When You Die, Your Crops Don’t Have To


Dad and Mom own 640 acres. They have 4 adult children, one of whom farms with Dad, three have successful off-farm careers. Assume the farm is worth $15,000/acre. In this article I will explore three reasons why putting this farm in a family farm limited liability company is a good idea.

OVERVIEW

The logical place to start this analysis is with a broad overview of how a limited liability company works.

A limited liability company:

  • Is an entity which for tax purposes is either ignored (if it has only one owner) or treated as a partnership (if it has more than one owner)[1]; and
  • For operating/legal purposes is just like a corporation[2]:

o Members of a limited liability company are just like shareholders of a corporation-they own the company and elect the managers of the limited liability company

o Managers of a limited liability company are just like directors of a corporation- they make the strategic decisions and appoint the officers of the limited liability company

o Officers of a limited liability company function exactly like officers of a corporation-they make operating decisions.

o The operating agreement of a limited liability company is substantially similar to bylaws of a corporation- it stipulates the ruleswhich govern operations.

Manager(s) and officer(s) of a limited liability company do not have to be a member of the limited liability company, nor must they be a resident of the State of Iowa.

Unlike other types of businesses which are formed as limited liability companies, if the limited liability company owns a farm, all MEMBERS must be of the same family.[3]

REASON WHY PUTTING THE FARM IN A FAMILY LIMITED LIABILITY COMPANY IS A GOOD IDEA

REASON #1-It facilitates lifetime transfers (either by sale or gift) without relinquishing control and/or income for Dad and Mom

Dad and Mom can be the majority (or sole) owners of the limited liability company. As such they can elect themselves as managers, and appoint themselves as officers. In organizing the limited liability company, Dad and Mom can adopt an operating agreement which provides that they cannot be removed as managers/officers (unless they resign; become disabled; act oppressively to minority owners; or act contrary to the best interests of the limited liability company) without a super-majority vote. This provision could insure that Dad and Mom stay in control.

In exercising their authority as manager(s)/officer(s) they could establish a compensation system (it would have to be reasonable) which would allow them to retain an income from the farm or if the farm is sold, from the income from the other assets.

After the operating agreement solidifies their operational authority, and their right to compensation, Mom and Dad can:

  • Make gifts to their children of limited liability company units (shares)
  • Sell the farm, and replace it with other types of assets (like cash, bonds, or financial instruments)

without giving up control of the company or their rights to compensation.

REASON #2-It can reduce estate taxes.

Currently, estates with assets up to $5,340,000 which are not given to a surviving spouse, are exempt from Federal Estate taxes[4]. Any part of the unused exemption can be added to, and used by, the surviving spouse’s estate[5].

Assuming Dad and Mom have a large estate in addition to the farm, Dad and Mom can make gifts of the limited liability company, which removes the gifted units from their estate. Moreover, the gifting can be turbo chargedby use of valuation discounts. The way gifting gets turbo charged by valuation discounts is as follows:

Assuming the company has 10,000 units and is worth $9,600,000 (640 acres @ $15,000), although upon liquidation each unit gets allocated $960, for gift tax purposes the “value” of each unit is significantly less since a minority share of a company which has no ready market is worth less than its full liquidation value. The IRS commonly allows discounts for minority interest, and discounts for marketability between 20% and 40%. Assuming a 30% discount, a gift of 10% of the company (1,000 units) reduces the value of Dad & Mom’s estate by $960,000 (1,000 units x $960/unit) but for tax purposes is considered a gift of only $672,000 (960 units x 1000 units less 30%). Accordingly, the gift of membership units allows an additional reduction of the estate by $288,000 ($960,000 – $672,000).

REASON #3– It can promote family harmony

Off-farm beneficiaries often have disagreements with the farming beneficiary as to how the farm should be run. In a limited liability company the manager(s) make operating decisions. If the on-farm child becomes the manager (after Dad & Mom) he/she can manage the farm in the best interests of the entire family, which avoids indecision and allows for problem resolution. It is important to note that this right to make managerial decisions does NOT extend to making decisions which are unfair to the other family members[6].

Each beneficiary has their own financial situation. If the farm is in a limited liability company, one family member can simply sell their units to another member, thereby keeping the farm in the family. This is best accomplished through a buy/sell agreement established while Dad and Mom are still living and majority owners. If the farm is given outright to the family members, and there is a disagreement on the value of the beneficiary’s interest, the disappointed beneficiary could cause the farm to be partitioned which could result in the farm passing outside the family even though there is still a family member who wants to farm.

For more information, or for assistance in forming a family farm limited company, please contact us at 515-727-0900 or info@kreamerlaw.com.


[1] Internal Revenue Code Reg. §301.7701-1 through 301.7701-3

[2] Iowa Code§489 and §490

[3] Iowa Code Section 9H

[4] Internal Revenue Code §2014

[5] Internal revenue Code §2010(c)(2)(5)(A)

[6] Baur v. Baur Farms, Inc. 832 NW2d 663 (Iowa 2013)


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