(Note: this article is a continuation of a several part series)
Almost all of us are familiar with the adage that there are only two certainties in life, being death and taxes. Congress has expanded upon this adage by tying death and taxes together by way of the Federal Estate Tax (FET).

Basically, the FET is a tax that is levied against a person’s estate after their death.

Worse, with a maximum tax rate of 55 percent starting in 2011, it is one of the harshest taxes on the books.

No matter what your goals are for your farming operation, reducing your FET liability is of utmost importance.

Many farms have ceased to operate or have had to sell large quantities of assets because proper planning was not performed so as to minimize the tax liability.

Like a squeaky bearing on a piece of farm machinery, ignoring it will not make it go away and failing to properly plan for the FET will be costly.

Let’s start by discussing some of the tools that are available to reduce the FET. First, there is what is called the “marital exclusion” between spouses. Simply put, at the death of the first spouse all assets held either jointly or solely can pass to the surviving spouse tax free. As such, Uncle Sam is held at bay until the death of the second spouse. The problem is that because the surviving spouse now owns all the assets, there is less flexibility to minimize the amount of taxes by way of gifting or other means. Basically, relying on the marital exclusion on delays the tax liability.

Fortunately, over the years Congress has offered what is called “Exclusion Amounts” that are not subject to the FET. I tell clients to picture the IRS giving you a briefcase each year, and saying if you die during the year, you’ll be able to stuff the briefcase with a certain amount of assets that will not be taxed. Over the past decade, these Exclusion Amounts have increased up to $3.5 million per person in 2009. For 2010 the Exclusion Amount is unlimited. However, starting next year the Exclusion Amount drops back to $1 million unless Congress changes it.

Unfortunately, the Exclusion Amount is a “use it or lose it” benefit. In order to use your briefcase, you need to set up a trust and have a certain amount of assets put into the trust.

For example, let’s say a husband and wife owns a farming operation worth $2 million. If the husband passes away, $1 million in assets can be put into his briefcase, aka his trust, so as to avoid the assets from being taxed.

The wife is able to draw the income each year generated by the trust, or dip into the assets of the trust if certain conditions warrant such. When the wife passes away she can put the other $1 million worth of assets into her briefcase, aka her trust, and shield these assets from the FET.

After that, the assets in both trusts can pass tax-free to the heirs.
In the above example, you can see that just a little planning saved $2 million dollars in assets from being taxed. Instead of the government “inheriting” part of the farming operation, the entire value of the farm was shielded from the FET. Amazingly, from an estate planning perspective taking advantage of the Exclusion Amount is easy to do. Most times, all it takes is for the husband to take sole title of a certain amount of assets and the wife to do the same. That way, the husband’s assets are solely owned by him and can be placed in his trust and the wife can do the same with her trust.

Sometimes people tell me that the FET will not affect them because their estate is too small. I kindly remind these people that 1) their assets, especially land, will appreciate over time and be worth much more in the future and 2) who knows if the Congress will always allow for the current Exclusion Amount. As such, it is still important to have your estate plan address the FET even if your estate currently may not have the level of assets to generate a tax liability.

What about those farming operations that have more assets than can be protected by the Exclusion Amounts (in excess of 2 million dollars)? We’ll address that next month.

John J. Schwarz, II, is a farmer and attorney in Steuben County, Ind. He focuses his practice on agricultural law and legal issues important to farming communities. He can be reached at 260-665-9779 or jschwarz@cresslaw.com

These articles are for general informational purposes only. If you have a specific legal question, you should consult an attorney. The views and opinions expressed in this column are those of the author and not necessarily those of Farm World.