Taxes! This is usually the first question that comes up for families considering giving their farm away to the next generation. One fact that sometimes surprises customers is that Oregon and Washington don’t have gift taxes. For this reason, the taxes that are of concern with lifetime gifting are federal gift tax and, if the children ever sold the farm, capital gains tax.
Let’s look at every tax from the perspective of a family business. Currently, most private individuals can give away a large part or all of their business assets to their children without a gift tax. The state gift tax exemption is currently $ 11.7 million per person. Because of this, a married couple can give a child a $ 23.4 million farmhouse and there is no gift tax from either parent or child. Little do many people realize that there is this lifetime gift waiver on top of the $ 15,000 per year allowed as an annual exclusion gift.
On the investment income side, the children who receive the company shares also receive the income tax base of their parents in the company. Should the children ever sell the farm, they will pay capital gains tax on the difference between the sale price and their parents’ income tax base. If the holding is inherited at death, inheritance tax can be paid, but the holding is given a new income tax base at market value at the time of death.
Most parents who give presents do not care about this basic income tax risk for several reasons.
First, they don’t want their children to sell the farm. The aim is to create an inheritance by keeping the farm in the family. If a child sells the farm against the will of the parents, the child bears the tax consequences at this point in time.
A second reason is the recent proposals on inheritance tax and capital gains tax. The maximum amount that can be passed on tax-free through gifts and inheritance should decrease in the next few years. The current regime allows the income tax base to be “topped up” to the fair market value for assets in a person’s estate upon death.
A few weeks ago, the Biden government proposed new capital gains tax rules that would trigger a capital gains tax in the event of death on profits over $ 1 million. There is also a proposal to raise top tax rates on capital gains.
Not much is known yet about whether such a change will go through the legislature or whether there would be an exception for family businesses. If this is not the case, the administration can again propose a reduction in inheritance and gift taxes. What we do know is that future tax law is unknown. This requires people to decide for themselves whether they believe taxes will go up or down in the future.
We also know that the current inheritance and gift tax exemption is one of the cheapest exemptions we’ve ever had, so many people schedule their gifts while the exemption is cheap.
Once you’ve decided on a gift, the next question is who to give it to. This often involves a decision between creating a trust for the benefit of your spouse or donating it to your children. A trust is an arrangement between the person who creates it (the donor) and the person who manages it (the trustee) to hold assets (like a farm) on behalf of someone (the beneficiary).
Some spouses choose to donate to an irrevocable trust called a Spousal Limited Access Trust (“SLAT”). This trust has many requirements, but in essence one spouse can gift an asset such as property or a business interest to an irrevocable trust for the benefit of the other spouse for life. If the trust is set up correctly, the assets will be kept out of the estate upon the death of both spouses and the trust can be passed on to the children without inheritance tax after the death of both spouses.
Many customers decide to pass the farm on to the next generation. If that is the goal, then what is the best way to do it? One possibility is a direct gift. A gift can also be made to a trust fund that has some controls over how the property can be used.
After all, how much to give away? People often opt for a partial interest gift rather than giving away an entire property or company. This can be a minority stake in the property or company so that the parent company can continue to hold the majority stake. Before donating, parents must ensure that they have sufficient funds to continue their own lifestyle. Gifts to children should only be assets that a parent does not need.
When giving the farm as a gift, it’s not just about the numbers, but also about the people involved. It takes evaluating personal goals and values to determine if the time is right.
Maria C. Schmidlkofer is a lawyer for estate planning, taxes and agricultural succession in the Schwabe industrial group raw materials. She can either be contacted at [email protected] or 503-540-4265. This article is a brief summary of the tax implications of gifting a family business and does not constitute legal advice. You should seek legal advice for legal advice that is tailored to your situation.