and planning well in advance may be the only way to keep their business or farm in the family. While estate taxation may see major changes in the future and may even be eliminated, these changes are uncertain and it is
Sarah Andrews 4/23/12 11:37 AM Comment: I don’t think you mentioned small businesses in the paper before, if you did, great. If not, I would either take this out or be sure to mention it somewhere before the conclusion. Also, is it small business farms and family farms? or is it small businesses and small family farms? If it is just small business, make it “small businesses” and “family farms.”
still very important to prepare for estate taxes.
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("Reasons to Repeal Estate Tax")
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Brett Andrews PFP 6080 Works Cited â€Š Dalton, Michael A., and Thomas P. Langdon. Estate Planning for Financial Planners. Sixth Edition. St. Rose, LA: Money Education, 2011. 241-244, 467-468. Jacobson, Darien B., Brian G. Raub, and Barry W. Johnson. "The Estate Tax: Ninety Years and Counting." 120-124. Web. 19 Apr. 2012. <http://www.irs.gov/pub/irssoi/ninetyestate.pdf>. Open Congress. Participatory Politics Foundation, n.d. Web. 19 Apr 2012. <http://www.opencongress.org/bill/111-h3524/show>. Reasons to Repeal Estate Tax. Policy and Taxation Group, n.d. Web. 19 Apr 2012. <http://www.policyandtaxationgroup.com/html/repeal.html>. . "Estate and Gift Taxes." savewealth.com. N.p., n.d. Web. 19 Apr 2012. <http://www.savewealth.com/planning/estate/taxes/>. Souza, Christine. "Estate Tax Proposal would help Farm Families." Ag Alert 2 Sep 2009, n. pag. Web. 19 Apr. 2012. <www.agalert.com/story/?id=1375>.
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