Farm Transition Issues: Farming
Children and Non-Farming Children
Kathleen Schomer Kohorst
602 Market Street
Harlan, Iowa 51537
kate@harlannet.com
712-755-3156
What is the Value of the Legacy
Letter to your Estate Planning
Attorney?
1. Helps Define Estate Planning
Goals—what is most important to
the planner?
2. Helps us understand who are the
“players” and their roles
3. Helps us ask the right questions
and balance goals and reality.
What are the Family Goals?
Dad’s
“I have nurtured and cultivated
the farm my entire life. I want
it to continue in the hands of a
family member, even if it
means that one member gets
a benefit that the others don’t
get. He has been helping me
since he graduated from high
school.”
Mom’s
“I want my children to be
treated equally. I want there
to be peace (and happy
Thanksgiving celebrations)
together after we die.”
Federal Estate Tax : Where It’s Been
Where are We Headed?
Year
Applicable
Exclusion
Amount
Lifetime Gift
Exempt
Amount
Annual
Exclusion
Highest Estate
and Gift Tax
Rates
2008
$2 million
$1 million
$12,000
45%
2009
$3.5 million
$1 million
$13,000
45%
2010
Tax Repealed
$1 million
$13,000
35% (gift tax)
2011
$5 million*
$5 million
$13,000
35%
2012
$5.12 million
$5.12 million
$13,000
35%
2013
$5.25 million
$5.25 million
$14,000
40%
2014
$5.34 million
$5.34 million
$14,000
40%
2015
$5.43 million
$5.43 million
$14,000
40%
Land Acquisition Cost (20 Year Loan Payment)
Acres
Price/Acre
Number of
Children to buy
out
Sweat Equity
Loan to Buy Out
Other Heirs
Payment/Acre
@ 3.5% interest
Payment/Acre
@ 5.5%
Payment/ Acre
@ 7.5%
Case #1
Case #2
Case #3
Case #4
Case #5
Case # 6
100
$8,000
2
100
$8,000
4
100
$9,000
2
100
$9,000
4
100
$12,000
2
100
$12,000
4
20%
$426,667
20%
$512,000
15%
$510,000
15%
$612,000
15%
$680,000
20%
$816,000
$301.75
$362.10
$360.68
$400.76
$480.90
$577.10
$361.21
$433.46
$431.76
$479.94
$575.68
$690.82
$426.94
$512.33
$510.33
$567.03
$680.44
$816.52
Concept Originally Reported in the Iowa Farmer Today 3/16/2014 “Farm
Transition” by Steve Bohr
Are these practical and legacy
goals mutually exclusive?
The Legacy Wins!
The special son receives an outright gift of certain
parcels of land
OR
The special son can buy at a hugely discounted
purchase price
OR
The special son has an option to buy for an
indefinite period of time at a major discount.
Absolute Fairness Wins!
All the children receive equal ownership in all
the farm assets, including the land.
The farm may be divided.
The farm may be sold to an outside party.
The special son is unable to maintain any
farming operation.
How can we find the win-win solution?
Give the special son an option to farm:
All my farmland shall be divided among my
children in equal proportions, subject to the
rights of my special son to farm the real estate
either on a cash rental or crop share basis upon
terms customary in our farming community.
This option is personal to my special son as long
as he personally farms the real estate in a
sustainable manner.
Language somewhat like that
was challenged by the non-farm
heirs, and the Court found that it
was valid.
Caution regarding Article I, Section
24 of the Iowa Constitution:
20 year maximum
How can we find the win-win solution?
• Enter into a long term lease with the special
son. It can be automatically renewed each
year, or can have a fixed term.
• This also was upheld by the Courts, with the
caution that the lease renewal would expire
after 20 years.
Revocable Trusts
• We can draft revocable Trusts that take effect
at death.
– Avoids probate
• Less legal fees at death
• Private family document
– Can contain the language that either grants an
option to purchase to the special son or gives him
the right to purchase
What About An LLC?
• Put farmland into an LLC
Deed 600 Acres into an LLC
Mom gets 3000 membership interests
Dad gets 3000 membership interests
Let’s say the land is worth $9000/acre
Each membership interest is worth $900
(600 x 9000 divided by 6000=900)
How does this create fairness?
We can begin to gift farmland
interests during lifetime to all the
children. With a $14,000 per person,
both mom and dad can gift 15 shares
of the LLC to each child per year,
treating all the children equally.
How does this continue the
Legacy?
As long as the LLC provisions require
it, unanimous consent is required of
all members to dissolve and liquidate
the LLC.
Can use lease terms in the LLC.
What is this LLC?
Limited
Liability
Corporation
How is it Formed?
• File a Certificate of Organization with the Iowa
Secretary of State (a “bare bones” outline)
Only requires name of LLC and Registered agent’s name and
address.
• Prepare an Operating Agreement
Can be owned by one or more members
Akin to the Owner’s Manual of your Car. It provides all the
details in running the Organization.
This should contain either a buy/sell agreement, option to
purchase to special son or long term lease arrangement
How is it Taxed?
• A one person LLC’s income is usually reported
directly on the member’s income tax return.
• A multimember LLC is a partnership for tax
purposes so that income flows to the
members’ income tax returns and is taxed at
the members’ respective income tax rates.
Different Terminology
Members= the owners of the LLC
(shareholders)
Manager(s)= the person or persons
who run the LLC (officers)
Membership Interests= The bundle
of rights each member has (shares)
C Corporation
• An LLC is not like the old C Corporations
– Is not usually separately taxed
– Members still get a step-up in basis at death
– But like a corporation, members do not own the
land; they own membership interests in the LLC
Issues to be Resolved
Governance
Who is really going to run the
operation?
Voting Requirements
Day to day operations vs. dissolution
or sale of assets or incurring debt
.
Exit Strategies Need to be Resolved
Interest transfer restrictions:
What if a child dies? Does a spouse
or children have the automatic right
to inherit?; Rights of first refusal by
company or other members
Exit Strategies Need to be Resolved
• Purchase price and payment requirements
should be made clear. How do we decide
what a share is worth? Do we need an
appraisal?
• Do we need to buy key-man life insurance to
fund the purchase?
Possible Exit Strategies
Drag along Rights: If the majority of the owners want to
sell, can they drag along the unwilling party?
Tag along rights: If the majority owner is selling, do the
minority owners have the same rights to sell on the same
terms and conditions?
Put Rights: The owner’s right to have his units purchased by
the company upon the triggering or an event
Call rights: The company’s right to buy upon the occurrence
of a certain event
Dead lock and mandatory buy-sell provisions: Abel can
hand Broc a piece of paper with a number on it. Broc can
choose to sell at that number, or buy Abel out at that
number. (Does give advantage to the wealthier person)
Other Operating Agreement
Issues
What If Parents want to give Special Son
more Control?
-designate him as the manager of the
LLC; require unanimous consent to
remove him (need to waive manager’s
duty of loyalty to the others)
-include in the operating agreement an
option to farm
Bauer Issues
Court’s concern with oppression of the
non-farm heirs.
-limit activities of the LLC to the leasing
of the farmland.
-tie lease payment to IA State or USDA
surveys
-require unanimous consent to
purchase additional farmland or incur
debt.
Bauer Issues
• Use put options:
-Non farm heirs may elect to sell to the LLC and
the LLC shall purchase all the membership units
of the LLC then owned by non farm heirs for
cash at the purchase price to be determined
-Purchase price could provide for a discount to
the company and/or payment in installments
Bauer Issues
• Use call options
Special son may elect to purchase for cash at the
purchase price defined below all of the units of the
LLC owned by all the other members by notifying
such members in writing of his intention to exercise
his rights.
The purchase price can be defined to allow for a
discount to the Company, at no discount, or use a
pre-established formula, or an average value of
farmland by IA State or the USDA.
Other Issues
1. Special Son may have a problem
financing his operation without
land ownership, or the ability to
pledge the land as collateral.
2. Can have a provision that allows a
mortgage, but only to the extent
of a part of the special son’s total
membership interest.
Other Estate Opportunities
Special Use Valuation Still Available
(reduces farm values by up to
$1,100,000 for 2015)
-need family farmer
-land must be a significant part
of estate
-10 year farming requirement
Other Estate Opportunities
Minority Discounts
Marketability Discounts
*******************
Planning for Maximum Step Up in
Basis
*******************
Portability Between Spouses
Don’t forget!
• The importance of Powers of Attorney
Health Care
Financial
• Plan for long term health care
• Review beneficiary designations
Thanks for Your Attention!
Kate