farm transition

The Use of Windfall Gain Agreements in Farm Transition Planning

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farm transition

By: Jennifer Denchak Wetzel, Esq.

The importance of farm transition planning has become increasingly understood and accepted by the agricultural community.  The topic is regularly discussed in agricultural literature as well as through live seminars.  Yet, despite widespread awareness and adoption of the concept, there can still be a general reluctance, for a number of different reasons, to approach and tackle the issue.

Many times, the topic is ignored because it reminds the parent generation of their mortality.  The parent generation may also have a resistance to losing control and may operate under the assumption that no one could ever run the farm business as well as they have run it.  Sometimes there just is not enough of time to handle the farming obligations, let alone deal with this complex and time-consuming issue.

Another major deterrent is not knowing how to handle the “non-farm child” fairly.  In most farm transitions, the farm child receives the farm assets by gift or through a bargain sale at less than the fair market value.  This arrangement may reflect the sweat equity that has been contributed by the farm child to the farm operation over the years, as well as reflect the maximum price that can be paid by the farm child in order for the business to stay viable.  After the farm assets are transferred, few assets often remain for distribution to the non-farm child.

If your reluctance to approach this topic stems from your uncertainty regarding the treatment of the non-farm child, a possible solution is to add conditions to any transfer to the farm child requiring him/her to share a portion of the “windfall gain” that is recognized by the farm child if he/she sells or transfers all or a portion of the farm assets outside of the ordinary course of the farm business, or discontinues the farming operation, within a set period of time.  For example, for a period of ten (10) years from the date the farm child receives the farm real estate, he/she could be made to share a portion (often a higher amount initially and then decreasing over time) of the net profit he/she receives from the sale of the farm real estate with the parents and/or the non-farm child.  The time period and sharing percentage can be adjusted to fit each family’s circumstances, and parents can provide for exceptions to the windfall gain sharing requirement, such as the leasing of oil and gas rights and/or the sale of agricultural conservation easements, among others.

An agreement to share windfall gain may be part of the solution to guaranteeing fair treatment amongst your children, and may be the peace of mind needed to allow you to begin the farm transition process.

The attorneys at Mette, Evans & Woodside are available to counsel and assist you with the development of an Agreement-Sharing of Windfall Gain, as well as with all other aspects of your farm transition plan.

estate planning young families

The Importance of Estate Planning for the Younger Generation

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estate planning young families

By: Jennifer Denchak Wetzel, Esq.

A successful transition of the family operation and assets to the younger generation is a significant accomplishment, typically marked by a great deal of time and effort. Upon execution of the plan, the older parent generation is generally provided with an estate and elder law plan that, assuming no significant changes, should last for the rest of their lives. Throughout the farm transition planning process, the advisors (being an attorney, tax preparer, lender, financial advisor, etc.) normally represent the parent generation. However, if the transition is successful, the younger generation could definitely benefit from their own assistance, whether involving lending, tax planning and/or estate and business planning matters.

The typical next generation farmer is in his/her 30’s or 40’s, married, with young children, asset rich, cash poor, and in substantial debt. Although it is easy to focus on the needs of the business, of which you are now the owner, it is important to consider whether your family and business will be taken care of in the event of your untimely death. You do not want to lose what you have just worked so hard to obtain.

First, as a young parent, one of the most important things you can do to protect your children is to execute a Will that provides for a guardian in the event of your and your spouse’s deaths. For example, your closest kin may not be the best choice given his/her age, location, marital status, etc., but may be selected by a court if no one else is designated by you.

A properly drafted Will can also provide the guidelines for the preservation of the family operation for the next generation until the time when your children reach majority and can decide for themselves whether they want to continue in the family farm business. Often times this is accomplished through the use of a trust.

Finally, most farm transitions involve an installment sale to the younger generation for some or all of the farm assets. It is important to evaluate what payment alternatives would exist in the event of your untimely death. The purchase of life insurance may be essential so that your spouse and children are not saddled with this debt.

Stepped-Up Basis Considerations in Farm Transition Planning

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By: Jennifer Denchak Wetzel, Esquire

Stepped-Up Basis Considerations in Farm Training Transition Planning

“Basis” is a tax term used to describe an owner’s financial investment in a property. When that property is sold, the basis is the gauge for determining whether there is gain or loss from the sale and the resultant income tax consequences of the transaction, if any. Within most farm transition plans, farm assets are transferred to the younger generation. The method of transfer will determine the recipient’s basis in those farm assets.

Lifetime transfers of farm assets can occur through sale, gift, or a combination of the two. If the younger generation purchases the farm assets, the purchase price usually establishes the basis of the assets in the purchaser’s hands. If the older generation gifts the farm assets to the younger generation, the recipient receives a “carry-over” basis, which is the same basis that it was for the older generation. If the younger generation sells these farm assets that were acquired by gift, there could be significant gain and income tax consequences.

At-death transfers, on the other hand, provide a significant tax benefit to the recipient through what is commonly referred to as “stepped-up basis.” The recipient of inherited property receives a basis in that property equal to the fair market value at the time of the deceased owner’s death. If the recipient sells the farm assets that were acquired through an at-death transfer, there may be no gain and no income tax consequences.

To illustrate the above, consider the following: Parent owns a tract of farm real estate that was purchased for $50,000 in 1970. The farm is now valued at $1,000,000. If parent gifts the farm real estate to child during lifetime, child receives a basis in the property of $50,000. If child then sells the property, there will be $950,000 of gain subject to income taxes. If, instead, Parent dies owning the farm real estate and transferring that real estate within his/her Will to child, child now has a basis of $1,000,000. A subsequent sale for $1,000,000 will result in no income tax consequences. The savings in this example between an at-death transfer and a lifetime transfer could be over $200,000.

The concept of stepped-up basis applies not only to real estate, but also to assets such as equipment, livestock, inventories and entity interests (LLCs, partnerships, corporations). With certain assets, the new owner of the property can take advantage of the increased tax basis to obtain additional depreciation expenses thereby reducing both income and self-employment taxes.

The determination of how and when to structure a farm transition is complex and unique to each farm family. Basis consequences are just one of many factors to consider. However, if an at-death transfer is planned, or if you have just inherited property, it is important to be aware of and take advantage of the benefits of stepped-up basis, which can be significant. Stepped-up basis may also be applied to property received by a surviving spouse at the death of the first spouse to die.

Many farm families and their attorneys overlook the stepped-up basis factor in the farm transition process. Mette, Evans & Woodside attorneys are knowledgeable about the tax implications of lifetime and at-death transfers, and are able to assist you to reduce potential income tax liability and to increase tax savings.

Choice of Business Entity for Agricultural Operations

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By: Jennifer Denchak Wetzel, Esquire

Choice of Business Entity

The question of whether to form a legal entity to manage and run your agricultural operation is often a major concern for farmers. Further, the choice between a corporation (S or C), limited liability company (LLC), limited partnership (LP), general partnership (GP), trust, or “simply” a sole proprietorship can be overwhelming. Each option carries its own advantages and disadvantages with respect to liability protection, tax issues, ease of transferability, and formation/administrative requirements, among others.

Since its introduction in Pennsylvania in 1996, the LLC has become the entity of choice for many farm businesses and their tax and legal advisors, as it provides the liability protection similar to a corporation, but with the option to be taxed as a partnership/individual, rather than as a corporation. An LLC is a uniquely versatile business entity that can be taxed either as a corporation or a non-corporate taxpayer and its organizational structure can be corporate (manager-managed) or non-corporate (member-managed). An LLC is often an excellent choice for operating and transitioning a farm business to the next generation. However, LLCs may not be the best option when, for example, the business involves high indefinable risk activities or does not qualify for the family farm exemption to Pennsylvania’s capital stock tax.

Further, the choice of no entity, or operating as a sole proprietorship, should not be overlooked. In many instances, the cost and complexity of forming and operating a separate business entity, including the maintenance of separate books and filing of tax returns, can outweigh the anticipated benefits of the entity, particularly if the farm operation carries sufficient liability coverage through an umbrella insurance policy. Further, there can be unexpected negative consequences associated with forming an entity. For instance, farm assets owned by an entity, rather than outright by an individual, do not qualify for the most favorable of the 2012/2013 agricultural/business exemptions to Pennsylvania’s inheritance tax. Similarly, absent additional legislation to address this issue, a farm business can lose tens of thousands of dollars to inheritance taxes if the otherwise exempt farm assets are held by a trust rather than the individual decedent or another type of legal entity.

Mette, Evans & Woodside attorneys can work with you to evaluate your business’s need for a legal entity, to assist with the selection of the proper entity type, and to create/form the appropriate entity.

Responding to Cell Tower and Similar Lease Offers

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By: Jennifer Denchak Wetzel, Esquire

Responding to Cell Tower and Similar Lease Offers

Since agricultural land, almost by definition, is located in rural, sparsely-populated areas across the state, often in townships with loose, or even no, zoning requirements, many such landowners will be approached by a telecommunications company to lease a small portion of their land to construct a cellular tower and related equipment. Like the real estate market in general, location has a significant impact on the market rental price, with some geographic areas seeing significantly higher rental amounts. Having a proposed cellular lease negotiated and reviewed by an attorney who is familiar with these types of leases and aware of market values can be very important for ensuring fair terms and compensation for the landowner.

The standard lease presented to a landowner is written from the perspective of the cellular company tenant. It likely does not provide for the best rental payment and escalator, a signing bonus, payment of attorney fees for lease review and negotiation, and/or payment of a portion of the revenue received by the tower company for additional carriers that co-locate on the site. Further, if the property is enrolled in the Clean and Green program, the lease needs to contain language that requires the cellular company to cover any roll-back taxes attributable to the non-agricultural use of the property.

Agricultural landowners statewide have been, and continue to be, approached by telecommunications companies with leasing opportunities. In the counties bordering Philadelphia, telecommunications companies have entered into agreements with landowners to either lease space on an existing silo for placement of their antennae or to actually assist with the process and cost of constructing a silo for this purpose. In northern and central parts of the state, sites are often selected on the tops of wooded mountains. An optimal site in western Pennsylvania saw the use of a mobile temporary tower for immediate operation. No two telecommunications leases are exactly the same.

If a cellular company needs coverage in your geographic area, and if your site is preferable for any number of reasons, such as elevation, lack of other viable alternatives, preferable zoning requirements, etc., you will have a significant amount of bargaining power, and do not need to settle for the initial lease terms offered by the tower company. Since the duration of the standard cellular tower lease is approximately thirty (30) years, it is important to arrive at lease terms that will benefit the landowner into the future.

Aside from telecommunications leases, agricultural landowners are also often approached by companies to lease portions of their property for other purposes such as wind energy and solar energy. Most of the same concepts apply to the negotiation of the leases associated with these non-agricultural uses.

The attorneys at Mette, Evans and Woodside have experience representing landowners in the review and negotiation of lease agreements for all of the above-mentioned purposes, and are available to assist you in that regard.