UNL presents ideas for ag estate, transition planning

Editor’s note: A series of recent articles from the UNL Center for Agricultural Profitability gives tips and advice for successfully passing along a farm or ranch operation to the next generations of Nebraska ag producers. The following is a compilation of the first three articles in the series which can also be found at cap.unl.edu. 
For many farm and ranch families, bringing children or grandchildren into the operation is the ultimate goal. Successfully bringing additional family members into the operation may require some creativity as all parties need to maintain a viable standard of living.

Paying family members 
One tactic is to provide new family members with monetary compensation, such as an hourly wage or salary. The total compensation should be comparable to the market value of wages to hire a non-family member to do the same work.
Here are things to consider when employing this strategy:
Start anytime - This strategy can begin early in life. Children under 18 can earn monetary compensation from the farm or ranch. This can give family members a sense of responsibility and allow them to learn how to manage money at an early age. Furthermore, this can jump-start their savings for education, retirement, or business assets. Work with a financial advisor to explore tax-advantaged ways to save and invest on a child’s behalf such as Roth IRAs or 529 Accounts.
It’s tax-deductible – Wages or salaries paid to family members may be tax deductible. The downside is that it may require additional paperwork. Work with your accountant to make sure you have the correct documentation and reporting.
Financial Freedom – Providing monetary compensation can provide financial autonomy.  A competitive compensation package shows that you value their contributions to the business. Additionally, being able to make their own spending and investment decisions can be empowering for them.
Setting Expectations – One of the biggest challenges for farm and ranch families is setting expectations for work. Different generations often have different views on this matter. When setting a monetary compensation rate, also consider writing position descriptions that clearly define working hours and responsibilities.
Maintain control – By monetarily compensating family members, ownership of the entity and capital assets are not being transferred. In the early stages of the transition process, paying wages or a salary may be a way to test the waters and see if working together in the operation is feasible. If it is not, the owner still maintains control of the capital assets. The family member also now has cash to start their own operation or choose a new career path.
Not all compensation has to come from an hourly wage or salary.  Often, owners will provide compensation to family members in various forms providing housing, vehicles, insurance, etc. Non-monetary compensation should be valued and factored into the total compensation package. The total compensation package should allow both owners and other family members to maintain a viable standard of living. The compensation package, both monetary and non-monetary, should be discussed, and in writing, before someone becomes involved in the operation.

Gifting 
The second tactic to transfer wealth between generations is gifting. The U.S. tax code has two main laws that apply to gifting: the annual gift tax exclusion and the gift and estate tax basic exclusion amount.” In this article, the person gifting assets is going to be called the donor, and the person receiving the gift is going to be called the donee.
Each year the IRS releases the annual gift tax exclusion amount. The annual gift tax exclusion is the amount of assets that can be gifted from the donor to a donee, without reporting the gift to the IRS. The annual gift tax exclusion applies to anyone, the parties do not have to be related. In 2024, a donor can gift $18,000 to a donee. The limit is per donee. In other words, the donor can gift up to $18,000 per year to as many donees as they want.
The second law is the lifetime gift and estate tax basic exemption amount. Any gift over the annual gift tax exemption ($18,000) must be reported to the IRS and is then accumulated toward the donor’s lifetime gift and estate tax basic exemption amount. In 2024, this limit is $13.61 million. This means that a donor could gift more than the annual exemption to a donee in a single year, without paying gift tax. Estate or gift tax applies when the cumulative lifetime gifts to all donees and taxable assets passed through the estate are above estate tax basic exclusion amount.
There are some exceptions to these gifting rules. First, spouses can gift each other an unlimited amount, as long as they are U.S. citizens. The second exception is that a donor can pay qualified medical or education expenses to an institution on a donee’s behalf, without it counting toward these amounts.
If you are thinking of gifting as a strategy to provide a viable standard of living for a family member, consider the following points.
What is a gift? - These gifts must be true gifts. According to the IRS, “You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift.”
No Step up in Basis - Many families debate gifting assets during life versus waiting to pass an asset until after death. A key consideration is the basis the donee will have in the asset. If the asset is passed as a gift while the donor is alive, the donee retains the donor’s basis. This loss of the step up in basis means that if the donee eventually sells that asset, they may pay more in capital gains tax.
Gifting Assets Rather Than Cash - Often we think of gifting cash. However, the gift tax applies to other assets including, but not limited to, equipment, livestock, land, or shares of an entity.

Things to watch for
Gifting assets rather than cash can be tricky. Work with your financial team to determine the asset basis and value.
*Losing Control: When assets are gifted during life, there is the risk that they could be “lost” by the operation. For example, if a donee receives a piece of equipment using the annual gift tax exclusion, the donee could sell that asset without the consent of the donor. Additional agreements, such as a buy-sell agreements or lease agreements may be needed to mitigate some of this risk.
*Look Back Period: Gifting is often discussed when the donor needs to reduce their estate tax liability or protect assets from long-term care. When using gifting for these purposes it must be done well in advance. Both of these situations have “look-back periods.” For long-term care, the look back is five years. For estate taxes, it’s 3 years. 
Gifting assets during life is not the only way to compensate family members. When developing a strategy to bring the next generation back into the operation, consider the viable standard of living for both the owners and the heirs. Gifting too much while owners are alive can be problematic.

Gift-leaseback
Simply gifting assets helps reduce estate value and potential taxes for the owners and increase the wealth of the heirs. However, some families are hesitant to engage in gifting strategies because the farm or the ranch needs access to those assets to remain viable. To solve this problem gifts can be combined with a lease agreement.
In the scenario below, the donor will be gifting farmland to the donee. If it is a true gift, the donee could do anything with the farmland they want. If the donee wants to, they could lease the farmland back to the donor at fair market value.
This scenario greatly benefits the donor. First, the donor would continue to farm the land, allowing them to maintain their standard of living. Second, the asset would be removed from their estate, and if completed outside of the applicable lookback periods, could reduce the assets counted toward long-term care and/or estate tax. Depending on the nature of the asset, removal of the asset may also decrease the donor’s property taxes. Finally, like with other leases, the donor would be able to deduct the rent as a business expense, potentially lowering their income tax liability.  However, the donor also has the risk of the lease being terminated.
The donee benefits by receiving the asset as a gift, and the income from the lease. Additionally, they may also be able to depreciate the asset if it is depreciable and there is value to depreciate. If the terms of the lease are not followed, the donee has the flexibility to terminate the lease.
Land is not the only asset that could be used in this scenario. Any physical asset used on your farm or ranch could be employed in a gift leaseback. However, land, machinery, and equipment are the most logical as they are often leased by farm and ranch operation.
The IRS is very critical of these types of transactions. Work with your financial team to make sure it is handled correctly. There needs to be a written lease agreement in a gift leaseback scenario, and the agreement needs to be followed.
Written by Jessica Groskopf, UNL Extension Educator and Agricultural Economist.