The Mechanics of Legacy Building

Transcription

1 The Mechanics of Legacy Building Shannon Ferrell Dr. Rodney Jones J. C. Hobbs OSU Department of Agricultural Economics Professor, Agricultural Law OSU Department of Agricultural Economics Professor, Agricultural Finance OSU Department of Agricultural Economics Associate Extension Specialist Agricultural Taxation

2 The Mechanics of Legacy Building

3 Every new beginning comes from some other beginning s end

4 $1,000,000,000,000 per year

5 Fugit Tempus inreparabile fugit tempus

6 FV = PV x (1 + t i)

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9 G1 30% G2 G3 12% 3% G4

10 No estate plan Insufficient capitalization Failure to prepare next generation Source: Spafford, 2006

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12 Start, at the beginning Move consciously, consistently, and constantly Don t go it alone, and don t stop

13 Start, at the beginning

14 A B

15 Mission Statement Core Values Vision Statement

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25 7%: the words you use 93%: Tone Body language Non-verbal cues

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27 Mark 6:4 Jesus said to them, "A prophet is not without honor except in his hometown and among his own relatives and in his own household. Ferrell s corollary: You cannot regard someone as an expert if you have changed their diaper.

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32 Entitlement vs. Opportunity

33 EQUAL EQUITABLE

34 Sometimes right isn t equal, sometimes equal s not fair.

35 The value of transition planning Farm Business Value $4,750,000 Illustration courtesy Dick Wittman, Wittman Consulting Time

36 The Farm Family: Mom, Dad, Farm Kid, City Kid Everyone lives on the averages Representative Indiana farm derived from KFMA South Central and Southeast Associations Targeted $100,000 NFI as estimation of commercial farm for 1.0 FTE operator supported by family labor

37 The Farm 100% of income from crop operations 33% owned land, 67% leased land NFI: $100,000 NFI ratio: 15% Value of farm production: $660,000 Asset turnover ratio: 20% Family living: $70,000 Off-farm income: $44,165

38 The Farm Balance Sheet Assets Operating assets Breeding livestock $0 Equipment $500,000 Total operating assets $500,000 Liabilities (None) Buildings $100,000 Land $2,700,000 Owners Equity $3,300,000 Total Assets $3,300,000 Liabilities + OE $3,300,000

39 Mom Dad Farm Kid City Kid 0 12 Year Mom and Dad born Farm Kid born City Kid born Mom and Dad s Early Epiphany

40 Mom Dad Farm Kid City Kid Mom and Dad s Average Epiphany Dad dies Early +36 Average +18 Mom dies Early +41 Average +23 Farm Kid dies Mom dies +21

41 Scenario 1: Split it down the middle Undivided ½ interests to Farm Kid and City Kid Assume City Kid demands buyout A. Commercial loan B. Seller financing - AFR interest rate, 20 year note

42 Scenario 1A: Commercial Loan Results Equipment: 5 yrs. at 5.75% Real estate: 20 yrs. at 6.5% Down payment: $270,972 Annual payments: $127,375 for 5 years then $80,219

43 Scenario 1A: Commercial Loan Results With Off-Farm Income Without Off- Farm Income % 0% Deficient -$61,031 for 5 years -$13,875 for 15 years

44 Scenario 1B: Family Loan Results One loan 20 years AFR Rate: 3.05% Down payment: $270,972 Constant loan payment: $89,135

45 Scenario 1B: Family Loan Results With Off-Farm Income Without Off- Farm Income % 10% Deficient -$22,791

46 Scenario 2: Grow to equal All farm assets to Farm Kid Mom and Dad create financial asset to equal projected farm net worth A. Sinking investment fund B. Permanent coverage, second-to-die life insurance policy

47 Scenario 2A: Investment Fund Results Present asset value: $3,300,000 Projected value: $12,605,174 Investment growth rate: 4.55% 23 years Annual payment: $300,403

48 Scenario 2A: Investment Fund Results With Off-Farm Income Without Off- Farm Income 0 0 0% 0% Deficient -$234,059

49 Scenario 2B: Life Insurance Results Present asset value: $3,300,000 Projected value: $12,605, years Annual payment: $157,673

50 Scenario 2B: Life Insurance Results With Off-Farm Income Without Off- Farm Income 0 0 0% 0% Deficient -$91,329

51 Scenario 3: Estate balancing Farm operating assets and farm land placed in separate entities, respectively Farm Kid receives operating entity Farm Kid and City kid receive equal interests in land entity Farm entity pays FMV rents to land entity; entity distributes income to Farm Kid & City Kid

52 Scenario 3: Estate balancing Mom and Dad create financial asset equal to projected value of operating entity; give to City Kid A. Sinking investment fund B. Permanent coverage, secondto-die life insurance policy

53 Income distributions Farm Kid Operating Entity Land Entity Rental payments City Kid Financial Asset

54 Scenario 3A: Investment Fund Results Present asset value: $500,000 Projected value: $1,909,875 Investment growth rate: 4.55% 23 years Annual payment: $45,516

55 Scenario 3A: Investment Fund Results With Off-Farm Income Without Off- Farm Income % 17% Surplus $20,828

56 Scenario 3B: Life Insurance Results Present asset value: $500,000 Projected value: $1,909, years Annual payment: $24,139

57 Scenario 3B: Life Insurance Results With Off-Farm Income Without Off- Farm Income % 35% Surplus $42,205

58 Scenario 4: Sweat Equity recognition / discount Similar to Scenario 3 Both kids get ½ interest in land entity City Kid receives ½ value of operating entity Acknowledgement of contributions of Farm Kid to grow operating assets Implicit: Mom and Dad purchase life insurance Explicit: Mom and Dad pay Farm Kid; uses proceeds to purchase policy

59 Scenario 4: Sweat Equity recognition / discount Present asset value: $250,000 Projected value: $954, years Annual payment: $12,212

60 Scenario 4: Sweat Equity recognition / discount With Off-Farm Income Without Off- Farm Income % 39% Surplus $54,132

61 Move consciously, consistently, and constantly

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66 The Ballad of Bill and the Gator

67 Sell it Lease it Move it through entity Transfer at death

68 Sale forms Outright sale Sale with accompanying loan Installment sale Financing (or capital ) lease

69 Lease forms Financing (or capital ) lease Operating lease

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71 Year 1 Year 2 Year 3

72 How unlimited liability works

73 How joint & several liability works

74 How partnership liability works

75 How limited liability works

76 Founder On-farm heir Off-farm heir Ownership Control Participation Separate Entity Unrelated Successor

77 Transition policy landmines

78 Goldberg Farms Adam Erica Barry Beverly Murray $125K $125K $125K $125K $125K Combined limits = $625K

79 FSA s Joint Operation concept

80 Combined limits = $625K Goldberg Farms Joint Operation Adam Erica Barry Beverly Murray $125K $125K $125K $125K $125K

81 Goldberg Farms, LLC Adam Erica Barry Beverly Murray $25K $25K $25K $25K $25K Combined limit = $125k

82 Combined limit = $625k Goldberg Farms Joint Operation Adam, LLC Erica, LLC Barry, LLC Beverly, LLC Murray, LLC $125K $125K $125K $125K $125K

83 Buy/sell agreements

84 Death Debt Disability Deceit Divorce Don t wanna

85 To pre-nup or not to pre-nup

86 Management & decision-making

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89 Taxation Sole Prop. Gen. Part. Limited Part. C Corp. S Corp. LLC All to owner Based upon partnership agreement Based upon partnership agreement All to corporation Pass through to shareholders Depends upon tax filing election (disregarded entity, partnership, S corp., or C corp.) Sources: Ohio State University, A Comparison of Business Entities Virginia Cooperative Extension, Planning the Future of Your Farm National Association of Tax Professionals, Entity Comparison

90 C corporation taxation under Old: the TCJA New: 21%, period

91 Pass-through income deduction Applies to pass-through entities (partnerships, S Corps, LLCs taxed as pass-through) 20% deduction of qualified business income Say a farm S Corporation makes $150,000 in income $50,000 paid in shareholder salaries $150,000 - $50,000 = $100,000 in qualified business income $100,000 qualified business income x 20% qualified business income deduction = $20,000 reduction in taxable income

92 BobCo, Inc.

93 Allocation of income Sole Prop. Gen. Part. Limited Part. C Corp. S Corp. LLC All to owner Based upon partnership agreement Based upon partnership agreement All to corporation Based upon ownership shares on a per share / per day rule Depends upon tax filing election (disregarded entity, partnership, s corp., or c corp.) Sources: Ohio State University, A Comparison of Business Entities Virginia Cooperative Extension, Planning the Future of Your Farm National Association of Tax Professionals, Entity Comparison

94 Salary Sole Prop. Gen. Part. Limited Part. C Corp. S Corp. LLC Does not apply Distributions / guaranteed payments allowed Distributions / guaranteed payments allowed Required Required Yes if C/S Corp elected Sources: Ohio State University, A Comparison of Business Entities Virginia Cooperative Extension, Planning the Future of Your Farm National Association of Tax Professionals, Entity Comparison

95 Fringe benefits Sole Prop. Gen. Part. Limited Part. C Corp. S Corp. LLC Most are nondeductible Most are nondeductible Most are nondeductible Most ARE deductible Most are nondeductible Depends upon tax filing election (disregarded entity, partnership, S corp., or C corp.) Sources: Ohio State University, A Comparison of Business Entities Virginia Cooperative Extension, Planning the Future of Your Farm National Association of Tax Professionals, Entity Comparison

96 Who has ownership? Sole Prop. Gen. Part Limited Part. C Corp. S Corp. LLC One individual 2 or more general partners 1 or more general partners plus 1 or more limited partners 1 or more shareholders 1 or more shareholders Depends upon selection (single member or multimember) Sources: Ohio State University, A Comparison of Business Entities Virginia Cooperative Extension, Planning the Future of Your Farm National Association of Tax Professionals, Entity Comparison

97 Ease of Formation Sole Prop. Gen. Part Limited Part. C Corp. S Corp. LLC Very simple Partnership agreement Partnership agreement Articles of incorporation Articles of incorporation Operating agreement Sources: Ohio State University, A Comparison of Business Entities Virginia Cooperative Extension, Planning the Future of Your Farm National Association of Tax Professionals, Entity Comparison

98 Management Sole Prop. Gen. Part. Limited Part. C Corp. S Corp. LLC Single individual Managing partner(s) Managing general partner(s) 1 or more officers 1 or more officers 1 or more members Sources: Ohio State University, A Comparison of Business Entities Virginia Cooperative Extension, Planning the Future of Your Farm National Association of Tax Professionals, Entity Comparison

99 Directing and control Sole Prop. Gen. Part. Limited Part. C Corp. S Corp. LLC Single individual All partners All partners 1 or more officers 1 or more officers 1 or more members Sources: Ohio State University, A Comparison of Business Entities Virginia Cooperative Extension, Planning the Future of Your Farm National Association of Tax Professionals, Entity Comparison

100 Liability Sole Prop. Gen. Part. Limited Part. C Corp. S Corp. LLC Owner has unlimited liability Partners have unlimited liability General partner has unlimited liability and limited partner has limited liability Limited liability (must not pierce the veil) Limited liability (must not pierce the veil) Limited liability (must not pierce the veil) Sources: Ohio State University, A Comparison of Business Entities Virginia Cooperative Extension, Planning the Future of Your Farm National Association of Tax Professionals, Entity Comparison

101 Continuation of life Sole Prop. Gen. Part. Limited Part. C Corp. S Corp. LLC Owner's death terminates Ends upon death or withdrawal of a partner Ends upon death or withdrawal of a general partner Perpetual Perpetual Operating agreement specifies continuation Sources: Ohio State University, A Comparison of Business Entities Virginia Cooperative Extension, Planning the Future of Your Farm National Association of Tax Professionals, Entity Comparison

102 Transfer of ownership Sole Prop. Gen. Part. Limited Part. C Corp. S Corp. LLC Does not apply May be assigned but assignee cannot be a partner May be assigned but assignee cannot be a partner Stock easily transferred Stock easily transferred Operating agreement specifies transferability of an ownership interest Sources: Ohio State University, A Comparison of Business Entities Virginia Cooperative Extension, Planning the Future of Your Farm National Association of Tax Professionals, Entity Comparison

103 Fundamentals Flexibility is crucial Someone will go insane In not choosing, you have chosen

104 How does the administration of an estate work? 1. Decedent dies 2. Inventory / maintain estate 3. Handle creditors 4. Submit final inventory & accounting 5. Close probate / administration

105 The Brady scenario Property acquired after marriage Property acquired before marriage

106 Intestate succession Pros Well, uh its definitely loweffort on your part Cons Unable to select who handles your affairs (and several people may volunteer ) Unable to direct who gets your property succession rules dictate heirs No provision for those not specified by rules

107 Wills Pros Leaves control with testator until death Can direct where property goes almost anywhere Can select executor Can name guardians Does its job then goes away Cons Must go through probate Easily contested Lengthy and public process State-specific Cannot operate long-term w/o other tools

108 LIVING TRUSTS Pros Eliminates probate for assets in trust Don t need guardian to hold assets for minors Not public information Very difficult to contest Cons May have trustee fees Adds complexity to management of assets in life Requires coordination with other estate tools Still needs will

109 Controversial hot take by Ferrell Rigor mortis makes you an inflexible farm manager

110 The new estate tax landscape $11.4 million personal exemption $22.8 million combined exemption Spousal portability retained Stepped-up basis retained $15,000 / $30,000 annual gift limit Sunsets and ABCs

111 Other critical estate planning documents Guardian nomination for minor children Beneficiary designations Durable (and perhaps springing _ powers of attorney Business Healthcare Advanced directive for health care Will Trust (?) Life insurance (?)

112 Don t go it alone, and don t stop

113 Don t go it alone

114 The transition team: The Accountant

115 The transition team: The Attorney

116 The transition team: The Production Consultant

117 The transition team: The Investment Advisor

118 The transition team: The HR Advisor

119 The transition team: The Referee

120 Step 5: Deploy your plans / evaluate / revise

121 The hit by a plan

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125 For more information

126 THANKS! Dr. Shannon L. Ferrell OSU Department of Agricultural Economics