Written by Riley Cronen, Tax Supervisor
Effective farm succession planning is essential to ensure a smooth transition of your agricultural business to the next generation while minimizing estate tax exposure. What does this look like, in practical terms?
We have three examples of farm families, with parents who are 65 and holding $3 million of deferred income in grain, prepaids, and equipment with zero basis. Their children live off the farm, and none want to farm.
- Ole and Lena want to retire and have not done any exit planning.
- John and Jane are also starting to plan retirement at 65, and file Schedule F.
- John and Jane (S Corporation) are the same couple and the same facts, with one change: they start an S corp instead of filing Schedule F.
What are the strategies these couples could take?
Ole and Lena plan to take $1 million per year over three tax years, which lets them manage their tax brackets rather than recognize everything at once. They will invest the after-tax cash in a taxable fund and assume a 7% return. They will then draw 4% of the investment each year beginning at age 73 to fund retirement.
Under this approach they pay about $420,000 in income tax and $49,660 in self-employment tax each year. That leaves $530,341 of after-tax cash annually, or $1,591,022 in total. Their investments are projected at $2,885,534 at age 80.
| Ole and Lena (Schedule F, cash out over 3 years) | Annual | Total |
|---|---|---|
| Taxable income | $1,000,000 | $3,000,000 |
| Income tax | ($420,000) | ($1,260,000) |
| Self-employment tax | ($49,660) | ($148,979) |
| After-tax cash | $530,341 | $1,591,022 |
| Value of investments at age 80 | $2,885,534 |
John and Jane as Schedule F tax filers spread their $3 million of deferred income over five years and use a cash balance plan to keep tax deferral going through age 80 and beyond. They fund the plan with $600,000 per year, which reduces their taxable income to zero. The trade-off is that they must still pay self-employment tax on those contributions, about $38,947 per year ($194,735 in total).
Their after-tax cash is $561,053 per year, or $2,805,266 in total. The cash balance plan grows at 7% per year, and they take taxable distributions averaging 4% per year beginning at age 73. Their investments are projected at $4,769,403 at age 80.
| John and Jane (Schedule F, cash balance plan) | Annual | Total |
|---|---|---|
| Cash balance funding | $600,000 | $3,000,000 |
| Self-employment tax | ($38,947) | ($194,735) |
| After-tax cash | $561,053 | $2,805,266 |
| Value of investments at age 80 | $4,769,403 |
John and Jane as S Corp tax filers have a slightly revised strategy. The S corporation holds the cash balance plan, the farm operations, and the $3 million of deferred income. Taxable income is still reduced to zero through the plan contributions.
The difference is in payroll taxes. Instead of self-employment tax on the full $600,000, they pay payroll taxes only on reasonable S corporation wages, estimated at $100,000 per year. That comes to $15,300 annually, or $76,500 in total, versus $194,735 as Schedule F filers.
Their after-tax cash is $584,700 per year, or $2,923,500 in total. The plan again grows at 7% per year, with taxable distributions averaging 4% per year beginning at age 73. Their investments are projected at $4,970,421 at age 80, about $201,000 more than as Schedule F filers.
| John and Jane (S corporation, cash balance plan) | Annual | Total |
|---|---|---|
| Cash balance funding | $600,000 | $3,000,000 |
| Payroll tax | ($15,300) | ($76,500) |
| After-tax cash | $584,700 | $2,923,500 |
| Value of investments at age 80 | $4,970,421 |
Takeaways for planning your farm retirement
Two different couples with the same financial situation have three every different financial outcomes based on their strategies. There is no one-size-fits all approach to an exit.
If you’d like help building a forecasting process suited to your business, or want a second set of eyes on your current approach, please contact our office to speak with one of our expert advisors. If you have questions or would like to discuss your unique situation, please contact our agribusiness tax team. Call Christianson at 888‑852‑5937 or fill out the form below.
This article is for general educational purposes only. Figures are illustrative and rely on the stated assumptions. Please consult an advisor about your individual situation.
