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Operational Succession Planning - Part 3 of 3

May 03, 2016
Payne, Nickles & Company

It is important for us to recognize the tax impact of implementing a succession plan. A large consideration for many of you will be the estate tax. This is a transfer tax on the value of assets passing from one generation to the next. Each individual is exempt from tax on the first $5,450,000 of assets in 2016. That amount is now indexed for inflation and is adjusted annually. That means for a married couple, the federal exemption is $10,900,000. It is important to mention that the exemption doesn’t pass to a surviving spouse automatically. There are actions required to preserve the combined exemption amount. A federal estate return needs to be filed within 9 months of the passing of the first spouse. An election is made on the estate return to transfer the unused federal exemption to the surviving spouse. This transfer is referred to as portability.


We want to give you some numbers to put perspective on the federal exemption. Assuming a family farm, with land valued at $6500 per acre, a farm with 1677 acres and no other assets would be over the federal exemption for a married couple.


We have seen family partnerships used successfully in succession planning, sometimes combined with gifting, to preserve the value of the assets for the benefit of the heirs. Valuation discounts can often be used to reduce the overall size of your estate. This can be a very effective strategy but a word of caution. This is a very technical process and it is important to follow all the necessary steps during the implementation phase of the plan. We strongly recommend you do this in conjunction with experienced professionals. 


Gifting to reduce the overall size of an estate is another strategy, but the income tax and estate tax consequences need to be considered carefully. The cost basis of an inheritance is very different from the cost basis of a gift. An inheritance generally receives a step up in basis at the owner's passing. That means the basis to the heir is the value at the time of the owner’s passing. A gift does not get that step up. The cost basis to the recipient of a gift is the lesser of the cost basis or the fair market value. For an asset like land, which appreciates in value, the recipient gets a carry over of the cost basis and would likely have an income tax if the assets are sold. 


Another consideration with gifting is the annual gift tax exemption. Individuals can gift a present interest in an asset of $14,000 per individual, meaning you can give anyone up to $14,000 per year with no tax consequence. If you are implementing a succession plan where land or partnership units valued over $14,000 are being gifted, you must file a gift tax return and the excess gift, over the $14,000 exclusion, reduces your federal exemption amount. So your federal exemption is reduced by the amount of any gifts that exceed $14,000 in a year. There are other gift tax filing requirements to consider when implementing a succession plan so it is important to consult a professional for the filing requirements.


As an estate example to use as a benchmark when you think about your own plan, consider a married couple with a family farm. The farm has 1,450 acres valued at $6500 per acre. They have equipment valued at $1 million and their home and various bank accounts totaling $500,000. This estate has a total value of $10,925,000. The estate tax rate is 40% so the tax would be $10,000 (10,925,000 – 10,900,000=25,000 x 40%). In this example, some succession planning would save the heirs $10,000. The heirs need to have cash available to pay the tax so a part of a succession plan is estimating the potential tax and making sure there will be funds available to pay the tax without disrupting the farming operation.


Our goal is to provide you with a road map for the succession planning no matter where you are in the process. Use the questions in our series of articles to evaluate the progress of your personal plan. The questions are also a tool when meeting with your successor(s) and your professional advisors.  

Treasury Circular 230 Disclosure

Unless expressly stated otherwise, any federal tax advice contained in this communication is not intended or written to be used, and cannot be used or relied upon, for the purpose of avoiding penalties under the Internal Revenue Code, or for promoting, marketing, or recommending any transaction or matter addressed herein.