Strategies for Avoiding Federal Estate Tax

Key Takeaways:
  • The change in the federal estate tax exemption is 18 months away (Jan. 1, 2026) so time is running out.
  • For many farmers, the tremendous appreciation in the value of land and equipment over the past several years may have, indeed, elevated their estates to estate tax territory.
  • Farmer’s estate may also be liable for state estate taxes, depending on where the farm is located.

 

Estate planning these days is focused heavily on pushing value down below the federal estate tax exemption of $13.6 million (or $27.2 million for married couples). Estates that exceed those exemption levels are subject to the 40% marginal federal estate tax.  

These are big numbers, and most farmers will look at them and think they would never have to worry about estate taxes. But consider these two factors: 

  • The federal exemption is scheduled to be slashed in half as of Jan. 1, 2026, pushing thousands of taxpayers’ estates into estate tax territory.  
  • For many farmers, the tremendous appreciation in the value of land and equipment over the past several years may have, indeed, elevated their estates to estate tax territory. If you have any question about the size of your estate, it may be time for a valuation. 

How the Estate Tax Works 

The federal estate tax is a marginal tax, meaning it applies only to the portion of an estate that is above the federal exemption. In other words, if an unmarried farmer dies and their estate totals $16.5 million, to calculate the estate tax you would subtract $13.6 million (the current amount that is exempt from the estate tax) from the estate’s value of $16.5 million.  

The remainder is $2.9 million. The federal estate tax would be applied only to this “marginal” amount, not the full value of the estate. Hence, the 40% estate tax in this case would total $1.16 million.  

But consider what could happen if that same farmer were to die after Jan. 1, 2026, when the estate tax exemption is scheduled to be reduced to about $7 million.

The marginal portion of the estate subject to the estate tax then would be $9.5 million, and the estate tax would be $3.8 million – more than a 200% increase. 

In addition, the farmer’s estate may be liable for state estate taxes, depending on where the farm is located. Kansas and Arkansas do not have a state estate tax. Nebraska also has no estate tax, but it does levy an inheritance tax on beneficiaries. 

(An estate tax is levied on the estate of a deceased person, and the tax is paid out of the proceeds of the estate. An inheritance tax is levied on the beneficiaries of an estate after the estate’s proceeds have been distributed.) 

How an Estate is Valued – Implications for Farmers 

The calculation of an estate is fairly simple. It is based on the value of total assets minus liabilities. 

For farmers, this means the value of land, farm vehicles, equipment, livestock, accounts receivable and other farm-related assets are added to the value of personal assets such as bank accounts, investments and retirement plans, houses, property, vehicles and other items. Liabilities such as farm and personal debt are backed out of the total to reach the final calculation of estate value. 

With many houses these days valued at $500,000 or more, land going for $2,000 to $10,000+ per acre, depending on its use, and new combines costing over $1,000,000 in some cases and tractors at $400,000 or much more depending on the type, it’s easy to see how a farmer’s estate can exceed the federal estate tax exemption before the owner is even aware.  

That’s why estate planning is even more critical today for farmers than in the past, and must be considered an on-going process since the estate tax is poised to affect more taxpayers and the value of land and other assets continues to rise. 

Estate Planning Strategies for Farmers 

For farmers concerned about avoiding estate taxes, several strategies can be utilized to lower the overall value of their estates or place assets into entity structures that will protect them. Here are a few: 

  • Gifting: In anticipation of the change in the federal estate tax exemption, many farmers have already begun gifting portions of their land and other assets to family members who will take over the farm operation after the owner dies. Gifting must be done in consultation with a trusted advisor, as there are tax consequences for all parties. 
  • Legacy Trust: A farm owner and his son manage the farm together and the son has begun to build his own equity. They have started to transition the operation to the son, and there’s a grandson just graduating from high school who will also join the team. The owner established a legacy trust, which is an irrevocable trust that allowed him to set aside assets for his son and grandson. The trust functions as a separate estate, which minimizes the impact of estate taxes and protects it from creditors. The legacy trust doesn’t prohibit the land from being sold, but it does protect the corpus. The trust will last for 250 years, during which time it will never be included in any of the heirs’ estates. If the land were to be sold, the proceeds could not be distributed until the trust expires after 250 years.  
  • Revocable Trust: A revocable trust bypasses the probate process when an owner dies, which significantly simplifies the transfer of the estate for the heirs. These are commonly used by farm owners. One advantage is that there is no requirement to file a tax return for the trust until the owner dies. As the name suggests, a revocable trust can be altered or cancelled by the grantor during his or her lifetime. 
  • Irrevocable Trust: An irrevocable trust moves the assets from the grantor’s control to that of the beneficiary, consequently reducing the value of the person’s estate and protecting the assets from creditors. Irrevocable trusts cannot be amended or cancelled without permission of the trust’s beneficiaries or by court order. (Rules vary by state.) For a farm owner, an irrevocable trust lowers the value of their estate for estate tax purposes. 
  • Limited Liability Corporation (LLC) or Limited Partnership (LP): Putting the land portion of the estate into an LLC or LP can bypass probate. An LLC typically has two or more partners, each of whom has limited liability and each of whom has decision-making responsibilities. An LP also has two or more partners, but only one assumes full liability and decision-making responsibilities. Assets that are in LLCs or LPs are discounted in value from what they would be without that structure, due to the reduced authority of the owner to make decisions. If an LLC has five members with equal decision-making authority, any one member has no more than 20% control over the assets. This results in a marketplace discount that can, for example, dilute the value of a $15 million estate down to $11 million, which is below the current federal exemption. 
  • Charitable Lead Trust: A charitable lead trust is a type of irrevocable trust that provides for regular payments to a designated charity for a specified period of time such as 20 years, then distributes the corpus of the estate to beneficiaries. It allows beneficiaries to inherit larger sums than they would without it.  

Oftentimes a “trust protector” is appointed to help oversee a trust. This is a person who is completely removed from the process and independent – possibly a lawyer or a banker – who can disband the trust if there is a legitimate reason for doing so. For example, if the government changed tax laws in such a way that the trust was severely disadvantaged, the trust protector could step in. But they could not terminate the trust simply at the request of a beneficiary. 

Time is Running Out 

The change in the federal estate tax exemption is 18 months away, and it’s anyone’s guess whether Congress will step in and make the current exemption permanent. There is no longer any time left to wait for that.  

If you have not begun the process of updating your estate plan, contact an Adams Brown farm CPA.