farm transition planning

Although farm transition planning often focuses on passing assets smoothly from one generation to the next, in some cases, it may be preferable to skip a generation and distribute assets to the following generation. A Generation Skipping Trust (GST) is an estate planning tool that allows a farm owner to do so. A GST is a concept applied in a trust rather than a specific type of legal instrument or document, and it can be used to designate that certain assets will transfer to the grandchildren's generation, while providing financial benefits from the trust to the children's generation during the children's lifetimes. 

Our new bulletin is part of the Planning for the Future of Your Farm series and is entitled Using Generation Skipping Trusts to Transfer Farm Assets. This bulletin explains how a GST works, examines what types of farm assets might be best for a GST, how using GST as a tool might affect your federal estate tax exemption, and how different GST provisions can be used to accomodate the needs of multiple generations of a farm family. 

Please check out our new bulletin now available on the Farm Office website, or by clicking here. 

Join experts David Marrison and Robert Moore at Ohio Maple Days for a hands-on workshop on farm transition planning. This engaging session is designed to guide farm families in making thoughtful plans for the future of their farm business. Discover how to have essential conversations about succession and explore practical strategies and tools for transferring ownership, management, and assets to the next generation.

The workshop will take place on December 6, from 10:00 a.m. to 3:00 p.m., at the Ashland University Convocation Center. Visit woodlandstewards.osu.edu for additional information. Can't attend? More farm transition workshops are scheduled in the coming months—find dates and locations under the Farm Transition section at farmoffice.osu.edu.

Second marriages present unique challenges for farm transition planning.  This is especially true when the second marriage occurs later in life and the spouses have accrued significant assets and/or have children from prior marriages.  The spouses in a second marriage obviously want to help provide for each other but may have a competing interest of providing for their children but not necessarily stepchildren.  Without good planning, it is possible that farm assets will end up with a spouse or stepchildren who were not involved in the farming operation.

One of the challenges with second marriages occurs when one or both spouses have children from a prior marriage.  The spouses usually intend to provide adequate income to the surviving spouse upon the death of the first spouse to pass away.  Also, the spouses will usually want some or all of their assets to ultimately go to their children, not their spouse’s children.  So, the issue becomes, how to establish a plan to take care of the surviving spouse while ensuring the deceased spouse’s assets go to their own children?

Consider the following example, a typical second-marriage, farm transition scenario:  

Mark and Mindy each have two children from previous marriages.  Mark has farmed his entire adult life and built a large farming operation prior to marrying Mindy.  Mindy has two children and is not involved in the farming operation.  Mark’s two children plan to take over the farming operation.  If Mark dies before Mindy, he wants to make sure Mindy has adequate income for the rest of her life.  However, he wants his assets to be inherited by his children and not Mindy’s children.

Let’s first look at what poor planning might look like.  If Mark and Mindy do not have an estate plan or a simple estate plan where everything goes to the surviving spouse then to the children, Mindy’s children could end up with some or all of Mark’s assets.  In this scenario, if Mark dies first, all of his assets will go to Mindy.  At that point, Mindy will have total control of the assets and could sell them all or leave them all to her children.  For second marriages, no plan or a simple plan is usually not adequate to meet the goals of a farm transition plan.

The better plan is to use a trust.  A trust can hold the deceased spouse’s assets for the surviving spouse’s life, thus providing income.  Then, at the surviving spouse’s death, the assets are distributed to the deceased spouse’s children.  The surviving spouse never has ownership of the deceased spouse’s trust assets, so the assets are never in danger of ending up with the surviving spouse’s children.

Continuing the previous example, Mark establishes a trust with the following terms: 

“Upon my death, my farm assets shall be held in trust for the life of Mindy.  While held in trust for Mindy, my Trustee shall distribute all income to Mindy.  Upon the death of Mindy, my Trustee shall distribute the assets to my children.”  

These trust provisions will meet Mark’s goals of providing for Mindy while having his children eventually inherit his assets.  

Sometimes we may want some assets to go directly to the deceased spouse’s children at death and some held in trust.  This is very common for farm plans.  When children will be taking over the farming operation, we may not want to tie up the operating assets in trust but instead have those go directly to the farming children.  To implement this plan, the trust may have provisions similar to the following: 

“Upon my death, my Trustee shall distribute all my farm machinery, grain, crops and other farm operating assets to my children.  The remainder of my assets, including my farmland, shall be held in trust for Mindy.  While held in trust for Mindy, my Trustee shall distribute all income to Mindy.  My Trustee shall offer to lease the farmland to my children for 80% of the county cash rent average.  Upon the death of Mindy, my Trustee shall distribute all remaining trust assets to my children.”

These trust provisions allow the farming operation to be inherited directly by Mark’s children, allowing a seamless transfer of the farming operation.  The farmland is held in trust and leased by the children.  The rental income from the farmland is provided to Mindy for the remainder of her life.

A third variation provides some assets outright to the children, some assets outright to the surviving spouse and some assets held in trust.  This type of plan might be used when the spouses wish for some assets to go directly to the surviving spouse, without being held in trust.  This is often done with cash or other financial accounts to provide immediate and freely available money to the surviving spouse.  Trust provisions reflecting this type of plan may be as follows:

“Upon my death, my Trustee shall distribute all my farm machinery, grain, crops and other farm operating assets to my children.  My Trustee shall distribute my First National Bank account and Acme Financial Account to Mindy, outright and free of trust.  The remainder of my assets, including my farmland, shall be held in trust for Mindy.  While held in trust for Mindy, my Trustee shall distribute all income to Mindy.  My Trustee shall offer to lease the farmland to my children for 80% of the county cash rent average.  Upon the death of Mindy, my Trustee shall distribute all remaining trust assets to my children.”

These trust provisions provide cash to Mindy for which she has immediate access and control.  The farm assets continue to go directly to the children so that they can continue the farming operation and the farmland is held in trust to provide income for Mindy.

In conclusion, a trust can be designed with a great deal of flexibility and creativity. The surviving spouse can be provided with adequate income while protecting the assets for the deceased spouse’s children.  A simple transition plan or no plan at all can result in some or all the deceased spouse’s assets being inherited by the surviving spouse’s children.  Trusts are often an important component of a farm transition plan for second marriage scenarios.

In Part 2, we will discuss prenuptial and postnuptial agreements.

One of the primary challenges for a retiring farmer is the large tax burden that retirement may cause.  Throughout their farming careers, farmers do a good job of managing income taxes, in part, by delaying sales and prepaying expenses.  This strategy works well while the farm is operating but can cause significant tax liability upon retirement.  The combination of a large increase in revenue from the sale of assets and little or no expenses to offset the revenue can cause a retiring farmer to be pushed into high tax brackets.  It is not unusual for 40% or more of the sale proceeds from a retirement sale to go to taxes.  One strategy to reduce income tax liability at retirement is a Charitable Remainder Trust (CRT).  A CRT can be an effective way of managing income taxes at retirement, but it is not for everyone. 

A CRT is a charitable trust because at least some of the assets in the CRT must eventually pass to a qualified U.S. charitable organization such as a church or 501(c)(3) corporation.  This charitable nature of the CRT is central to the CRT strategy.  As a charitable trust, the CRT may sell assets without paying tax on the sale.  So, instead of the retiring farmer selling assets in their own name, they donate the assets to the CRT and then the CRT sells the assets.  The retiring farmer then receives an income stream from the CRT.  After a period of time, the income stream stops and the remaining trust assets are contributed to the named charity.  The following are the steps of the CRT strategy:

1. Assemble a team of advisors and develop a CRT strategy.
2. Donor establishes a CRT.  The trust document declares the income beneficiaries and the charitable beneficiaries. 
3. Donor determines the assets to be contributed to the CRT.
4. Donor contributes assets into the CRT, typically grain, machinery and/or livestock.
5. The CRT sells the assets but does not pay tax.
6. The Trustee of the CRT uses the sale proceeds to establish an annuity.  The annuity must be designed to provide at least 10% of the sale proceeds to the charity.
7. The annuity pays out to the Donor over a number of years.  The Donor pays income tax on the annuity distributions.
8. When the trust is terminated, the charity is paid the remaining assets.

Consider the following example to help further explain how a CRT strategy works:

Farmer decides to retire at the end of the 2023 crop year.  After harvesting the 2023 crop, Farmer owns $1 million of grain and $1.5 million of farm equipment.  Farmer’s accountant tells him that if he sells all the grain and machinery in one year, he will pay around $1 million in taxes. Farmer decides to implement the CRT strategy.  He establishes a CRT and names himself and his spouse as the income beneficiaries and the local children’s hospital as the charitable beneficiary.  Farmer transfers his grain and machinery into the CRT.  The CRT sells the grain and machinery and receives $2.5 million in sale proceeds. 

The CRT establishes an annuity that will pay out $125,000 for the next 20 years.  Farmer pays income tax on each $125,000 payment which results in $20,000 of annual income taxes.  After 20 years, the trust is terminated, and the children’s hospital receives the remaining funds in the CRT.  

As the example shows, the strategy avoids a large, up-front tax payment in the year of the asset sale.  Farmer pays taxes on each annual $125,000 payment which allows him to stay in a lower tax bracket.  In the example, instead of paying $1 million in taxes in 2023, Farmer spreads the payments out and ultimately pays $400,000 over 20 years.

The primary disadvantage of a CRT is that it is an irrevocable trust.  Once the CRT is set into motion, it cannot generally be undone.  A CRT may not be the best option for farmers who wish to keep flexibility with managing their assets or who are transitioning the farming operation to family members.  While a CRT provides many tax and business benefits, it is not an adaptable plan that can be changed in the future.

Another disadvantage of a CRT is the cost.  It is usually a rather complicated process to establish the trust, calculate the potential tax savings, file a tax return, and establish an annuity.  Legal and other professional fees will often be tens of thousands of dollars. It is important early in the planning process to weigh the potential tax savings against the cost of establishing the CRT.

For more information on CRTs, see the newly published bulletin Charitable Remainder Trusts as a Retirement Strategy for Farmers available at farmoffice.osu.edu.  This bulleting provides details on how a CRT strategy is implemented and its advantages and disadvantages.  Be sure to consult with an attorney, tax advisor and financial advisor before deciding on a CRT for your retirement strategy.