by Sally Colby
It’s easy to put off retirement planning, but Tracy Garofalo, an accountant with Pennsylvania Farm Bureau’s MST business services, said retirement planning should not be ignored.
Garofalo said the biggest issues for most are when to start, structuring a plan and determining the tax implications. “The earlier, the better,” she said. “When you’re 65 is a little late – not that it can’t be done, but there are things that are more likely to happen as you get older.”
Garofalo suggested the first step is to determine whether the next generation has a desire to join the business. “Maybe not the next generation, but their kids,” she said. “How do you structure the business so you are minimizing tax implications that can bring the kids in easily through sweat equity, gifting or them purchasing part of the business? Remember the adage ‘Farmers are land rich and cash poor.’”
Farmers who reach retirement age may not have a lot of cash because the value is in their land. Although most would love to be able to give the farm to the next generation, they must be able to provide a living for themselves. “That’s where the sale of the farm, perhaps at lower than fair market price, comes into play,” said Garofalo, “along with the transitioning part of how to structure and put land and buildings into the next generation’s name.”
When there is ample time for retirement planning, several options can minimize tax liabilities. If you’re able to be the “bank” for the kids with you holding the note on the farm, tax liability is spread over 20 or 30 years as you receive principle and interest from the farm.
Equipment sold on an installment plan (to children who will be taking over) is not recognized by the IRS. “They’re going to want their money in the year you sell it,” said Garofalo, “whether you take it on installment basis or not. So if you have one million dollars’ worth of equipment and sell it for $500,000 on note to the next generation, you’re paying tax on the gain of that money in the year of sale, regardless of when you get the money.”
An important mantra in retirement planning is “fair is not always equal.” There’s value in sweat equity, and Garofalo said children who are not putting in sweat equity may have to wait until your passing to get their share of the inheritance. Children who are currently putting in sweat equity might get their share now, but that can become a divisive issue.
Garofalo said a retirement plan should include training the next generation to ensure they have the skill set to run the farm. “They may be a great employee of the farm and do as they’re told, but they can’t think outside the box,” she said. “Maybe the next generation isn’t a family member – it’s somebody unrelated that has the ability and skills and you can bring them along.” She noted that family dynamics are the most difficult aspect of transition planning. “The hardest thing is maintaining relationships that you have going into estate planning coming out of estate planning,” she said.
Attorney Gary Heim said it’s often difficult for the older generation to let go and begin training and providing an opportunity for the next generation to run the business. “I usually say ‘We’re only 30 years apart from one generation to the next’ so if you run the business for 30 years, your time is up,” he said. “Move to the side, get out of the way, and let the next generation start running the business. They’ll probably do a better job than you and if they don’t, you don’t have a good successor.”
In bringing in the next generation, it’s important to be sure there’s ample farm income. “If you make it to 65 as a couple, there’s a more than 50% chance that one of the two of you will hit 93,” said Heim. “You’ve got a 25- to 40-year retirement period now. That farm is going to have to produce income not only for the operators of the business but also the retired generation. Make sure there’s enough income, and if not, do something about it.”
Heim said that while some older generation members were willing to live on a shoestring budget as they started farming, many in the next generation are not. A spouse may have had a job that provided health insurance and a flow of income, but your child doesn’t necessarily have that. Plan for an income source that will keep the business going.
Another issue is fairness among family members, which is hard for those who don’t plan to divide assets equally among children. “It’s difficult,” said Heim, “and sometimes there’s a difference between the husband and wife. The more common situation I’ve seen is the son is operating the farm, the daughter is not and the mother may think differently than the father as to what’s a fair treatment for the son and the non-farm children. Try to get on the same page – if it’s a matter of the farm success depending on whether Dad survives or Mom survives, that isn’t a good position to be in.”
When farmers have health issues that force them to consider retirement, Heim said it’s important to address whether there are family members who want to continue the farm and have the capability to do so. “Physical ailments might be the catalyst that cause you to take action,” he said. “You could either bring the next generation in as part of the operating entity (such as an LLC). You’ve been operating as a sole proprietorship or single member LLC, and now operate as an LLC with multiple members – your children and yourself. There might a period of five to 10 years that you operate jointly with an eye toward eventually withdrawing completely from the LLC and letting them operate it exclusively.” When there is no next generation, additional options may include working with a neighbor farm, leasing the farm or selling – which often doesn’t go over well. Liquidating a farm has an emotional connection but farm owners have to face the fact that selling may be the answer.
“You can buy time by involving another farmer in some way in the business,” said Heim. “You either quickly transition to the next generation, which is something you would have been thinking about anyway, or involve another farmer, perhaps leasing the land and/or facilities.” Evaluate your situation – is it long-term or temporary? “It forces you to pull the trigger more quickly,” he said. “Ideally, plans are in place and money or other resources to fall back on to buy a couple of years.”