Estate planning includes requirement for complexity
“You need good information to make good choices, particularly in estate planning. You need to understand the advantages and disadvantages of all the techniques and tools to design the plan that will meet the objective you have,” says Rock Springs attorney Galen West.
In light of the uncertainty surrounding the estate tax and the inaction of Congress to let people know either way, West says it’s important to understand how to maximize an estate.
“In the planning objectives on farms and ranches, reducing the estate tax is important. Land values tend to accrue over time, while ranching does not produce any more income. There’s a desire to pass on the ranch to heirs, particularly those who wish to continue ranching, at the lowest taxes,” says West.
“It’s difficult to talk about the estate tax in 2010, because it’s in limbo. In 2011, if Congress does not act, we’ll have a $1 million exemption on the estate tax. We don’t know if they’ll retroactively impose that tax on 2010,” explains West. “That means I can pass $1 million to whoever I want tax-free, and my spouse also has a $1 million exemption.”
However, he says those two opportunities to exempt $1 million are a use-it-or-lose-it scenario. “If I die first, and I don’t design my planning to use my exemption, that coupon is at the bottom of the garbage and there will be $1 million only. It requires proactive action to ensure you’ll double that exemption.”
“There are common planning objectives applicable to all of us, and there are specific planning objectives that apply in certain situations, including ranching,” says West. “One generally accepted definition of estate planning is to control the property while alive and well, while planning for you and your loved ones should you be mentally incapacitated and, upon death, give what you have when you want, the way you want and to whom you want.”
“Another objective of estate planning is to do all of it at the lowest possible taxes and other costs, including estate taxes, income taxes and legal and administrative fees. The planning objectives are designed to accomplish those costs as well,” he adds.
“Some techniques and tools are more effective than others, like assigning wills, but there are significant problems with each technique in meeting the estate planning definition – the control that will affect minimizing taxes and other considerations,” he comments.
West gives joint tenancy as an example. “The opportunity is created to omissions or unintended errors if circumstances don’t transpire as you assume they will – the wrong people die first, or people have disabilities. Those circumstances can create unintended tax consequences, and sometimes adverse tax consequences. While joint tenancy has a place in the planning pantheon, how it fits into what you want to accomplish has to be considered.”
“The same holds true with beneficiary designation,” continues West. “That won’t provide good asset protection for a spouse or minor, and can create omitted or unintended beneficiaries and unintended tax consequences. The control factor isn’t present, and there may be opportunity to not have things go to whom you want, when you want and how you want.”
West says wills also tend to be problematic. “You can design them for absolute control as to whom and when and how, but to meet that all your assets have to pass under the will, and be subject to probate and the fees and expenses and be public documents. There’s the loss of privacy and the third-party involvement, and that’s the price you pay for the control of a will.”
He also says a will cannot assist you if you become incapacitated. “One thing that can assist is power of attorney, but it’s difficult. Third parties often have trouble with powers of attorney, and it won’t be free of taxes.”
West offers a revocable living trust as an alternative to those planning techniques previously mentioned. “A fully funded revocable living trust is comprehensively drafted to address all these considerations,” he says. “It says who you want to receive, what and when, and the how and what protections are built in, as well as what tax savings you want to build, and all assets are transferred or payable to the trust. It can provide for disability, lifetime disability and tax savings.”
“A fully-funded living trust ensures long-term control over the assets. You set the rules of inheritance, guidelines for care and disability, and you can plan for a lot of situations,” says West. “You can plan for children with different needs, spouses and charitable contributions. It’s easily amendable and can be designed to maximize utilization of deductibles.”
“Beyond that, it’s a fully private document. The only people who have access are the beneficiaries of the trust and their advisors and the trustees,” he adds.
“A living trust can be designed so an irrevocable trust is in place for a beneficiary when they receive their inheritance, and you can provide them creditor protection,” says West. “You can plan to ensure the benefit and control, and have it on a long-term basis. Sometimes we have kids who need some self-protection with their lifestyle or habits that raise concern over proper management of their inheritance.”
For larger estates, a common technique to cover estate taxes is to create an irrevocable life insurance trust situation where insurance is acquired to pay the estate tax, says West. “The insurance is income tax-free, but it’s not estate tax-free. A portion of the insurance is subject to tax.”
Another challenge in estate planning on farms or ranches is equalized distribution, says West. “The ranch might be 70 or 80 percent of the total estate value, and how are things equalized among all the kids? Sometimes the ranch can’t take the capital debt to pay out to the other kids, and preserving liquidity or creating liquidity becomes an important planning objective in many ranch planning circumstances.”
One technique available to ag operations is a special use valuation applied to the Internal Revenue Code to appraise the ranch at ranch value, rather than at its highest and best use value. “There’s a limit on how much of a reduction in value you can get, and you have to meet some very stringent requirements on what percentage of the ranch is in the total estate, and have a qualified family member continue to ranch it for 10 years.”
Another Internal Revenue Code provision allows ranches to pay estate taxes over a 10-year period at low interest. However, West cautions many times the IRS will require a lien to allow that to occur, and if a ranch uses an operating line with a bank, that IRS lien will dam up those opportunities.
Ranch owners can also freeze the value of the ranch at its current value using lifetime gifts. “A lot of people have the ranch incorporated, and gradually the kids get a larger ownership of the ranch so the parents don’t own 100 percent at their death. The sooner that process gets started, the more opportunity there is to move the ranch away,” says West.
“People always want to strive for simplicity, but there are certain things that have a requirement for complexity,” says West of taking the time to understand and make an estate plan. “This is an area where there is some requirement to design what fits you. There’s not a one-size-fits-all solution, we’re all individuals with different circumstances in our families and different objectives. We need to meet the definition of controlling what we have, planning for incapacitation, directing what we want in and out and when, and in the process save as much as we can in taxes.”