Good Fruit Grower / February-1st 2009 / Exit ­strategies

 Email  Print  Feed

Exit ­strategies

Treating children equally instead of equitably in farm transfers is a mistake, says an accountant.

Transitioning small businesses, including farming operations, to the next generation is not easy. Most small businesses fail in the profitability and successful transfer to the next generation, says an accountant and financial planner.

Less than 15 percent of all small business owners succeed in passing the business to the next generation, said accountant-attorney Dominic Zamora. One of the biggest reasons for their failure is that there are no deadlines. "Nobody says that you must do this by April 15 on your 70th year. Nothing is pressing or pushing you."

Zamora, a former auditor and attorney for the U.S. Internal Revenue Service, is now a member of the LeMaster Daniels accounting firm in Spokane, Washington. His unique experience provides farmers with interesting insights about retirement and exit strategies.

American agriculture has been called an "aging industry" due to the graying of American farmers. The average age of farmers has increased to 54.3 years, meaning the majority of growers are nearing retirement.

"The number-one fear of those thinking about or in retirement is 'will I outlive my money,'" he said to growers attending statewide juice and wine grape talks last November. That's a gigantic fear for most people, especially for those who retired in October 2007 when the stock market was at a high and have just watched their portfolio drop by 40 percent.

Time spent

Retirement income is as unique as the individual. Zamora said he is frequently asked how much money is needed for retirement income. Is $1 million in assets enough? Is $2 million enough? "It all depends on what will you be spending your money on and how you will be spending your time," he said. "It's not the money you have, but how you spend your time and what you do with it that dictates how much you need."

Retirement is also affected by how long you live. In the 1930s, life expectancy for men was 49 years, for women, 52 years. Few lived long enough to see their Social Security and Medicare days, he said. American males born in 2000 are expected to live 79 years, and females 84 years, he said. New data moves life expectancy to 90 years. "If I retire at 65 years, I'll be alive for another 25 years—that's 25 years of not working or being compensated and having to rely on what I acquired," he said.

Spending rates

Those retiring soon must think about spending rate formulas and projections to calculate how long their retirement assets can last. For example, spending 5 percent annually of $1 million in assets that are invested in diversified stocks and funds would provide $50,000 annually—about $4,360 monthly. Based on spending rate formulae, the 5 percent scenario has an 80 percent chance that the structured assets would last for 30 years and a 60 percent chance the portfolio would continue to grow and something would be left to pass on.

But a spending rate of 7 to 8 percent gives only a 50 percent chance that the money will last 30 years and only a 30 percent chance that anything will be left, he said. "If you go down to a 3 percent spending rate or $30,000 per year, the money never runs out."

Accountants can help growers and business owners evaluate the various financial impacts (tax cost) of transferring their business and examine options to lower the value of an estate. In 2009, individuals can give up to $13,000 annually without any requirements to disclose the gift to anybody, including the IRS, he said. Over a lifetime, individuals can gift $1 million.

Asset transfer

"If you give away $1 million, that's zero taxes you pay compared to selling the asset, which may mean a 15 percent capital gains tax," Zamora explained, adding that growers must discuss with their accountant the different tax rates associated with different means of transferring assets.

"If you die, and the value of your estate exceeds the maximum allowed, your estate is charged 45 percent," he reports. "There are a lot of different ways you can sell your stuff to save in the taxes paid. Capital gains taxes are 15 percent, while ordinary income tax rates are 28 percent. You could save 13 percent—keep 13 cents more of every dollar that otherwise goes to Uncle Sam—if some of your assets are converted to long-term capital gains."

Whatever strategy is used to transfer assets, growers will have to determine if the cash flow from the sale will generate enough to support their retirement spending. Cash flow is not the same as retirement income.

Zamora said that many growers don't plan for the transfer of assets while they are alive because they don't want to give up control.

"When you think about the transfer of a small business, the biggest thing that people have to get over—once they understand the tax and the finance piece—is the philosophical piece of relinquishing control," he said. Ironically, federal and state governments allow the past owner to be involved in decision making.

Equal or equitable?

Zamora said business transfers to the next generation fail not only because of nebulous retirement deadlines, but they also fail because of how siblings involved in the transfer are treated.

"Whether you keep the farm, sell it to a competitor, or transfer it to Junior, the biggest question that most people can't get past is what about their children who live in Manhattan, San Francisco, or Phoenix, and are doing fine on their own or maybe not, and yet expect a return on this farm," he said.

In the last 30 wills and estate plans he has been associated with, Zamora notes that only three treated siblings equitably, instead of equally.

Equal versus equitable is a philosophical question that each family must answer. There is no perfect answer, but he suggests that parents treat their children in an equitable financial manner. "Equal only spells additional questions, issues, and confrontations down the way. The kids staying on the farm are the ones that are taking all the risks. Profits should reflect the labor of those involved and not be shared with siblings."

For additional information, Zamora recommends that growers visit the Web site www.dinkytown.net, which offers free financial calculators for retirement planning.