A wave of retirements could be flooding over farm country this season. But right after savoring a career well spent, seniors could be shocked with a tax bill that could claim 50% or more of their equipment values and commodity inventories.
Exiting agriculture without a plan can be the largest tax event in a farmer’s career — even more than many would owe in estate taxes, cautioned Paul Neiffer, a CPA and tax principal with the accounting firm of CliftonLarsonAllen LLP in Yakima, Washington.
“If someone wants to quit out of the blue and hasn’t been working with a tax adviser, their normal reaction is to have a deer-in-the-headlights kind of look. Then they ask what is the pain threshold for some alternatives,” said Neiffer. He expects a flurry of retirements this season now that low commodity prices are taking the fun out of farming.
Take Dan, a real Montana wheat grower in his mid-60s who asked us not to use his real name but plans to call it quits after this season. He’s been partnering with a younger farmer for several years to transition operations and will continue to rent the operator his land. However, if Dan sold the $2 million of farm equipment he’s accumulated outright, he’d owe more than $1 million in income taxes from depreciation recapture. That doesn’t count his tax exposure for his last crop, which will have few deductions and also would push his income into tax-bracket stratosphere.
“It’s quite a shock to write that kind of seven-figure check,” he told DTN. “Farmers are averse to paying income taxes, but sooner or later it comes back to get you.”
Serial use of Sec. 179 accelerated depreciation between 2008-2014 compounds problems for some would-be retirees, Neiffer said.
Back in 2007, small businesses could expense $125,000 of equipment purchases annually. In the midst of the recession in 2008, Congress lifted that cap to $250,000 and upped the ante to $500,000 for 2010-2014. (Although it has reverted to $25,000 this tax year, a tax-extender bill in Congress still could restore those higher limits to $500,000 before year-end). During that period of generous depreciation, however, many growers offset their unusually large farm incomes by loading up on farm equipment. In effect, they just postponed their tax judgments.
“Unfortunately, tax laws are harsh on machinery sales. Any sale, even for no down payment and over installment terms, results in full depreciation recapture at ordinary rates, not capital gains rates,” Neiffer said. That means a seller must incur the entire income tax in the year of sale, even if a buyer was stretching out repayment over a number of years.
The tax shock for retirees has become a selling point for expansion-minded farmers like Mark Wachtman, M and D Farms, of Napoleon, Ohio.
“I just call myself a ‘service provider,’ because with a little time and planning, I can help reduce a retiree’s tax burden,” said Wachtman. When a local farmer recently offered to rent Wachtman his farm next year, Wachtman offered to arrange an equipment lease as part of the package.
A short-term lease, rewritten every year or two, will reflect the diminishing value of the equipment. After five or seven years, the retiree can execute a sale without severe tax consequences. Meanwhile, it gives Wachtman a chance to expand his operation without scrambling for more equipment. “I’m willing to work with him to unwind his tax liability,” Wachtman said.
Neiffer recommends a separate option agreement, giving the buyer the right to buy the equipment from the owners’ estates. Also, if the buyer needs to replace equipment, he can purchase it from the seller and use it for a trade-in.
Another increasingly popular alternative is to establish a charitable remainder annuity trust (CRAT) for farm equipment and a grower’s last year’s crop or raised livestock. In this situation, the farmer transfers ownership of the machinery and crop to a trust prior to sale. The items are sold tax-free, providing an annuity to the farmer over a period of years (from three to 20), with a 10% residual designated to go to a charity of the giver’s choice. The farmer can name himself trustee so he can control how the funds are invested for the life of the trust.
Neiffer uses this example: A Minnesotan without a plan and who was left with $1 million in grain inventory and $1 million in farm equipment at retirement would owe $1.022 million in federal, state and social security taxes his last year farming. Using a CRAT would cut that tax burden by more than $400,000 and benefit charities of the giver’s choice at the same time.
In this case, the grower would still owe more than $600,000 in taxes, but the burden would be spread over many years and he would be using some of that tax savings to reward worthy charities at the end of the trust’s life.
Dan, the Montana farmer, saw merit in gifting. His CRAT named the Yellowstone Foundation as his trust’s beneficiary. He wants to support a program that pays for troubled urban youths to take vacations in the national park. More frequently, farmers choose to donate to their churches, universities, humane societies, or the Salvation Army, Neiffer said.
CRATs aren’t hard to establish and are relatively inexpensive, but retirees do need legal and tax counseling to work out details.
“Farmers have a genetic chip that seems to tell them, ‘thou shalt not pay taxes’ throughout their careers,” Neiffer said. “But they need to monitor their tax liabilities. It’s one thing if it’s a $100,000 problem, but it’s a whole other issue if it’s a $1 million or more problem.”