The Importance of Estate Planning
More than 50 percent of Washington farm owners are over 60 years old, according to data from the agricultural census. As this large proportion of farmers plan to retire, there will be thousands of farm transfers occurring in Washington State. For orchards and vineyards, estate planning is critical because of their high capital investment and production risks. The key components of farm estate planning are to ensure that your assets provide the necessary resources upon which to live, are transferred according to your wishes, and estate taxes and court costs are minimized.
Most farm businesses have reinvested farm profits back into the business for maintenance, expansion, and reestablishing orchards. Retiring farmers have built up large capital asset holdings but typically lack liquid investments that match retirement cash flow needs. Most farmers' retirements are funded by maintaining a share of farm proceeds until the death of both the farmer and their spouse. When farm profit funds retirement, it becomes absolutely essential to have a complete set of financial statements—balance sheet, income statement, statement of cash flow, and the owner equity statement. These statements provide the foundation for both financial and estate planning, and may eliminate some of the financial uncertainty and its associated stress in the estate planning and transfer process.
The income statement reports profitability and needs to be evaluated in coordination with the statement of cash flow. The income statement does not include debt principal payments that may alter net cash available to support the inheriting and retiring farm families.
After determining available retirement income, the next step is determining cash needs by budgeting living and health care expense. This is not easy, because the timing and extent of health-care expenses are largely unpredictable but highly likely to occur. Health care and insurance expenses will continue to increase due to health care economics. Long-term disability needs should be planned for by either self insuring through the farm's financial capacity or through purchasing disability insurance. Two things are certain to occur in retirement—death or disability. Since you never know which one will come first, it is necessary to plan for both. Disability is an expense that you hope to never incur, but like heath insurance, being uninsured could be financially devastating. Health and long-term care providers can exercise liens against the estate to collect incurred expenses, and they have ethical and legal responsibilities to provide standards of care that result in billable expenses. Farmers typically hold large capital assets. Shielding these assets from unplanned health-care expenses requires a long-term estate planning strategy.
The balance sheet and owner equity statement provides information to help develop an asset distribution plan. Increasingly common in agricultural financial statements are balance sheets that list both the cost basis and market value of the assets. If needed, the asset market value should be determined by an appraiser. The cost basis is important to recipients of farmer gifts, because gifts are recorded on the recipient's balance sheet at the asset's cost basis. This could have important capital gains tax implications for gift recipients.
At this point, farmers need to make tough decisions concerning equitable treatment among siblings. For many farms, it is unlikely that the orchard or vineyard has the financial capacity to support all offspring. Orchards and vineyards face the same general economic pressures forcing farms to increase in size to gain economies of scale. Consider also, where one sibling is the farm manager with his/her inheritance and is a tenant farmer to his/her siblings—potentially in perpetuity if the estate plan lacks a sale clause between siblings. Farmers need to face the possibility that to preserve farm financial feasibility, each offspring may not receive fixed equal shares. A complete set of financial statements can help evaluate alternative asset distribution scenarios for financial feasibility and sibling equity.
When the estate plan is formulated, legal instruments must be executed to record the estate plan and serve as asset transfer mechanisms. This involves wills and trusts. A will is a set of instructions regarding the disposition of property which takes effect at death. There are costs to have assets transferred through probate, and the transfer is recorded as public information. A trust is a set of instructions to manage the estate during a farmer's and spouse's life and transfers the estate upon death.
Farm estate planning is personal and incorporates complex financial, legal, and tax considerations. Intra-family relationships and unpredictable health expenses add to the stressful mix of issues that must be addressed. Care must be taken to maximize federal and state estate tax exemptions. Currently, the federal estate tax exemption is $2 million per person. For a married couple, a carefully crafted estate plan could exempt up to $4 million of value from federal estate tax. In addition, Washington State has its own estate tax laws. The purpose of this article is to raise the importance of estate planning, and briefly introduce some issues to discuss with competent professionals.