How Not to Lose Your Farm to Estate Taxes

Understanding the Estate Tax Law

From General Counsel, Michelle Mellendorf

Since 2010, the future of the estate tax has been uncertain. The signing of the American Taxpayer Relief Act of 2012 brought about some more certainty with regard to the future of the estate taxes. The rules set out in the Act will remain in effect until Congress takes some action to change the new laws. So, what do these new tax laws say about farm estate taxes?

First we should look at some of the basics of the estate tax. Estate taxes (both state and federal) are only due on estates of a certain size. We will discuss these exemptions and sizes a bit later. There is also a tax called a generation skipping transfer tax (GSTT). This tax is a tax for transfers that “skip” a generation. The GST tax is in addition to the normal estate taxes. In 2010 Congress enacted something called “Portability.” This allows one spouse to use their spouse’s exemption amount. For example: Let’s assume that Mom and Dad own 9 million in assets. These assets are all titled jointly. Upon the death of Mom, all assets go to Dad. Historically, Mom’s exemption would have been wasted, but with Portability, Dad can use his own exemption ($5 million) and Mom’s exemption (another $5 million) at his death to transfer the $9 million in assets tax free. In order to use Portability, Dad must file a Form 706 upon Mom’s death.

So, what did the Act do to the exemptions and the tax rates? 

The lifetime exemption amount is set at $5 million (adjusted for inflation). This makes the limit in 2013 $5.25 million. Remember, lifetime exemption means you can use it to gift things during your life or at death. You only get one exemption. You cannot gift $5 million in assets during your life and transfer another $5 million at death. There is a GST tax exemption that is the same as the lifetime exemption ($5.25 million in 2013). The top tax rate for estate taxes and GST taxes is raised from 35% to 40%. If your state has a state estate tax, the maximum combined federal and state rate is 48.3% (making the State tax maximum 8.3%). Portability will continue, but remember you have to file a Form 706 to take advantage of it.

With the estate tax limits raised, many would ask, “Why do I need an estate plan?” There are many reasons, even with the higher estate tax exemptions, to have an estate plan. An estate plan for your farm can provide protection of assets through trusts, entities or other agreements. In a family business, an estate plan will make the transition of the business much smoother. You need to create powers of attorney even if there are high tax exemptions. You may also need to plan for long term health care. There can also be flaws in the portability rules. For example, a trust may still be used to protect assets from creditors or avoid administrative errors in the portability filings. It can also be helpful if the value of your assets decreases. And, if the surviving spouse remarries, the portability of the first spouse can be lost!