Legal Considerations in Farm Transitions with Jody Anderson Leighty
This week’s episode is the third and final podcast takeover that is part of The Farm Transition Planning Podcast series. We will explore farm succession planning, business planning, and more. If you missed the first and second conversations within this series, we encourage you to go back and explore those episodes as well. Darlene Livingston, Executive Director with Pennsylvania Farm Link and operator of a family livestock and crop farm in Indiana County, will serve as our guest host for this series.
Today's guest is Jody Anderson Leighty, an attorney with Stock & Leader, a law firm in York, PA. Jody has a passion for agriculture and helping farmers put succession and estate plans in place. She'll share her perspectives on legal considerations for farm transition. For the full podcast, click here:
Can you tell us more about yourself and why agriculture is important to you?
I grew up in Southeastern York County, PA and I am the granddaughter of a beef cattlemen on one side of the family and orchard and fruit producers on the other side of my family. I still live in the area within a stone’s throw of my mom's family farm. Our area is still very agricultural in nature. I really respect and admire the farming community and I feel fortunate to still live in a farming community and to be able to serve them.
Farm transitions can be overwhelming. What's the first step that any farm family should take to prepare for the successful transition process?
The first step would be to create a team to help the family accomplish the transition. A good team includes a good accountant, a good financial advisor, and a good attorney to all work with the family to achieve the transition and make it successful.
Secondly, make sure to verbalize the plan with the members of the family. Recognize that this needs to be talked about and talk about the one, two, or three elephants that are in the room. Have those hard conversations.
This is where your accountant, your financial advisor, and your attorney can help guide you through those conversations.
Now let's talk about everyone's favorite topic, taxes. Could you walk our listeners through the tax implications of transitions?
There are essentially three taxes that you have to be aware of: the Pennsylvania Inheritance Tax, the Federal Capital Gains Tax, and the Federal Estate and Gift Tax. The federal estate and gift tax is not as much of a factor as it used to be. The amount that you can give away, either during your lifetime or at your death, has been increased to about $11.5 million per person. That means that there is no federal estate or gift tax assessed until you have given away more than $11.5 million per person, which means that you're looking at about $23 million per couple.
That's also the one that they call the death tax. That's the one that Congress monkeys around with every now and again. It's something to keep your eye on and to read articles about. If you see an article in the newspaper that references the death tax, read it, and keep yourself apprised as to what's going on, because that amount will change.
In terms of the Pennsylvania Inheritance Tax, it doesn't matter if you pass away with one dollar or one million dollars, the Pennsylvania Department of Revenue wants their share. The tax rate is based on the relationship between the person that passed away and the person that inherits. If the person that inherits is a spouse, there is 0% tax. If anything is inherited by direct lineal descendants, children, grandchildren, great-grandchildren, parents, grandparents, the tax rate is 4.5%. For siblings the tax rate is 12% and for everybody else, it's 15%.
The great thing about the Pennsylvania Inheritance Tax is that our legislature passed two agricultural exemptions several years ago. The one exemption exempts agricultural property. There are certain requirements. It must be inherited by members of the same family, which even includes siblings, nieces, and nephews. That exemption exempts all agricultural property, including land and buildings, but it requires a continued certification every year for seven years. The certification must show that the land has produced agricultural products of at least $2,500 a year. There's a continuing obligation that it has to be physically farmed by that family. You can't lease out the ground to somebody else. That does not count
The other agricultural exemption only applies if direct descendants inherit the property. It only applies to the land. It does not apply to any buildings on the land. It does not apply to the farmhouse or the barns, just the land. It also applies to agricultural commodities. For that one, there is no required certification. It's a once and done exemption. The Pennsylvania Inheritance Tax is not as big of a monster in the room as it used to be because of these exemptions. We're very fortunate in Pennsylvania that our legislature recognized the importance of agriculture and the importance of farmland being retained by the next generation. This allows them to continue the family farm. It is a real benefit to our agricultural families.
Capital gains taxes come into the analysis because if you sell something, the capital gains tax that you to pay is determined by your basis in that property. A real simplified explanation of basis is that it is what I pay for something. If I buy an investment property for $100,000, that's my basis. Obviously, it's not as simple as that, but this is a simplified version. If I sell that investment property for $125,000, I have made a gain of $25,000 and that will be subject to the capital gains tax.
If I inherit the family farm when my parents pass away, I get a step up in basis. My basis is the value of that farm at the date that my parents passed away. If my parents gift me the family farm, I take their basis. If they bought the family farm in 1967 for $8,500, that is now my basis if they gift it to me. If they were gifted the property from my grandparents, then their basis was whatever the grandparents paid for it. You can see how when you are gifted an asset or gifted a farm, your basis is very low. Then if you sell an agricultural preservation easement, or if you ever sell any of the farm or part of the farm, there will be substantial capital gains tax implications as a result of that.
If you wait and inherit it, you get that stepped-up basis. Now your basis is the fair market value of the farm, and you won't get hit as hard with capital gains taxes. What we typically tell folks is that it's always better to inherit than to be gifted assets during your lifetime from a purely tax perspective. Unfortunately, there's other considerations in the mix that make it a little bit more difficult to decide whether you should gift or whether you should allow someone to inherit.
Jody, I've heard you say before that the biggest threat to the success of a family farm isn't taxes, it's long-term nursing care. Help us to better understand the implications of Medicaid and the five-year look back in relation to farm transitions.
That's absolutely true. 30 years ago, the biggest threat to family farms were in fact taxes, but now it is long term nursing care. There are a couple ways to look at this and the real issue has to do with the Medicaid program. Now this is Medicaid with a D not Medicare. Medicaid is what will pay for your nursing home care if you medically qualify and if you don't have assets to pay for your nursing home care on your own.
There are two parts to this conversation. One is qualifying for Medicaid and the other one is the estate recovery program. This is where the state tries to get reimbursed for anything that they've paid on somebody's behalf that was on Medicaid. If we look at the first half, which is qualifying, here is an overly simplified version of what the program is: when somebody goes into a nursing home, they'll do what's called a resource assessment. This is a snapshot of what that person owns. Based on that snapshot, they'll determine whether that person will qualify for Medicaid. If not, how much of their own money do they have to spend down in order to qualify for Medicaid?
When they look at the resources that are available to pay for near nursing home care, there are some resources that are not considered to be available resources. For example, your primary residence, a car, and income producing property are not considered to be available to pay for your nursing home care. That means that nobody's going to come knocking on the farmhouse door and say, "Hey, you have to sell the farm to pay for grandma's nursing home care." It doesn't work that way. If it's income producing property, that income will have to be put toward her nursing home care, but the asset will not have to be sold. Everything won't have to be sold to pay for nursing home care.
Someone can qualify for Medicaid and still own income producing property. The problem comes in when that person passes away. When that person passes away, any assets that go through their estate will be subject to the estate recovery program of Pennsylvania's Department of Human Services. This is where they want to be reimbursed. If Medicaid was paid and they paid $40,000 of nursing home care, then they'll put a lien against the estate to be reimbursed $40,000 in nursing home care. If someone in the family wants to retain the assets of the person that passed away, they would need to come up with the funds to pay that estate recovery lien.
Some people say “Okay, well then we don't want that person to die owning the farm, so let's just gift it.” They decide to either give it away or sell it for a dollar. Everybody thinks “If I just sell it for a dollar and I call it a sale, then it won’t be a gift.” That's still technically a gift. The problem with gifting it all away comes when someone fills out a Medicaid application. That application is filled out after they've run out of money, so they're out of money and they need somebody to pay for their nursing home care. Now they file an application with Medicaid. One of the questions on that application is this: have you made a gift within the previous five years? If the answer is “Yes, I have,” then there's a calculation that is done that determines how long the nursing home resident is ineligible to receive Medicaid benefits because of that gift.
Essentially, they divide the value of the gift by the average monthly nursing home cost. That tells you for how many months that nursing home resident is ineligible for Medicaid. Since the nursing home resident has already run out of money at the time of that calculation, you're then in a situation where somebody is going to have to pony up the money and pay for that ineligibility period. Once the ineligibility period runs, then the nursing home resident gets on Medicaid and their monthly bills are paid for that way. If you're making a gift, you want to make sure that you gift it at least five years before somebody's going to need Medicaid, but who knows when that will be?
You've worked with plenty of families transitioning farms over your career. What have you found are the keys to successful transition?
The key is communication. Communicating with everybody that's involved is important. Even those that are off the farm need to know that this is really something that mom and dad want. That they want the farm to stay intact and they want it to go to the next generation to continue farming. Having those open and honest conversations is hard, but I think it's so important.
It is also important to pay attention to the details and following through. It is so easy for folks to get weary and fatigued with the transition process because of the hard decisions that have to be made. People don't want to hurt other people's feelings. They love all their kids the same, but it's impossible to treat all their kids the same or equally. This is where that whole concept of fair doesn't mean equal comes in.
The ones that are unsuccessful are the ones that don't finish. They get halfway through and then they want to avoid the hard conversations. They want to avoid some of the hard realities, and they don't complete the transition, or they don't include all their kids in the conversations about wanting to transition the farm. Some folks get a surprise then after the mom or dad passes away. Now relationships are damaged because some people are questioning the intentions of others.
The last key to a successful transition is starting early. When I say start early, I mean, don't wait till the patriarch is 70 years old. If it feels like it’s too early, then you're probably starting on time because it takes a while. There needs to be some mentorship between the older generation and the younger generation.
As a final sign off question, what is one piece of advice farm families should remember while embarking on a family farm transition?
I would say to assemble a team of trusted advisors that you're comfortable with and that are comfortable with each other to help guide you through this process and give you that little push when you get tired. If you don't want to have that hard conversation, you should have somebody who can give you a little nudge to help you get over the finish line.
The legal aspect of farm transition is such an important topic. Thanks to Jody for helping us understand the implications of Medicaid, taxes and more during this podcast. Jody's recommendation to form a team of advisors to assist in the transition process can especially be a great first step for many farm families beginning this process. To learn more about the mission of Pennsylvania Farm Link, visit PAfarmlink.org.
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