Estate Planning Basics for Farmers

Many farmers, ranchers, and rural landowners have spent a lifetime building their business and caring for their property. Others are just starting out, wondering what their business will become. Regardless of stage of life, farmers or landowners must consider the future.  Planning for death, disability, divorce, or disaster will ease difficult transitions and ensure your wishes are considered. While this task can seem overwhelming at times, information and education is key to smooth transitions. Here we review the basics of estate planning, the process of planning for the distribution of property at death.  You are encouraged to assemble a team of professionals to assist in creating and implementing a customized estate plan. Other publications in this series provide more specifics about business succession and other key planning considerations.

Key Terms in Estate Planning

An estate is created automatically at death and generally consists of any property in which the decedent had a legal interest at death. A decedent is someone who is no longer living. This term is used frequently in the world of estates. An heir is someone who is related to the decedent and can inherit from the decedent under the law.

An estate plan is the arrangement of one's estate for the disposition and management of property at death through the use of wills, trusts, insurance policies, beneficiary designations, and other tools.  The goal of an estate plan is to preserve the maximum amount of wealth possible and lessen the stress of management imposed on the heirs and beneficiaries.

An estate plan typically includes documents such as a will, trust document, and power of attorney.  A will is a written document that disposes of the decedent’s property at death in the way that the decedent wishes. A will must go through the probate process for the property to be distributed appropriately. Probate is the court procedure used to prove that a will is valid and was executed by the decedent. The probate court also oversees the distribution of property, ensures that creditors and taxes are paid, and settles disputes among heirs.

Interests in property come in many forms. Decedents can own property by themselves or in conjunction with others, such as with a spouse or family member. Even if the decedent did not have the right to possess the property, the property can potentially be included in the estate if the decedent had the right to use it or receive income from it.  

Benefits of Estate Planning

A common misconception with estate planning is that only high wealth individuals need an estate plan. This is far from the truth. If you have money in a bank account, minor children, a car, home, or land, you need an estate plan. Without such a plan, your loved ones will have to clean up loose ends. They will likely have to go through the probate process with no direction from you as to your wishes. If you have minor children, the court will have to guess who you wanted their guardians to be. If you are someone with a family business or farming operation, you lose the opportunity to direct whether and how the business should continue after you are gone. Without an estate plan, you also fail to prepare for possible early death or disability. You can avoid these consequences and save your loved ones time, money, and stress if you take the time during life to make an estate plan. Estates plans are not always complicated or expensive. You can customize the plan to meet your specific needs.

Directing the Distribution of Your Property

There are two forms of estate succession: intestate succession and planned succession. Intestate succession gives a decedent no control over the passing of the estate. Planned succession, on the other hand, seeks to honor the decedent’s wishes.  

Intestate Succession

A person who dies without a will dies “intestate,” meaning that the estate is distributed based upon the law of the state where the decedent lived or where the decedent owned real property. State law controls how the property passes from the estate, and the wishes of the decedent are not taken into account.

The court will appoint an administrator, someone to manage the estate through the probate process. The administrator collects the assets of the estate, pays the creditors during the settlement process, and pays the taxes if applicable. The administrator prepares a final report indicating to the court how the property has been disposed of and that all claims and taxes are paid. After court approval, the administrator may distribute the last of the property to the heirs under the intestate laws.

Intestate succession laws differ in each state, but there are many similarities. For example, if a decedent has no spouse or children but has surviving parents, intestate law will typically split the estate evenly among the surviving parents. If the parents have predeceased the decedent, the estate will generally pass through the parents to their heirs, i.e. the decedent’s siblings.

If the decedent dies with a spouse and no heirs, the spouse will usually receive the entire estate. In some states, the length of marriage can affect the spouse’s portion.  If the decedent and surviving spouse were only married for a few years, then the parents of the decedent might still receive property through intestacy.[i] If the decedent leaves shared children with a surviving spouse, then the surviving spouse generally receives the entire estate. The policy behind this rule is that the surviving spouse is expected to provide for the children in the same way that the decedent would have. However, if the decedent leaves children that are from another spouse, the surviving spouse will receive a minimum amount of the estate and the heirs will share the remainder of the estate.      

Testate Succession

A decedent with a validly executed will is a testator. With testate succession, the court distributes the estate as directed by the will or any other testamentary documents, including testamentary trusts. A will gives the decedent control over who will receive the property, as well as how much each beneficiary will receive.

Even with a will, state law sometimes limits the amount of control a testator has over the distribution process. For example, in most states, testators cannot entirely exclude a spouse from receiving an inheritance absent a valid prenuptial agreement. State law usually dictates a minimum amount—called an elective or statutory share—that the spouse is entitled to receive from the decedent, even if the decedent attempted to write the spouse out of a will or trust document.  

Testate succession may also give the decedent control over when an heir can receive the property. With a testamentary trust, the testator can require the trustee to hold property for the benefit of beneficiaries until they reach a specific age or for a specific time. It can also direct the trustee to make available a specific amount each year for the beneficiaries. A trust can also direct the trustee to spend the trust funds as needed for the support and well-being of a beneficiary.

Through a will, the testator can also retain some control over who becomes the guardian over minor children. If children survive the testator and do not have another surviving parent, then the court will look to the will to determine who the testator wanted to care for the children. Courts usually take the wishes of the decedent into consideration when making this determination.

Planning to Streamline the Distribution Process

Probate is the process of proving a will and supervising the distribution of the estate, with or without a will. Probate can sometimes be a long and expensive process. But that is not always the case. If the decedent has very little property and no real property, for example, the heirs may usually transfer the property by filing an affidavit. Most states also have simplified processes in place for “small estates.” Even so, having an estate plan in place will usually help to streamline the process of distributing property at death.

Assets Distributed Outside of Probate Process

To minimize or avoid probate, some choose to use trusts and other tools to take property out of their “probate estate” prior to death. Property titled in the name of a trust passes outside of probate according to the instructions in the trust instrument.  Other property that can pass outside of the probate process includes the following:

• Payable on death accounts (with a valid POD designation)
• Transfer on death deeds (with a valid TOD designation) (not allowed in all states, including Iowa)
• Retirement accounts with beneficiary designations other than the estate
• Life insurance with a beneficiary other than the decedent or the estate
• Property held as a Joint Tenant with the Right of Survivorship (JTRS)

Revocable Living Trusts

Trusts created to avoid probate are called revocable living trusts or will substitutes. The person who creates a revocable living trust is generally the grantor and the trustee. The creator of the trust can use the trust assets for any purpose or change or revoke the trust while living. The trust document names the beneficiaries who are to receive the property at the death of the grantor. It also provides for a successor trustee in the event of the disability or death of the grantor. While a revocable living trust can ease administrative burdens at disability or death, it does not alter tax or creditor liability or Medicaid eligibility. Property owned by a revocable living trust continues to be the property of the grantor for these purposes. It is included in the grantor’s taxable estate. Consequently, property owned by a revocable living trust receives a step up in basis at the death of the grantor.

A revocable living trust may also be useful for keeping the details of a decedent’s property holdings private. In probate, the executor must compile and submit an inventory of every asset in which the decedent had an interest at death. This is a public document. Passing property through a revocable living trust will keep the details of the estate private. Another reason for creating a revocable living trust is to facilitate the transfer of property owned by the decedent in other states. Without a trust, the executor is required to open an ancillary probate action in each state where property is owned. The revocable living trust eliminates this burden.

Despite their advantages, revocable living trusts are not without their drawbacks. A trust generally costs more to create than a will alone. And, the grantor must also create a pour over will to ensure that any property left outside of the trust will be passed according to the plan. A trust also requires lifetime upkeep. Any property purchased must be titled in the name of the trust for the trust to control its disposition. One common error is to create a revocable living trust and then fail to fund it or put assets into it. Any property not titled in the name of the trust will be part of the probate estate. Finally, a trust must still be administered at the death of the grantor. The administration is just not court supervised. Sometimes, particularly where there may be disgruntles heirs, court supervision or statutory timelines built into the probate process may be helpful.

Planning with Business Entities

Many estate plans today include a business entity or two to facilitate the transfer of the business after death. Farmers in particular should consider the advantages of business entities in succession planning.

Limited liability companies (“LLC”) have in the last few decades become the most popular succession planning tool. LLC's generally retain the flexibility of a partnership in organization, but limit liability like a corporation. Another option is a limited partnership ("LP") or a limited liability partnership ("LLP"). Although partnerships offer many tax and transition advantages, general partnerships alone do not provide any liability protection to the owners.

Partnerships and LLCs both usually have a controlling document that is a key component of the estate plan. It may be termed an operating agreement or a partnership agreement, but the name is not really important. The contents of this agreement help determine the succession of the business should one of the owners die. Another advantage of a family entity is the ability to make gifts of ownership interest to children or others to allow them to have an ownership stake in the entity and to potentially lower the value of the interest that would be included in the decedent’s gross estate.

An estate plan with an entity or two is an efficient way to transfer the business, while remaining in control of the business during life. Entity planning should be at least a consideration for a farmer's estate plan and should be a topic discussed with an estate planning attorney to determine if it is a good option for you.