«ESTATE PLANNING A Simplified Guide for Oklahoma Farm and Ranch Families Circular E-726 Oklahoma Cooperative Extension Service Division of Agriculture ...»
4. The real property must have been owned by the decedent or a member of the decedent’s family and held for use as a farm five out of the last eight years preceding the decedent’s death.
5. The decedent or member of the decedent’s family must have materially participated in the operation of the farm or other business for five out of the last eight years immediately preceding the decedent’s death (or retirement or disability).
Special rules for decedents who are retired or disabled are as follows: The material participation has to be satisfied during periods aggregating five or more of the eight year period ending before the earlier of (1) the date of death; (2) the date on which the decedent became disabled; or (3) the date on which the individual began receiving Social Security retirement benefits, which continued until decedent’s death.
If the property was passed to the surviving spouse, he or she will be treated as having materially participated during periods when engaged in active management of the farm or business. The term “active management” means the making of management decisions of a business that is more than just the daily operating decisions.
The definition of a member of a family means only (a) an ancestor, (b) the spouse, (c) a lineal descendent of decedent or of decedent’s parents or of decedent’s spouse, or (d) the spouse of any lineal descendent described in (c) above. For purposes of the preceding sentence, a legally adopted child of an individual shall be treated as the child of such individual by blood. Lineal descendents of the decedent’s grandparents are no longer considered to be family members unless they are also descendents of the decedent’s parents. This means that aunts, uncles, nieces, nephews, and cousins are excluded.
6. The special valuation cannot reduce the decedent’s gross estate by more than $940,000 for 2007 and will be indexed for inflation in the future.
7. An election to specially value the property must be made on the other decedent’s estate tax return.
8. A written agreement must be signed by each person who has an interest in the property for which the special use is elected, stating that additional estate taxes will be paid if there is a premature disposition or cessation of qualified use of the property.
9. Special rules exist relative to standing timber.
• Computing “Current Use” Value. The “Current Use” value is determined in one of two ways:
1. Capitalization of rent, which is computed by dividing the average annual gross cash rental for comparable farmland in the locality, less average real property taxes, by the average annual effective interest rate for all new Federal Land Bank loans. Five year average data is used.
If there is no comparable land from which the average annual gross cash rental may be determined, “average net share rental” may be substituted for average gross cash rental. Net share rental is defined as the excess of the value of the produce received by the lessor of the land over the cash operating expenses of growing such produce, which are paid by the lessor under terms of the lease.
Each average annual computation is to be made on the basis of the five most recent calendar years. For decedents dying in 2006, the average interest rate was 7.75 percent. The following example assumes that the current average land rent is $32.50 per acre, taxes are $2.50 per acre, and the Federal Land Bank interest rate
32.50 - $2.50 = $ 387.10 per acre current use value.0775
2. If there are no comparable sales or the formula method is not used, the value of real property may be determined by application of the following factors:
a. The capitalization of income that the property can expect to yield for farming or for closely-held business purposes over a reasonable period of time under prudent management, using traditional cropping patterns for the area, taking into account soil capacity, terrain configuration, and similar factors.
b. The capitalization of the fair rental value of the land for farming or for closely-held business purposes.
c. The assessed land values in a state that provides a differential or use value assessment law for farmland or closely-held business property.
d. Comparable sales of other farm or closely-held business land in the same geographical area far enough removed from a metropolitan or resort area so that nonagricultural use is not a significant factor in the sales price.
e. Any other factor which fairly values the farm or closely-held business value of the property.
• Recapture of “Current Use” Benefits. If the property is disposed of within ten years after the death of the decedent to nonfamily members or ceases to be used for farming or other closely-held business purposes, the tax benefits are fully or partially recaptured.
1. Full recapture occurs within the first ten years.
2. Recapture does not occur, however, on death of the qualified heir.
3. Partial dispositions lead to partial recapture of the tax savings.
4. The qualified heirs are responsible for the recaptured tax.
5. For purposes of “cessation of qualified use,” absence of material participation for three or more years during any eight-year period ending after decedent’s death triggers recapture.
6. A special lien, in favor of the United States, will be attached to the property. Liens on loans by the Treasury will be subordinate to bank loans.
7. A two year grace period after the decedent’s death during which a qualified heir’s failure to use the qualifying property in the qualified use will not cause imposition of a recapture tax.
8. Active management by eligible qualified heirs will satisfy the post-death material participation requirement.
Eligible heirs in this case include the decedent’s spouse, or a qualified heir who has not attained age 21, who is a student or is disabled.
• Increase in Basis of Property on Which a Recapture Tax is Paid. Where the recapture tax is paid, the new law permits a qualified heir to make an irrevocable election to have the income tax basis of the qualified real property increased to the fair market value as of the decedent’s death or the alternative valuation date.
Computation of the Taxable Estate
The taxable estate is the gross estate less deductible:
• Funeral expenses.
• Estate administration expenses.
• Claims against the estate.
• Taxes accrued but unpaid at the date of death.
• Loss from fire, storm, and theft (casualty losses) not compensated for by the insurance or claimed as a deduction in an income tax return.
• An unlimited marital deduction is allowed for qualifying property that passes to a surviving spouse. The executor may even elect to have certain life interests qualify for the marital deduction. A special rule applies for charitable remainder trusts. See discussion below on marital deduction.
• The amount of transfers to charitable, religious, and similar institutions approved by IRS.
After the taxable estate is determined, the includible taxable gifts are added to the taxable estate before referring to the tax tables to determine the amount of the estate tax.
Marital Deductions.7 There is an unlimited marital deduction for decedents. The decisions on the use and amount of marital deduction will vary with the size of the estate and the unified tax credits, which increase each year up to 2010. The strategy for some persons will be to change the amount of the marital deduction during this period if the objective is to reduce estate taxes. The executor will often have to make computations to determine whether to elect to have certain qualified terminal interest properties qualify. Qualified terminal interest property means property that passes from the decedent, and in which the surviving spouse has a qualifying income interest for life. Disclaimers will likely be used more. (See section on disclaimers.) Special Benefit for Family-Owned Business In 1997, Congress added a special exemption for family-owned businesses allowing up to $1,300,000 to be transferred without federal estate tax to the extent the assets of the estate were family-owned business property. It required that at least 50 percent of the decedent’s estate consist of qualified family-owned business interests. If a couple planned to take advantage of this provision, they could avoid paying federal estate taxes on estates totaling $2.6 million. To qualify, decedent or a member of his or her family had to own the business for at least 5 years of the 8 years preceding his death and during that time, material participation by decedent or a member of his family in the business operation was required.
The excess amount above the exemption equivalent amount will be subtracted in computing the adjusted gross estate. A family-owned business was defined as one where a) at least 50 percent of such entity is owned directly or indirectly by the decedent and members of his family or b) at least 70 percent is owned by members of two families and at least 30 percent is owned by decedent and members of his family, or c) at least 90 percent is owned by members of three families and at least 30 percent is owned by decedent and members of his family. Ownership interests in publicly traded companies and companies located outside of the U.S. were excluded. The participation tests were similar to those used for special use valuation. This special benefit was repealed effective December 31, 2003, but the sunset provision of the Economic Growth and Tax Relief Reconciliation Act of 2001 will reinstate this deduction beginning January 1, 2011, unless the estate tax law is modified before December 31, 2010.
Federal Estate Tax Rates Federal estate tax rates are shown in Table 1. Table 1 is effective for years after 2006.
Determining Estate Taxes for Spouses Estimating the tax liabilities under different alternatives is a part of good estate planning. The tax estimates and other transfer costs should include the costs for both the husband and wife. Well thought-out plans will explore the potential tax burden resulting from the unexpected death of either husband or wife.
Credits Against Federal Estate Tax
Credits against federal estate taxes are allowed for the following:
a. Credit for estate taxes paid to the state. There is a maximum limit for the amount of this credit.
b. Credit for federal gift tax paid on gifts regarded by Internal Revenue Service to be a part of the estate for estate tax purposes.
c. Credit for taxes paid on transfers of property received from previous estates.
d. Credit for foreign death taxes paid.
e. Federal Estate Tax and Gift Tax Credit.
• Federal Estate and Gift Tax Credit. The following credits (shown in Table 2) are effective against estate taxes for decedents and for gifts made after 2006. The credit is applied against either the gift tax or estate tax, not as a deduction against the taxable value of the estate. Note that the credit was increased over time. In 2007, a decedent with an estate of less than $2,000,000 will not have to pay estate taxes.
• Credit for State Death Taxes. After December 31, 2004, the state death tax credit has been replaced by a deduction for state estate taxes.
• Installment Payment of Estate Taxes. If the closely-held business interest exceeds 35% (formerly 65%) of the adjusted gross estate, the taxes attributable to that interest may be deferred up to 14 years; annual interest payments may be paid for the first four years and the balance may be paid in up to 10 annual installments of principal and interest. The annual interest rate is 2% on the first $1,000,000 of taxable value. There will be a cost of living adjustment on the portion of estate’s taxable value that qualifies.
Federal Gift Taxes For gifts made in 2007 and thereafter the annual exclusion has been increased to $12,000 per recipient. Since 1997, the excludable amount has been indexed for inflation, but will only move in $1,000 increments. With gift-splitting, spouses may transfer $24,000 per recipient per year without gift tax even if one spouse owns all of the property. The consent of the spouse not owning property must be signified on the gift tax returns.
Also, an unlimited gift tax exclusion is allowed for amounts paid on behalf of a donee directly to an educational organization for tuition and to a health care provider for medical services.
For a gift in trust, each beneficiary is treated as a separate person for purposes of the exclusion. The annual exclusion is not available for gifts of future interests such as a remainder interest in a trust or life estate, except for gifts to minors in trust or under the Uniform Gift to Minors Act.
Gifts given within three years of death generally will not be included in the deceased donor’s estate. (The taxable portion of gifts would be included in the tax base for estate tax computations.) However, gifts with retained life estates, transfers effective at death, revocable transfers, transfers of general powers of appointment and transfers of life insurance will be included in the estate. The three year rule was retained for redemption of stock to pay estate taxes, special valuation of certain farm property, extension of time to pay estate tax, and for determining property subject to a lien for taxes.
Beginning in 2004, the gift tax exemption equivalent will remain at $1,000,000 even though the estate tax equivalent exemption continues to increase. In 2010, although estate taxes will be eliminated, gift taxes will remain in effect with a maximum rate of 35 percent and a $1,000,000 exemption equivalent amount.
Marital Gift Taxes An unlimited marital deduction is permitted for interspousal transfers and the law exempts all such transfers from gift tax filing requirements. However, interspousal transfers within three years of death must comply with the requirements listed above for gifts given within three years of death.
Gift Tax Computations A gift and estate tax rate schedule applies for taxable gifts made and for estate taxes (See Table 1 page 12).
• Example of Gift Tax Computations. A single unified gift and estate tax rate schedule applies for gifts made and