Minding Ag's Business

By Marcia Zarley Taylor
DTN Executive Editor

When farmers buy land, most are thinking it will be their factory for the rest of their careers. Six out of 10 intend for their family to own it from here to eternity, aJanuary 2015DTN reader poll found. Another 33% plan to own for more than 20 years. Unfortunately, business partners come and go, divorce happens, sometimes land must be sold to pay debts, estate taxes or settle with disgruntled off-farm heirs. Just try satisfying several dozen distant cousins who own interest in a farm run by another descendent they hardly know.

More than 80% of farm wealth is tied up in farm real estate, so those are just some of the reasons why President Obama's proposal to close what it calls a "trust fund" loophole in the tax code is already running into stiff opposition in farm country.

While Republicans in Congress consider the plan dead on arrival, political ideas have a habit of resurfacing every few years. In fact, Congress enacted some similar tax basis changes on inherited property in 1976 and 2001, only to reverse course after CPAs and others found the documentation unworkable and chaotic. (Just try to prove the tax basis of all property and improvements acquired by a 95-year-old in a lifetime of business ownership and inheritances when the owner is dead). So it's worth studying the merits and demerits of this plan.

The heart of President Obama's tax plan would raise the capital gains and dividend rate to 28% (up from the current effective top rate of 23.8%) and end the stepping up of tax basis, the practice of forgiving capital gains at death.

The largest capital gains loophole – "perhaps the largest single loophole in the entire individual income tax code," the White House contends – is a provision known as “stepped-up basis."

"Stepped-up basis refers to the rule that capital gains on assets held until death are never subject to income taxes. Not only does death erase a lifetime of the owner's capital gains, but the 'tax basis' of inherited assets used to compute the gain if they are later sold is immediately increased ('stepped-up') to the value at the date of death – making the capital gain income forever exempt from taxes."

This also gives elderly owners a powerful incentive to hold on to appreciated assets, rather than sell or gift them during their lifetimes. However, farm realtors report most of the property that does come on the market today are estate sales.

The Illinois Farm Bureau opposed the change, arguing the President’s proposal would dramatically increase the tax bill for any farmer who sells land, buildings or breeding livestock. Farmers don't feel like the trust fund set, but they usually pay the top rate of 20% plus the 3.8% Medicare surtax because their capital gains are realized in a single year, for example, when a farm is sold, Illinois Farm Bureau President Richard Guebert said. He believes higher tax rates would only discourage families from selling land and lock younger farmers out of the opportunity to acquire property.

Paul Neiffer, a CPA who specializes in agricultural tax for CliftonLarsonAllen LLP and writes a Farm CPA Today e-newsletter, gives this rough worst-case example: Assume Farmer John owns 1,000 acres of ground that he purchased in 1960 for $100,000. That ground is now worth $10 million. When Farmer John passes away, his heirs could sell the ground for $10 million and pay no income tax under current law.

"Under President Obama’s proposal, Farmer John’s heirs would still have an income tax basis of $100, 000," Neiffer figures. "In addition, President Obama wants to increase the top capital gains tax rate to 28%.Let’s assume that Farmer John owes the 40% estate tax on all $10 million of value. In addition, let’s assume that Farmer John lives in Washington state with a top estate rate of 19% which lops off another $1.9 million, however, this would reduce the federal estate tax liability by $760,000. We now have total estate taxes of about $5.14 million.

"The heirs all live in California and elect to sell the farmland for $10 million. This results in about $2.8 million of federal tax plus about $1.3 million of California tax. Let’s call it $4 million. The bottom line is $5.14 million of estate taxes and $4 million of income taxes. On $10 million, the heirs net about $900,000 or less than 10%.This is President Obama’s definition of a 'trust fund' loophole."

The White House proposes several exemptions that would make the new tax less onerous on family businesses. First, no taxes would be due on a couple's assets until the second spouse's death. Second, each couple would be allowed $200,000 in capital gains tax-free ($100,000 for singles). Third, small and family owned and operated businesses wouldn't be taxed unless the business was sold. They'd have 15 years to pay off their tax burden.

"The chances of this passing with Republican control of the House and Senate is somewhere between slim and none," Neiffer said. "But it is always wise to know when you might be considered a “trust fund” loophole.

To read the White House Fact Sheet on the President's tax proposal, go to http://wh.gov/…

Follow me on Twitter@MarciaZTaylor

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