By Art Littlefield
In conjunction with Lincoln Financial Advisors Agribusiness Services
Last month’s article, “Planning For Stepping Back – Part I”, highlighted nine topics that should be given careful consideration so you increase the likelihood of a relaxing and comfortable “retirement” while any unavoidable stress is kept to a minimum. In case you missed Part I, you can read it here.
I apologize for starting this article with an unpleasant topic, income taxes, but they definitely need to be considered. As you already know, in May of 2019, the Illinois Senate approved the Joint Resolution Constitutional Amendment 1. If passed by voters this November 3rd, the Amendment will allow the legislature to change the state income tax from the current flat or single rate to a graduated rate, i.e., taxpayers, both individuals and corporations, making more money will send a larger percentage to Springfield. Also, depending upon the outcome of this year’s Presidential and Congressional elections, federal rates may be “adjusted” to help replace the lost tax revenue and unexpected disbursements due to the COVID-19 pandemic.
As you know and likely have been doing, some very effective strategies are used to delay paying taxes such as placing a portion of grain and other commodities in storage, prepaying next year’s input costs, purchasing machinery, improving farm ground, etc. Sometimes grain and commodities are also stored in hopes of receiving a higher price in the future.
As a farmer retires or reduces their farming “activities”, farm related expenses are reduced. Unfortunately, this may be at the same time that stored grain is sold, equipment is sold or leased, farm ground becomes a source of rental income either through cash rent, crop share, custom share, etc. The net effect would be lower expenses, higher revenue, more income, and more taxes.
The 2020 federal tax law has a large single step increase in marginal rates from 24% to 32%. If you are married filing jointly, the 24% range is from $171,051 to $326,600 and then the marginal rate increases to 32% for incomes up to $414,700. As an example, if we assume that there is no other income received or expenses to be recognized and there is $500,000 of stored grain to be sold, then one should consider selling grain to realize income up to near the top of the 24% range in year one and then the balance in year two, rather than delaying the entire sale to year two resulting in a 32% marginal bracket. In addition to this strategy of gradual grain sales over time, consideration should also be given to reducing the amount that is stored each year.
For a stepping back farmer, there are further complications to the grain liquidation issue, these include the sale of farm equipment. This is because there may be gains from depreciation recapture, which is taxed as ordinary income, and long-term capital gains due to the increased value of the equipment sold over the original purchase price. The ability to pay future year input costs and other income minimization alternatives may no longer be available. Bottom line, early in retirement or stepping back, revenues will likely increase while available expenses will decrease, this can mean higher taxable income and higher marginal tax brackets.
To proactively minimize the negative impact, work closely with your financial advisors and professionals to ensure that these sales and revenues are coordinated from a global perspective for not only the retiring farmer and spouse, but also the child(ren) that will be assuming more responsibility. The benefits will far outweigh the expenses of bringing your advisor team together to address these topics and resulting concerns.
The following is a true client experience with a farmer in his first year of stepping back. It demonstrates the benefit of working together as a team. The first question we ask at every meeting; “How about updating us on any events that occurred since we last met?” His answer included, “last month I sold about $450,000 of grain and I think I am charging my son too much cash rent and his equipment lease is too high”. Fortunately, this occurred during the third quarter of the year. We arranged for a meeting with the husband and wife, the son, the accountant, and ourselves, for a total of six participants. The outcome was shifting some of the son’s payments to the following year which resulted in mom and dad reporting less income and a lower marginal tax bracket and tax bill. The son was able to improve the cash flow of his farming operation which was directed to purchasing new equipment. The outcome: two generations of clients won, while Springfield and the IRS lost.
As one is developing plans to step back, issues can surface regarding Illinois, and possibly federal, estate and gift taxes, family dynamics between on-farm and off-farm children, and problems and opportunities that can result from previously purchased life insurance. We’ll explore those in our next monthly article. After that, the topic will shift to brothers that have spent a lifetime farming together with a desire to step back or an acknowledgement that finally they need to plan for a transfer to the next generation. One might consider these to be “Family Legacy” issues.
Lincoln Financial Advisors Agribusiness Services. 1212 Banbury Circle, Naperville, IL 60540. Art Littlefield is a registered representative of Lincoln Financial Advisors Corp. Securities and investment advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. CRN-3136659-062320
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