Posted on 05/06/2011 at 10:52 AM by David Repp
In this special report prepared in conjunction with a presentation at the University of Iowa College of Law's 2011 Spring Tax Institute, David Repp takes in in-depth look at estate planning considerations for farmers and other landowners. Part 1 of 7, below, focuses on non-tax estate planning. Non-Tax Estate Planning Of particular concern to Dad is that the family farm he nurtured and cultivated his entire life will continue in the hands of a family member, even if it means special privileges and breaks are given to one family member that are not given to other family members. Of particular concern to Mom is that all the children be treated equally. Period. These two objectives may seem incompatible or perhaps even mutually excludable. If Dad wins, perhaps the anointed heir apparent receives an outright gift of certain parcels of land or a discount purchase price or an option to buy for an indefinite period of time, all at the expense of the other siblings. If Mom wins, the farm may be splintered and sold, leaving the on-farm heir unable to maintain any farming operation. What to do? Option One: Give On-Farm Heir an Option to Farm Any farmland devised to off-farm siblings could be subject to the right of the on-farm heir to farm such land for a fair rental value. Consider the following will provision:
". . . all my farmland shall be divided among my children and distributed in equal proportions subject to the following condition regarding a right to farm: My son, Henry A. Wallace, is hereby given the option to farm all of said farm real estate of which I die seized on either a cash rental basis or crop share basis upon terms customary in the central Iowa farm community for as long as he desires and is willing to do so. This option is personal to Henry A. Wallace and is exercisable by him only so long as he personally farms said real estate as farm operator and farms said real estate in a husbandlike manner. This option shall continue automatically from year to year until Henry A. Wallace notifies the respective owner or owners in writing of his intention of terminating the lease as provided by Iowa law."
The foregoing testamentary provision was actually a part of a Dallas County decedent's (the dad) probated will (the name in this example has been changed). The off-farm heirs complained about the provision and took the on-farm heir to court seeking to have the provision voided. The provision was upheld in a 2005 Dallas County court decision. As a side note, the off-farm heirs subsequently sold the property to a neighboring farmer at a discount, but the on-farm heir was able to keep farming the property for so long as he wanted which satisfied the intent of the dad. Option Two: Create a Limited Liability Company By putting their farmland into a limited liability company, or similar entity, Mom and Dad not only create a limited liability shield from creditors, they also are able to satisfy their divergent estate planning objectives. In its simplest form, interests of a family farm limited liability company can be distributed equally to all the children. This satisfies Mom. Iowa's Revised Uniform Limited Liability Company Act, absent an operating agreement provision to the contrary, requires unanimous consent of the members to dissolve and liquidate ensuring that the farmland will not be splintered and sold following the deaths of Mom and Dad. This satisfies Dad. Entrenching the On-Farm Heir. Dad may want further assurances that his anointed successor will actually continue the farming operation. This can be accomplished in the operating agreement. One way is to designate the on-farm heir as manager of the limited liability company and require unanimous consent of the members to remove the manager. This will effectively allow the on-farm heir to control the assets of the LLC, including its farming operation. However, the on-farm heir will not be allowed to lease the farmland from the LLC unless the operating agreement waives the manager's duty of loyalty. Iowa Code § 489.110(4) (2011). Such waiver can be specific or general. Following is an example of a general waiver:
A Manager, on behalf of the Company, may enter into contracts with himself or any of his affiliates, provided that any such transactions shall be on terms no more favorable to the Manager or his affiliates than generally afforded to unrelated parties in a similar transaction and the requirements of the Act are satisfied, if applicable.
An alternative method of assuring that the on-farm heir can continue to farm the LLC's farmland is to include in the operating agreement an option to farm similar to the provision in the Dallas County will (discussed above). Preventing Oppression by the Entrenched On-Farm Heir. Unless waived in the operating agreement, a manager of an LLC has all the fiduciary responsibilities of an officer of a corporation including the duty of loyalty and duty of care. Iowa Code § 4898.110 (2011). However, an on-farm heir's activities, although not rising to the level of a breach of fiduciary duty, may still result in oppression of the off-farm heirs. The on-farm heir, as manager of the farming operation, may use all the farm profits to invest in new, expensive machinery, new grain bins and other out buildings or purchasing more land. Such acquisitions could result in no cash flow to the off-farm heirs for many years. One solution is to limit the activities of the limited liability company to only the leasing of its farmland. The on-farm heir must then develop his or her own farming operation and lease the farmland from the LLC. Also, consider adding a provision that requires the consent of some or all of the off-farm heirs for the purchase of additional land. Land is expensive and can tie up all the cash flow of a family farm LLC for many years. Another solution is to include put and call options in the operating agreement. Put and call options may be desired if the off-farm and on-farm heirs are not capable of working together, and will not during the foreseeable future. A put option to an off-farm heir may take the following form:
Put Option Personal to Jane Wallace. Upon the earlier to occur of: (1) the last to die of Edward (Dad) Wallace and Mary (Mom) Wallace, or (2) the complete disposition of units of the Company by Edward Wallace and Mary Wallace, Jane Wallace may elect to sell to the Company, and the Company shall purchase, all the units of the Company then owned by Jane Wallace for cash at the "Purchase Price" as defined, below. Jane Wallace may exercise her right to sell her units in the Company by notifying the manager of the Company, in writing, of her intention to exercise her right herein. The Purchase Price shall be determined at the time Jane Wallace notifies the manager of the Company of her intention to sell her units to the Company (the "Determination Date").
The purchase price can be defined to allow for a discount to the Company and for payment in installments. A similar "call' option can be provided to the on-farm heir:
Call Option Personal to Henry A. Wallace. Upon the earlier to occur of: (1) the last to die of Edward (Dad) Wallace and Mary (Mom) Wallace, or (2) the complete disposition of units of the Company by Edward Wallace and Mary Wallace, Henry A. Wallace may elect to purchase for cash at the "Purchase Price" as defined below, all the units of the Company owned by any other member by notifying such other member in writing of his intention to exercise his right herein. The Purchase Price shall be determined at the time Henry A. Wallace notifies such member of his intention to buy the member's units in the Company (the "Determination Date").
For any questions regarding estate planning please contact David Repp.
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- David Repp
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