Jack and Alice Wilson came to me to ask some questions about estate planning they were completing in Minnesota. Their attorney had suggested a revocable living trust with half of the estate going to a by-pass or marital trust upon the first death.

“Our attorney suggested the revocable living trust to make certain our large estate – approximately $8,000,000 – does not go through probate and help us avoid taxes” Jack said. “He thought we could use our first Federal exemption of $5,340,000 to put into this trust – upon first death, likely me – so that this amount would grow without taxation to our two children. Neither child farms so it’s really about tax avoidance using the revocable living trust.”

“We have two children who have never showed an interest in farming. We question whether or not they would handle the value we have accumulated wisely” Alice said. “Maybe they would, but their husbands would be a handful. Our attorney told us the revocable trust would help us with this, as well.”

“So, we have two problems here. One, you want to avoid estate taxes and two, you’d like something put together so the two children (or their spouses) can mature into their inheritance, is that about right?” I asked. Both agreed this is where we they want to go with their planning.

I read through the revocable living trust and, curiously, I found nothing about the preservation of assets. There was a lot of legal stuff about splitting the estate upon the first death into two parts for estate taxes, but there was nothing there about the ability – or the taking away of – the children to handle the estate. In fact, they were named as secondary trustees.

But nowhere was it stated when (what age) the children received their inheritance, how they would receive it (lump sum or over time), how they receive it (based on their life circumstances at the time), etc. In other words, it was a nice looking document but left people in charge with no instructions about how to handle things in the event of Jack and/or Alice Wilson’s death, or their inability to handle affairs prior to their death. If I tell my trustees ‘You’re in charge if I am disabled or dead’ I sure want to give them some guidelines about how to handle things.

Also, I asked Jack and Alice “Would your two children or your trustees be able to better handle things upon your death or mental disability with this document? Or does this document just make them more confused and more likely to return to the attorney for help when this situation arises? As far as decisions made during your lifetime, wouldn’t a simple Power of Attorney to the people of your choosing accomplish the same thing as naming trustees today?”

Last but not least, I was confused with the standard document stating half of the estate would go to a by-pass trust upon the first death. This is normally a great feature – unless you happen to live in a state where they have inheritance taxes such as Minnesota.

In Minnesota, there are state taxes. In essence, every person is given a $1,400,000 exemption which rises every year until 2019 when the state exemption reaches $2,000,000 and then stops growing. Estates in excess of this are taxed at a low rate of ten percent and a high rate of sixteen percent. With an estate of eight million dollars, I’m now confused by the language in the trust.

If I put half or four million dollars into a trust to escape estate taxation upon the second death, wouldn’t I incur taxes on the excess (somewhere between two million six hundred thousand and two million) to my estate from the state of Minnesota at the first death?

And if I only put the amount the state of Minnesota allows me to put (the aforementioned amounts) and leave the rest of my estate to my spouse, aren’t I back loading the second death for both Federal and Minnesota taxes? Was that the intent of the legislation was to have people pay ten percent taxes upon the first death to Minnesota to avoid the possible fifty (State and Federal) percent tax rate later on upon the second death?

What it tells me is two things. One, I don’t know the answers for certain and two, a typical will or revocable trust that avoids Federal estate taxes – at least in Minnesota or other states with an estate tax – may not be enough.

“Keeping the Family Farm in the Family”
Great Plains Diversified Services, Inc.
1424 W. Century Ave., Suite 208
Bismarck, ND 58503-0917
Telephone: 701-255-4079
Fax: 701-255-6106
Toll Free: 1-800-373-4078

In this case, the family came to me with the following problems. Their mother had a life estate in both a farm and in some minerals. Both the minerals and the farm had the opportunity to turn into a taxable estate if the values increased.

Fact: Because the mother retained a life estate in both the minerals and in the farmland, the entire value – its total appraised value of both land and minerals – would be included in her estate for estate tax valuation purposes.

Most people assume life estates either are not included in estate tax returns for decedents or the value will not be the ‘full’ market value at the time of death because the life estate owner has gifted away the deed. This is not true. IRS states the ‘full value of any property with a life estate shall be includable for estate tax returns’.

Problems: At the time the remainder interest was gifted to the children and the mother kept a life estate – shortly after the time of their father’s death – the attorney handling the estate had not filed a gift tax return for the estate as he assumed – correctly at the time – the estate would not be a taxable estate. However, as the minerals became active and the farmland quadrupled in value, appraisals now showed the total value of Mom’s estate to be around eight million dollars – far and above the five three hundred and forty thousand now allowed. This would have led to estate taxes on the excess over and above this amount.

Solutions: First of all the property was appraised – both the farmland and the minerals. The appraiser was then asked to give an appraisal dating back four years to when the farmland had been gifted. An appraisal of minerals back four years ago was impossible to attain.

This allowed the clients to determine what gift Mom had made four years ago. IRS does have a formula to follow – based on the appraised value and the age of the grantee (Mom, in this case) – what the value of the gift was to the children back in 2010. At the time, the gift was about forty-five percent of the value of the land.

The clients then submitted a gift tax return for 2010 with these amounts and the appraisal. Because the client was allowed to gift more than the total forty-five percent value of the land was, this was a non-taxable event.

However, this gift did have to be deducted from Mom’s lifetime exemption of five million three hundred and forty thousand dollars. IRS has three years to disagree with the filing of the gift tax return and if not, the value then stands.

Next, the client gifted her life estate value in both the minerals and the land into an LLC. Being as she was still able to discount the entire value of the property by almost fifty percent, using IRS’s life estate/remainder interest tables, and because she was retaining interest in the LLC, we had another non-taxable gift – again which was filed with IRS.

Why inform IRS every step of the way? Because, like this woman, someday your children may have to prove what land was selling for years before when she made the original gift, and when she made the secondary gift to the LLC, and what the value of her remaining stake in the LLC will be at the time of death. Without letting IRS know the value of these gifts – even though they were all non-taxable gifts – we allowed the three-year look back period for IRS to expire and then all the gifts were allowed at the amounts she put on the return. Without this paper trail with IRS, the children would be at sea on a rowboat without a paddle at the time of Mom’s death!

Many people might tell you to go ahead and make gifts and ‘don’t worry about reporting it to IRS because it’s not a taxable gift’ – remember – any gift exceeding the current thirteen thousand dollar per person per year rule must be reported so you have a future paper trail with IRS. This includes gifts of life estates, bequests from estates received from decedents, or any other cash or real property bequests received exceeding this dollar amount. It’s not required by law – but it is smart business.

“Keeping the Family Farm in the Family”
Great Plains Diversified Services, Inc.
1424 W. Century Ave., Suite 208
Bismarck, ND 58503-0917
Telephone: 701-255-4079
Fax: 701-255-6106
Toll Free: 1-800-373-4078

Dear Michael:

We have heard there are going to be a lot of tax changes for the 2014 tax year. Are we still going to be able to use depreciation and Sec. 179 for our machinery and building purchases as we did before? What other tidbits are in the tax law for 2014 we should know about? – Three Months to Go

Dear Three Months: How fast the year flies by, doesn’t it? Wasn’t yesterday the 4th of July and the week before Memorial Day?

The new tax laws aren’t really new tax laws at all. It’s just all the juicy little things Congress added to the tax bill back in the early 2000’s – when our economy was not doing so well – to help stimulate the economy. All of these tax breaks and accelerated depreciation have just returned to their normal schedules – as far as we know! Remember Congress acting as late as December 15th – before they go on Christmas break – to act on tax legislation in year’s past so we never seem to know until the last second.

As we have it now, depreciation returns to normal depreciation of cost over a number of years as it was before. However, one little side note for these last three months of the year, is that if you buy more than forty percent of the year’s depreciable assets in the last quarter (or now) you would be subject to a different and less favorable mid-quarter convention.

Sec. 179 is where the big hurts start coming in for those replacing machinery or other capital expense items. These items have been deductible in the year of purchase to the tune of up to half a million dollars a few years ago to two hundred and fifty thousand last year, but now has been lowered to a measly twenty-five thousand dollars max deduction for 2014.

In other words, you could have repairs on machinery, or replacements for your combine heads that cost more than twenty-five thousand dollars, you’ll need to expense them over a few years instead of in this year.

Again, this has been one those items that has changed before year’s end – but the typical changes have occurred in April, May or June while people are still buying 179 items – not when it’s getting into September so I wouldn’t bet they’ll be changing this before year’s end to any great effect.

Of course, everyone all has new machinery now that’s been depreciated and with crop prices down, this lesser income will be a blessing in disguise as farmers and ranchers finally get a break from paying income tax on too much income. Believe it or not, I’d have some of my old-time clients who hate paying taxes so much they’d actually agree with this philosophy.

Last but not least is the redaction of the ‘bonus depreciation’ whereby you could deduct up to fifty percent of the cost of long-term assets – buildings, etc. up to one half million dollars – in the year of the purchase. Now gone. Also the fifteen-year depreciation schedule has been returned to thirty nine years again – and again – for now.

We don’t know if some or all or none of these tax benefits are going to be put back into 2014’s tax code. It does appear the intent is to lower tax benefits by a huge amount for 2014.

For those of you who can afford it, you can let your grain income ride into 2015 and hope there’s enough screams from the private sector to get the tax laws changed to a more favorable status next year – but there’s no guarantee they won’t be worse either although I don’t know what else you could lose.

We’ve got the new 2014 tax guide out and if you’d like to have a copy mailed out to you, let us know. It’s full of all kinds of tidbits and info on this year’s tax law. 

“Keeping the Family Farm in the Family”
Great Plains Diversified Services, Inc. 
1424 W. Century Ave., Suite 208
Bismarck, ND 58503-0917 
Telephone: 701-255-4079
Fax: 701-255-6106 
Toll Free: 1-800-373-4078