The Mechanics of Legacy Buildingtepap.tamu.edu/wp-content/uploads/2020/01/Ferrell-online.pdf• Farm...
Transcript of The Mechanics of Legacy Buildingtepap.tamu.edu/wp-content/uploads/2020/01/Ferrell-online.pdf• Farm...
The Mechanics of Legacy Building
Shannon Ferrell Dr. Rodney Jones J. C. Hobbs
OSU Department of Agricultural EconomicsProfessor, Agricultural Law
OSU Department of Agricultural EconomicsProfessor, Agricultural Finance
OSU Department of Agricultural EconomicsAssociate Extension SpecialistAgricultural Taxation
The Mechanics of Legacy Building
$1,000,000,000,000 per year
Tempus fugitFugit inreparabile tempus
FV = PV x (1 + i)t
G1
G2
G3
G4
30%12%
3%
No estate plan
Insufficient capitalization
Failure to prepare next generation
Source: Spafford, 2006
Start, at the beginning
Move consciously, consistently, and constantly
Don’t go it alone, and don’t stop
Start, at the beginning
• B
• A
Mission Statement
Vision StatementCore Values
7%: the words you use
93%:
Tone
Body language
Non-verbal cues
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.
Entitlement
Opportunityvs.
EQUAL
EQUITABLE≠
The Farm
• Family: Mom, Dad, Farm Kid, City KidEveryone 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
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
The Farm Balance Sheet
Assets Liabilities“Operating” assets (None)
Breeding livestock $0
Equipment $500,000
Total “operating” assets $500,000
Buildings $100,000
Land $2,700,000 Owners’ Equity $3,300,000
Total Assets $3,300,000 Liabilities + OE $3,300,000
Mom
Dad
Farm Kid
City Kid
Mom and Dad bornYear
0
Farm Kid bornCity Kid born
Mom and Dad’s
“Early Epiphany”
26
0
26
26
28
28
2
28
40
40
14
12
40
0
Mom
Dad
Farm Kid
City Kid
Mom and Dad’s“Average Epiphany”
58
Dad dies“Early” +36“Average”+18
Mom dies“Early” +41“Average” +23
Farm Kid diesMom dies +21
76
50
76
76
81
55
81
76
74
102
53
58
58
32
30 48
From calculatin’ to simulatin’
• Each strategy is imposed on model farm and simulated 500 times.
• Each time a strategy violates a criteria, that simulation is deemed a failure.
• Farm asset ratio ≥ 60%
• ≥ 3 consecutive years when operating loan is not cleared
• Only for Strategy 5, if the cash reserves of Mom and Dad ever fall to or below 0
• The total number of successful (i.e. “non-failure”) simulations divided by the total number of simulations gives the probability of success.
Simulated strategies
• Strategy 1: “Split Down the Middle”• Farm Kid and City Kid receive undivided ½ interest in all
assets
• Farm Kid must buy out City Kid
• Strategy 2: “Grow to Equal”• Ma and Pa give all Farm Assets to Farm Kid
• Ma and Pa create financial asset of equal value and give to City Kid
What’ll it cost, man?! What’ll it cost?!
Strategy Who pays Annual expense1a Farm Kid $172,518; $86,8071b Farm Kid $89,1352a Ma & Pa $104,6422b Ma & Pa $64,5033a Ma & Pa $28,8173b Ma & Pa $17,7644a Ma & Pa $14,4094b Ma & Pa $8,882
Remember, annual NFI = $100,000
ResultsTable 2. Alternative Strategies’ Probability of Success Strategy D/A Ratio < 0.60 Op. Debt < 3 years No Op. Debt Cash Reserves >0 1(a) 1% 0% 0% N/A 1(b) 100% 4% 0% N/A 2(a) 100% 0% 0% N/A 2(b) 100% 1% 1% N/A 3(a) 100% 96% 89% N/A 3(b) 100% 100% 97% N/A 4(a) 100% 100% 97% N/A 4(b) 100% 100% 99% N/A 5 100% N/A N/A 99%
1 Corinthians 12:31b
And I show to you a still more excellent way.
Farm Kid City KidOperating Entity
Land EntityFinancial Asset
Rental payments
Income distributions
Simulated strategies
• Strategy 3: “Estate Balancing”• Land placed in separate entity with equal interests given
to both kids
• Farm Kid given operating assets; City Kid given financial asset of equal value
• Strategy 4: “Sweat Equity Recognition/Discount”• Same as Strategy 3 except City Kid receives financial
asset equal to ½ value of operating assets
And now, I show you an even more excellent way
Strategy 5: “Lifetime Farm Business Transfer”
• Farm operating assets and farm land are placed in separate entities, respectively
• Farm Heir receives annual salary of $42,000
• Farm Heir purchases shares of the operating entity each year
• Farm Heir receives a larger portion of farm income as well as farm debt with each additional share
• In years when Farm Heir has insufficient funds to purchase a full share, Ma and Pa gift the difference
• At the end of the transfer, Farm Heir and Off-Farm Heir receive equal interests in land entity
• Operating entity pays FMV rents to land entity
• Entity distributes income to Farm Heir and Off-Farm Heir
• Any excess funds would then be split between Farm Heir and Off-Farm Heir
• Net any gifts Farm Heir received to help fund this transition
Strategy 5: “Lifetime Farm Business Transfer”
• Operating entity value: $908,784
• Planning horizon: 20 years
• Annual purchase: 5%
• Annual entity payment from Farm Heir: $45,439
• Annual gift to Farm Heir: Variable ($45,439-Entity payment)
Strategy 5: “Lifetime Farm Business Transfer”
ResultsTable 2. Alternative Strategies’ Probability of Success Strategy D/A Ratio < 0.60 Op. Debt < 3 years No Op. Debt Cash Reserves >0 1(a) 1% 0% 0% N/A 1(b) 100% 4% 0% N/A 2(a) 100% 0% 0% N/A 2(b) 100% 1% 1% N/A 3(a) 100% 96% 89% N/A 3(b) 100% 100% 97% N/A 4(a) 100% 100% 97% N/A 4(b) 100% 100% 99% N/A 5 100% N/A N/A 99%
What’ll it cost, man?! What’ll it cost?!
Strategy Who pays Annual expense1a Farm Kid $172,518; $86,8071b Farm Kid $89,1352a Ma & Pa $104,6422b Ma & Pa $64,5033a Ma & Pa $28,8173b Ma & Pa $17,7644a Ma & Pa $14,4094b Ma & Pa $8,882
Remember, annual NFI = $100,000
1%4%
0% 1%
96%
100% 100% 100% 99%
0%
20%
40%
60%
80%
100%
1a 1b 2a 2b 3a 3b 4a 4b 5
Pro
babi
lity
of s
ucce
ss (
all c
rite
ria
sati
sfie
d)
Transition strategy
The value of transition planning
Time
Farm
Bus
ines
s V
alue
Illustration courtesy Dick Wittman, Wittman Consulting
$4,750,000
Move consciously, consistently, and constantly
93 98
71
37
93 98
71
37
94 99
69
43
The Ballad of Bill and the Gator
Sell it
Lease it
Move it through entity
Transfer at death
Sale forms
Outright sale
Sale with accompanying loan
Installment sale
Financing (or “capital”) “lease”
Lease forms
Financing (or “capital”) “lease”
Operating lease
Year 1 Year 2 Year 3
How unlimited liability works
How joint & several liability works
How partnership liability works
How limited liability works
FounderOn-farm heir
Off-farm heir
Unrelated Successor
OwnershipControl
Participation
Separate Entity
Buy/sell agreements
Death
Disability
Divorce
Debt
Deceit
Don’t wanna
To pre-nup or not to pre-nup
Management & decision-making
Taxation
Sole Prop. Gen. Part. Limited Part. C Corp. S Corp. LLC
All to ownerBased 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”
C corporation taxation under the TCJA
Old:
New: 21%, period
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
BobCo,Inc.
Allocation of income
Sole Prop. Gen. Part. Limited Part. C Corp. S Corp. LLC
All to ownerBased 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”
Salary
Sole Prop. Gen. Part. Limited Part. C Corp. S Corp. LLC
Does not apply
Distributions/ guaranteed
payments allowed
Distributions / guaranteed
payments allowed
Required RequiredYes if C/S
Corpelected
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”
Fringe benefits
Sole Prop. Gen. Part. Limited Part. C Corp. S Corp. LLC
Most are non-deductible
Most are non-deductible
Most are non-deductible
Most ARE deductible
Most are non-deductible
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”
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 share-holders
1 or more share-holders
Depends upon selection (single member or multi-
member)
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”
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”
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”
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”
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”
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”
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”
Fundamentals
Flexibility is crucial
Someone will go insane
In not choosing, you have chosen
How does the administration of an estate work?
1. Decedent dies2. Inventory / maintain estate3. Handle creditors4. Submit final inventory & accounting5. Close probate / administration
Property acquired after marriage
Property acquired before marriage
The Brady scenario
Intestate succession
Pros Cons
Well, uh… its definitely low-effort up front
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
Wills
Pros ConsLeaves control with testator until death
Must go through probate
Can direct where property goes – almost anywhere
Easily contested
Can select executor Lengthy and public process
Can name guardians State-specificDoes its job then goes away
Cannot operate “long-term” w/o other tools
LIVING TRUSTS
Pros ConsEliminates probate for assets in trust
May have trustee fees
Don’t need guardian to hold assets for minors
Adds complexity to management of assets in life
Not public information Requires coordination with other estate tools
Very difficult to contest Still needs will
Controversial “hot take” by Ferrell
Rigor mortis makes you
an inflexible manager
The new estate tax landscape
$11.58 million personal exemption
$23.16 million combined exemption
Spousal portability retained
Stepped-up basis retained
$15,000 / $30,000 annual gift limit
Sunsets and ABCs
Source: Duft, 2017
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 (?)
Don’t go it alone, and don’t stop
Don’t go it alone
The transition team:The Accountant
The transition team:The Attorney
The transition team:The Production Consultant
The transition team:The Investment Advisor
The transition team:The HR Advisor
The transition team:The Referee
Step 5:Deploy your plans / evaluate / revise
The “hit by a ____________” plan
For more information
http://agecon.okstate.edu/farmtransitions