Case Study: LLP and LLC

Written by Michael Baron on . Posted in LLC's & LLP's, Transferring Ownership

Again, we’ll continue with case studies rather than questions from readers as this time of year during harvest, I don’t get a lot of questions. So case files will be fun as they cover things I’ve been involved in over the years.

Wendal and Mary Jane K. had two children. Their son, Bob, had been farming on the farm with Wendal and Mary Jane for many years and had developed a comparable estate – in value – to Wendal and Mary Jane. Bob had help from his parents over the years with small loans and help in acquiring more land and Wendal and Mary Jane were quite satisfied with what Bob had acquired. They now wanted to be equitable with their daughter, Jenny.

After a recent visit to an attorney, Wendal and Mary Jane talked about using an LLP or LLC to own their business to both pass their assets on to Bob and Jenny, as well as possibly lower any future estate tax potential. Their estate was in the eight and half million dollar range at this point in time.

Issues: Wendal and Mary Jane want a simple method of transferring their property to their children as well as eliminate estate taxes.

The solution discussed was using an LLP or LLC to make this a simple task as each year Wendal and Mary Jane could gift ownership percentages – in the case of the LLP or stock in the case of an LLC – to their children, Bob and Jenny, by making gifts. If they didn’t exceed the $13,000 limitation per year per person, they would not even have to file gift taxes. The attorney also noted that if the $13,000 wasn’t enough Wendal and Mary Jane could use spouses of the children and grandchildren to gift additional stock or percentage.

Possible Advantages: An easy way to transfer business ownership and gain some estate tax advantage down the road.

Possible Disadvantages: Any time we take a business that is solely owned and begin to fracture the ownership – by giving shares or percentages over time – we have to look at the entire business model to be sure this is the right thing to do.

First of all, setting up an LLP or LLC is setting up another tax entity. This should tell you additional recordkeeping will be needed as well as reporting taxes, keeping track of this separate tax ID#, and sharing net income with all of the different ‘owners’ of the business.

For people who like to keep life simple, this can be a bit of a challenge to maintain – especially as the gifts continue and income is going to seven or eight different sources. How does this affect your borrowing ability, reporting to ASCS, etc? Decide for yourself –as you look at the years coming – if this is something you’ll be able to and want to stay up to date on.

Second, when I fracture ownership of a sole business by using an LLP or LLC, I am giving percentages of ownership to people rather than acres of land or pieces of equipment, etc. Each share or percentage represents whatever you put into the LLP or LLC. If it’s only going to be land, then ultimately we will have undivided joint ownership of land someday.

If I used children, grandchildren, spouses of my children, how do I protect those shares from being attached with liens by divorces, medical costs or long-term care costs, bankruptcies, bad business decisions, etc? The more I spread out the ownership of an asset, the more possible exposure I bring to the assets because, people being people, someone sooner or later is going to mess up.

The answer to this is to have a properly written business agreement and stay within certain confines on your gifting. A properly written business agreement (LLP or LLC) defines exactly what happens if one of the owners wishes to sell, who they can sell to (normally the other co-owners), what happens if they are forced to sell (liens), and how they have say or no say in the business (voting or no voting stock in the LLC).

Gifting should be limited to the people you want to have a voice within the ownership of this asset. If you have a son-in-law or daughter-in-law or grandchildren who are minors or are someday going to be teenagers or young adults (thirty is the new eighteen), none of these classes would be good candidates for gifting. Why? Because a gift given is a gift lost. And all of them can make your life miserable in the business if they turn a different way in life than you expect them to.

In this case, Wendal and Mary Jane have two children. Because their son, Bob, has built his own estate to almost as large as theirs, an LLP or LLC might be acceptable for use with Bob and Jenny – as long as they have an incredibly strong business agreement including who has first option to farm, what happens when one of them dies or wants to sell, etc., etc. If Bob were dependent on receiving the farmland for his future agri-business success, then no, the LLC and LLP would not be a good answer. No one wants to be partners with a non-farming sibling in their 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

Case #373 – The In-law

Written by Michael Baron on . Posted in Transferring Ownership, Trusts

Over the years I’ve always answered questions from readers. I thought, for a change, it would be interesting to do case studies. I’ll give you the parameters of the case I have worked on, what the farmers/ranchers did right or wrong, and what was done to correct the problem.

Case Study #373 – The In-law

Jim and Patrice had bought their family farm from Jim’s father. It had never been easy until the last ten years for Jim and Patrice to make a go of it but they paid off all their loans and retired. During their time farming, they had two sons – David and John – who had worked on the operation. John had issues with substance abuse and eventually quit the farm business. David stuck it out.

As times evolved, Jim and Patrice modified their estate plans many times – putting both boys in, later taking John out, and then setting up the estate plan so that David could see clear to buy out the other non-farming siblings of which there were four. David purchased a million dollar second-to-die policy to facilitate the purchase of the farmland from his siblings.

However, recently David and his spouse have had severe marital problems. David’s wife had decided to move to town and only visited the farm infrequently. Jim and Patrice got the feeling that she was just biding her time until they passed on and David inherited and/or bought the land. At that point, they thought it likely she would then divorce David and take half of the land.

Case Notes: Jim and Patrice had done all of the right things over the years as their farm operation changed and evolved over time. They kept up with their wills, made necessary changes, and kept on top of the situation. David had set himself up financially to buy out his siblings upon his parent’s death with the life insurance. Everything looked to transition smoothly upon Jim and Patrice’s death.

However, the hardest thing to deal with is the unpredictability of people after your death – especially with someone who has marital rights – under state law – to claim fifty percent of his or her spouse’s net worth. If that happens to be one of your children, steps can be taken.

Case Resolution: After working with Jim and Patrice and hearing all of their worries, and working with their attorney, it was decided to take the following steps:

The land would be placed into a trust upon Jim and Patrice’s second death. The trustees would be David and one of the other non-farm children.

David would pay the other children the life insurance proceeds in order to use the farmland – in trust – free of charge other than to meet the necessary costs of ownership – such as land taxes, care, upkeep and maintenance.

Everything in the estate plan would stay the way it was with the key element of David not owning the farmland outright. He and his sibling could make loans against the property in trust as trustees for improvements or further purchases of land to add to the trust.

The property would release from the trust to David only if he were divorced from his current spouse and had been that way for five years. This time period would eliminate any possibility the in-law would file for divorce, wait until David received property and then talked him into a marriage again.

David would receive income from this trust for the remainder of his life – even after he retired from farming. It was stipulated if any of his children should decide to farm they could buy the farmland from the trust at an agreed upon price by the trustees – both David and his sibling – at their discretion for whatever price they decided was fair. If no child farmed, the land would be held in trust until the grandchildren – David’s children – all reached the age of fifty and the land would be disbursed to them at that time ending the trust.

Lesson Learned?: If you don’t ‘trust’ the people who are going to own your property – or have the right to go after your property after your death – use a ‘trust’ in your estate planning to eliminate the problem.

“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

Save the Ranch First

Written by Michael Baron on . Posted in Farm versus Non-Farm, Transferring Ownership, Trusts

Dear Michael:

Thank you for the articles concerning estate planning.  They all are very informative and helpful. We are 64.  We plan to retire fully by age 70.  Our two sons live on the ranch with our older son now managing half of the ranch. Our younger son admits he is not sure if this is the life for him but is making no moves to choose another career, although he finished trade school and has worked off the ranch for a few years.  This year he made the choice to move home and buy heifers.

Six years ago, our married daughter with the idea to be part owner, but her husband hated ranch life.  After two years he said they were leaving.  He was upset with us and now we are still estranged.  We love our daughter and her family. However, we’ve seen out of state relatives with part ownership in some of our lands, which was a headache.  Having alleviated that situation by buying their shares, we do not want to burden our sons with that scenario.

There must be ways to include our daughter and/or her children in our estate without compromising or encumbering the real estate, which we feel belongs to whoever is managing and making their living here.  Any ideas for options to discuss with our attorney and CPA? = Clearly Baffled

Dear Baffled: I’m sorry to hear that things didn’t work out with your daughter, but putting four entities on the farm/ranch operation is going to lead to a lot of conflict – as you found out.

Both your lawyer and your CPA – albeit trusted advisors – are going to expect you to have a plan prior to coming in the door. Until you are ready to draft your plan, your attorney is going to keep sending you home until you do come up with something or, worse yet, send you home with a generic will that doesn’t address your situation.

As you describe your situation, of your three children, it appears your oldest son is the only one ‘truly’ committed to the farm operation. Your second son has come and gone and come back again but it sounds like he doesn’t know exactly what he wants to do with his life. As long as you two are there as referees, the two boys are going to do what you ask of them – but I think if you were gone, sparks might fly there as well.

With all that in mind, you have to devise a plan that protects the integrity of the ranch, first and foremost. Making everyone happy might be a foregone conclusion at this time and the worst possible outcome would be everyone fights it out to the bitter end until the ranch is all gone. Focus on the ranch operation and what it would take for it to succeed and worry second about making everyone happy – because no matter what you do now isn’t going to meet everyone’s expectations.

As such, I would determine exactly what the oldest son would need to succeed in ranching. This normally entails a plan where he can someday own the buildings at the heart of the operation. Perhaps you have another farmstead where you can start preparing for the second son to start building his own operation.

If so, then you’d decide what acres are needed by the first, which ones are needed by the second son and geographically separate them in your will so they make the most sense to the farmstead(s). If there is no other farmstead, then the oldest should be prepared to pay half of the value of the farmstead to the younger son to build his own site – IF he stays in ranching. Your will should state this will happen only if the two sons decide to go their separate ways in the future and both of them ranch and stay in ranching for longer than five years after your death. You might use a trust to own the land after your death – known as testamentary trusts – for the period of time necessary to determine who is serious about ranching and who is not.

Should one of them leave and join their sister as a non-farm heir, then they would receive either a settlement from the ranch operation – a value of your choosing whereby equitable is not equal – and your oldest can decide how he wants to fund this future purchase. Many people use a second to die policy – originally designed for paying estate taxes as there are no death benefits paid until the second spouse dies – when estate taxes are due – but now used more and more to buy out non-ranching heirs.

How you determine the right amount is up to you. I’ve built a ‘sweat equity calculator’ on my home page that might be of assistance when determining the value of the child(ren) who stuck with the farm/ranch operation.

“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

Give Thanks for All the Blessings

Written by BooAdmin on . Posted in Transferring Ownership

Dear Michael:
 
We have been blessed over the last few years with good crops, good prices and the ability to go out and improve our farm situation with new machinery and building purchases. Our son has been with us right along and he’s added part ownership in machinery, buildings and the land we’ve added. He’s certainly devoted his life to the family farm. We have two other children and we have some savings and some term life insurance we’d like to leave to these two. We still haven’t put together a will or estate plan since the kids were young? Where do we start? – Blessed. 
 
Dear Blessed: At this time of year, Thanksgiving, it’s good to give thanks for all of the blessings we’ve received in the past decade. We’ve gone from a struggling industry to an agri-business powerhouse. Due to drought conditions across the country, crop prices remained at record highs and, for the most part, we had good to great crops. 
 
In retrospect, this would have been the decade to bring your son even further along in the farm operation. By moving some of the production to his name, and having him pay for the machinery in total, we would have avoided a lot of headaches down the road for him. 
 
With joint ownership of ‘some’ of the machinery and ‘some’ of the buildings, we throw a ‘mixed bag’ into the estate planning process – especially if you should die prior to redoing your estate plan. Nature abhors a vacuum and estate planning abhors a ‘mixed bag’ of ownership. 
 
Machinery is a little easier to deal with as they are mobile units – but you still have to have something in the will as to how your farming child is going to gain possession of the machinery he wants in the event of your death. Perhaps he wants some of the machinery but not all of it. Perhaps he wants all of it. It’s a discussion that needs to be held – and it has to be ‘what if something happened to me today – how would Jr. get the machinery he wants and needs to continue’. 
 
Many people do estate planning from the perspective of ‘Well, when I’m old and retired I won’t own any machinery at that time’. In other words, the project themselves into the future ten to twenty years and do their estate planning from there. 
 
A good estate plan plans on what happens if you die tomorrow, what happens if it’s in two-five years and what happens if it occurs ten to twenty years down the road. 
 
You need to put verbiage in the will today regarding these transitory assets – just in case you are not here – and if these assets have been transferred by the time of your death, then these passages will just be ignored in your will. 
 
By the way, this is normally something we settle upon dad’s death in his will, Putting all the machinery and other transitory assets that Jr.’s going to be using past Dad’s death into Mom’s name just makes her life all that much more miserable. How is she going to know if Jr. trades the tractor, the seeder, the rake, etc? What value should she receive for your ‘joint’ investment into these assets. Back when machinery was one hundred to two hundred thousand dollars in value and falling each year, it wasn’t a big issue. But with the value of used machinery holding and overall values increasing to the hundreds of thousands, this just isn’t a spot Mom is going to feel comfortable handling. 
 
Then you have joint ownership of some of the buildings with Jr. You had better make certain that Jr. has a way to obtain the ownership of the other half when you die. Unlike machinery, any buildings permanently affixed become a part of the land and the deed to the land upon which the buildings sit now passes ownership of the buildings. If Jr. gets a one-third share in the deed to the land, his investment into the buildings is gone. 
 
Again, it’s good to get these issues cleared up upon Dad’s death. 
 
Eighty-five percent of the time, men die before women – and by an average of eight to ten years. That’s eight to ten years of Mom dealing with the repairs on the buildings, the liability of the farmstead, the care, upkeep and maintenance of these structures and – again – not where you should leave her. 
 
Each asset class – machinery, buildings, grain held over, land, livestock – has to be discussed between you, your spouse, and your son as to what happens if something happens to Dad. 
 
Without a plan, it’s likely Mom will be left in the cross-hairs between the child farming and the children not farming. As she ages, she’ll become more and more susceptible to standing up to her children and seeing your wishes through. Right now, you’ve got all the power. When you’re gone, she’s going to be outnumbered and out-gunned. 
 
Give thanks for all of the good things you’ve received in the past decade, but don’t waste these gifts by leaving it up to chance or time to resolve these issues for you. We all know, as good as we’ve had it now, it can get just as bad just as fast if we don’t plan properly. 
 
“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

Michael Baron is not an attorney. Information given through written, verbal, or electronic means by Michael Baron or Great Plains Diversified Services, Inc. is not to be construed as legal advice. An attorney, tax advisor, or other registered advisor is needed for the completion of the estate planning process. An attorney must be consulted for legal advice and the drafting of legal documents.