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Estate Planning: Heirs at Odds

The call I got from a farmer friend might help someone else avoid a financial meltdown. Here's what happened.

This farmer asked if I could help him calculate his cost of production and analyze his financial position. The farmer had operated a partnership with his father-in-law for years. He owned the grain equipment and farmed other ground outside the partnership. Another son-in-law of the senior partner also worked in the operation as an employee. The farmer had a reasonable net worth but the operation was struggling to make a profit.

I had consulted with the father-in-law almost twenty years ago and knew the father-in-law had an estate tax problem that was the result of some extensive non-farm assets that were largely inherited. Profitability was tight even twenty years ago when the son-in-law had first joined the operation.

Father-in-law realized that something needed to be done to minimize potential estate taxes and engaged an attorney from outside the area. The attorney represented that he had a lot of agricultural experience but was not one of the attorneys I usually see in the farm sector.

Poor planning

The plan that was generated was not an alternative I would have advocated. The attorney recommended that the father-in-law consider a Family Limited Partnership (FLP). One of the advantages of holding assets in a Family Limited Partnership is that the assets held in the FLP often receive a discount from fair market value upon the death of the first generation. Generally the first generation enters into a gifting program to transfer assets to the second generation retaining a measure of control during the lifetime of the first generation. This is a fairly common strategy that I have advocated in a number of previous cases. The twist in this case is that the attorney wanted to throw all the assets, even equipment and the actual operating partnership, into the FLP. My client was advised that he was to become an employee of the FLP and would lose the operating partnership between the father-in-law and the client. The attorney and the father-in-law thought this was an excellent strategy to keep the family together because the family members would be managing the new FLP together and be required to have regular business meetings.

Trouble ahead

The attorney violated one of the primary rules of estate planning: Never place farming heirs and non-farming heirs in an operating business. Non-farming heirs can make excellent landlords, but they normally don’t have the same goals as the operating children.

If the FLP were to take over this farm, the farming heir would be required to negotiate his salary every year with the family as well as negotiate what the FLP would pay the operating farmer for the use of his equipment. If the salary was too low, the farmer would actually be subsidizing the income of the other heirs. If the salary is too high, the farmer would be receiving a subsidy from the other heirs.

Non-family heirs may not be interested in replacing equipment because the purchase of equipment would actually reduce the amount of funds available for distribution to the heirs. What if the non-farming heirs decided they didn’t want the farming heir to expand the operation? The farming heir could be trapped in a business with a questionable future.

A better solution

What should have happened? The land and the other fixed assets could have been placed in the Family Limited Partnership. The same gifting program could have taken place, but now the farming heir would be renting assets from the FLP. The farming heir would control his destiny and the non-farming heirs would be relieved of the day-to-day management activities of operating an active business.

The goals of the first generation would be accomplished while avoiding potential conflict within the family.

The resulting operation would have a predictable cash flow without the risks of an operating business. The fixed assets found in the business would receive the same discount as in the attorney’s plan, but the operation would be much simpler to manage.

Dunteman is an agricultural financial consultant and accountant in Bushnell, Ill. Dunteman also edits Ag Executive, and is Management Coach at Farm Futures magazine. Email him at agexecutive@earthlink.net.