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These 3D's Could Wreck Your Operation

In today's world, there is a real fear that one of the children will get a divorce and the "out-law" who used to be your in-law will walk away with a sizable chunk of the family farm.Anytime you form a relationship, whether it's marriage, a business partnership or a parent or child joining the business, there's some risk that divorce, disagreement or death of one of the people involved will break

In today's world, there is a real fear that one of the children will get a divorce and the "out-law" who used to be your in-law will walk away with a sizable chunk of the family farm.

Anytime you form a relationship, whether it's marriage, a business partnership or a parent or child joining the business, there's some risk that divorce, disagreement or death of one of the people involved will break up the relationship.

"That's unavoidable," say Wayne Wilson and John Dollar, law partners in the firm Wilson, Deege, Dollar & Despotovich, West Des Moines, IA who specialize in wills, estate probate and trusts. Dollar also does a lot of divorce work.

"But losing the business as a result of one of those three 'Ds' is not unavoidable," says Dollar. "Planning for a breakup you hope will never happen can help you avoid disaster."

Plan For Divorce The law concerning splitting up assets in a divorce is clear. Assets accumulated during the marriage are to be split in an "equitable" manner. That means as close to a 50-50 split as possible, says Dollar.

That's pretty uniform law in all states. However, Wilson and Dollar are licensed to practice law only in Iowa. They advise checking with an attorney in your state.

Then do some "breakup" planning. "In situations where gifting makes sense for good estate planning, the parents will say, 'I want to gift it. But if the kids get divorced, I want to make sure that the son-in-law or daughter-in-law doesn't get any of it,'" says Wilson.

Technically, that shouldn't be a problem. "For Iowa's divorce laws (and for most other states), assets received by gift or inheritance are not considered to be assets accumulated during the marriage," Dollar explains. "Neither is property brought to the marriage by one of the persons to the extent it is still identifiable as such in a reasonable manner."

In practice, it's not always that easy.

"Here's where we get into trouble," says Wilson. "Dad and Mom make gifts to their daughter, for example. Daughter puts the money or other asset that was received in joint names with their spouse. Then all bets are off. She may be presumed to have made a gift of half of the asset to her husband - depending on the type of asset."

Creating a joint tenancy on a checking account is not considered to be a gift, says Wilson. But creating a joint tenancy on land is a gift.

The problem comes when the child who has received the gift or inheritance starts mixing things together with his or her spouse.

So What Do You Do? Rule No. 1: If Dad and Mom are going to gift to the son, for example, then the gift should be to the son only if you are really concerned about divorce planning, says Dollar. It should not be to both the son and daughter-in-law in any way, shape or description, unless you feel confident that there will never be a divorce or feel okay about those assets staying with the in-law if there is a divorce.

"In a combined gift/sale situation, it is harder," says Dollar. "Dad and Mom gift son the down payment on land they are selling to him and make gifts as son makes the payments. It's hard to remember years later how much was gifted to the son and how much he purchased.

"You need to document it as much as possible or you risk litigating (fighting in court) how much was a gift and how much was a sale," Dollar warns.

This first rule also applies to inheritances. Leave it to the child, not the child and his/her spouse.

Separate Gifts, Inheritances Rule No. 2: Keep assets received by gift or inheritance separate. Don't let his or hers become "ours."

"In a lot of cases in farm situations, the husband's name shows up on most or all of the assets," says Dollar. "He thinks that has some significance in case of divorce. It doesn't - unless he can trace back to show that the asset was gifted, partially gifted or inherited from somebody to him."

Or he buys the neighbor's 160-acre farm and makes the down payment out of current assets that he and his wife have accumulated and the payments out of profits each year. It's "theirs" - his and his wife's. In case of divorce, it should be split 50-50 no matter whose name is on the deed.

"The court pays no attention to whose name is on the deed," says Dollar. But keeping assets received through gifts or inheritance in separate names makes tremendous sense for divorce planning.

"Somebody will inherit 40 acres," Dollar says as an example. "They will eventually sell or trade that and buy another piece of property and they will put that new piece of land in joint ownership. They roll it over one way or another and it eventually gets lost."

Husband and wife "politics" can be a big problem. A wife (or husband) gets tired of hearing, "Well, we could get divorced some day so I have to keep this separate." A wife (or husband) will often resent her spouse accumulating a big amount in his name while she's accumulating nothing.

To ease the family politics problem, put assets you accumulate together as a result of your efforts (not received through gift or inheritance) in the name of the spouse who hasn't received gifts or inheritances, the lawyers suggest. In case of a break-up, that's going to be split 50-50 anyway.

Estate Planning Conflicts For good divorce planning, you keep assets that have been gifted to you or inherited by you, separate - solely in the name of the recipient.

For good estate planning, however, it's usually best to divide assets evenly between the two spouses. It can be a tax disaster at death if the spouse who owns little or nothing dies first and doesn't get to use his/her federal unified estate tax credit. You can easily be talking more than $200,000 of extra, unnecessary federal estate tax cost.

For good divorce planning, you make gifts to your children only. For good estate planning in large estates, gifts of $10,000/year to as many people as reasonable (usually family members) makes sense. You may want to use the sons-in-law and daughters-in-law to expand the amount you can gift.

With present estate tax law and the best estate tax planning, each spouse should own at least $600,000 of the net worth when the total net worth is $1.2 million or more. When the net worth is less than $1.2 million, neither spouse should own more than about $600,000 of that net worth.

So what do you do if one spouse has received a lot of the assets through gift or inheritance?

Follow Wilson and Dollar's plan where most or even all of the assets accumulated together are titled in the name of the spouse who has not received gifts or inheritances. If divorce planning is important to you, be sure to keep ownership of the gifted and inherited assets in the sole name of the spouse who received them.

Pre-marital Agreements A pre-marital agreement is like writing the divorce agreement before the wedding takes place. The advantage, of course, is that it is done while everybody is happy, rather than when nobody really likes each other very much.

"You really don't see pre-marital agreements much in first marriages of young couples," says Dollar. "They usually don't have a lot of wealth to protect."

However, says Wilson, when you see families with more wealth, you start seeing pre-marital agreements considered even with first marriages. "As a lawyer, I say it doesn't hurt," he adds.

In reality, the pre-marital agreement just follows the law in regard to property owned before the marriage and property that is gifted or inherited, Dollar says.

"The best thing it does, though, is it sets everybody down to take a look at things," he says. "The financial disclosure statement showing what assets each party owns that has to go into the pre-marital agreement is half to two-thirds of the value of the pre-marital agreement in most cases.

"It is saying, 'Here is what I have, here is what you have.' It also says, 'I want you to know that, if something happens (divorce), I'm going to say, this is mine and you are relinquishing a claim to it,' " Dollar adds.

Wilson says, "I see parents sitting down with their children who are ready to get married and saying, 'Look, there is a lot of money at stake here, we want to work you into the operation. If you are getting married and want to be part of this business, you're going to have a pre-marital agreement.' The urban businesses are doing that and the agriculture community needs to get educated on it, too."

Beyond The Law - Negotiate If a couple can't agree on a property settlement, the law will turn that task over to a court (a judge) who will try to make a 50-50 split of assets accumulated during the marriage. But negotiation may be the key to keeping the farming operation going successfully.

"Courts have often recognized that a farming operation is unique," says Dollar. "It's not like somebody's investment portfolio. As a lawyer, I could give my wife half of my investment portfolio, split up and go on practicing law and make a living.

"But you can't take half of the assets from a farmer and expect him to continue to make a living in the same way as before." You rip a big hole in the business.

In many cases, the property settlement in divorce is actually one spouse buying out the other by installment payments, Dollar explains. "The court says you have to give her a million bucks. But it might be $100,000 a year for 10 years."

Then you negotiate some other things.

"In the divorce proceedings, the lawyers can get creative," says Wilson. "Maybe she gets some land but agrees to a long-term lease so the farming operation doesn't lose the use of that land. If she dies, there can be an option to buy or a buy-sell agreement."

Death Of A Partner It has been politically correct to say we need to eliminate death taxes to save family farms. Wilson and Dollar don't see taxes as the biggest problem.

"The problem in business planning and continuation has been when you have four children, for example, and one child is on the farm and wants to continue the business," says Wilson. "The parents say they want to make sure the farming child can continue the farming operation and end up with the assets. But then they insist that all the children be treated equally when it comes to distribution of the farming assets."

First, plan your estate to save taxes and estate settlement costs. There are good tools that can greatly reduce and even eliminate the death costs if you start early enough and are aggressive in using them.

Then look at tools to get the right assets to the right people such as gifts, options to buy, buy-sell agreements and trusts.

One of the easiest ways to transfer assets from one generation to the next is through incorporation of the farming business, the lawyers say. In most cases, however, you do not have the corporation own all of the farmland.

"Incorporation makes it easy to gift assets within the $10,000 a year per person limit," says Wilson.

"The shares of stock will also show a transfer date, making it easy to track when gifts were made and the amount," Dollar says.

"Within the corporation, you can have options to buy and buy-sell agreements once the stock is out of the parent's hands so that, if an in-law ends up with it, the corporation or other shareholders can force him/her to sell," Wilson says. "Say a farm or non-farm son has received shares of stock as gifts and then dies. The daughter-in-law might not have an active role in the business. That could trigger a forced sale of the shares of stock she would own and put those shares back in the hands of the corporation or direct family members."

Options to buy and buy-sell agreements can be funded with life insurance.

In cases where there are several children and only one of them farms with the parents, the parent's estate planning documents may contain an option-to-buy or a buy-sell agreement - or both - that allows the farming child to buy the farm assets from the estate or from the siblings.

The farming child might own life insurance on the parents. It would be an amount to provide cash for the down payment, thus assuring the farming child has cash to exercise the option to buy or to fund the buy-sell agreement.

The key is to look at the goals and objectives of all the family members, then consider the tools to best achieve those objectives. Putting them in place through wills is the final, legal step.

Disagreements Can Destroy You might have two or more brothers who have farmed together with Dad for years. When Dad dies, they might find they can't get along. The breakup can be bitter.

"Even if they have been farming together for years with no written agreement, it's time to put it in writing," says Wilson. "They need to determine who owns what and get that in writing.

"Then they need to write the 'divorce' agreement that outlines what will happen if they decide to break up the partnership in case of disagreement, in case one partner retires and the other is to continue or in case one of them dies."

Like pre-marital agreements, it's easier to write a dissolution plan while everybody is happy than to agree to anything reasonable when they're mad.

A "friendly" divorce was what "Mike" believed he and his ex-wife could work out about eight years ago. The financial scars, however, stretch out to the farming partnership he and his parents operate in Michigan.

As Mike's parents, "William" and "Mary," talk about the effect of divorce on a family farming operation, they don't point fingers of guilt. They just talk about the effects and some things they might have done differently.

"Our partnership was machinery and livestock," Mary explains. Mike had bought a 50% share - mostly cattle because the Top parents rent out the land they own. "His estranged wife got half of Mike's share of those assets as a property settlement."

Timing was the biggest problem.

"When the divorce happened, we were doing pretty good so the child support was set fairly high because Mike's income was good," his father says. Then problems hit and the market fell. Between this and the divorce, their net worth dropped 50% in eight years, he explains.

"It isn't always just the child support," says Mary. "It's also expenses like braces for the children's teeth, and college. No one denies an obligation to pay support for Mike's two daughters. It's the amount and the extras that concerns them.

"Our partnership was set up so each of us could have a 'draw' each month to live on," says William. "They counted that as income from wages for figuring the amount of child support, even though we were paying wages with borrowed money some years because the partnership was losing money. When you have a bad year in farming, it's almost impossible to get the child support lowered. But it has gone up when we had good years."

What would they do different?

"We asked Mike at the time if he needed help and he said, 'No, I have an attorney and I can handle it.' We didn't want to add to the problem so we stayed out and that was probably wrong," says William.

"The first thing you need to do is to get the best darned lawyer you can find for the child going through the divorce. The second is to get your own lawyer for advice on what you ought to do. The third is to document everything," he says.

"Paper yourself to death," Mary adds. "We kept good records for ourselves. But there are other things we probably should have legally documented."

At least ask your attorney to guide you on what records you will need, William adds.

"Most people think this is never going to happen to their family," William says. "But be prepared because it can happen."

Finally... "Our plan was to see this operation going from generation to generation," Mary adds. "Now, it doesn't look like that is going to happen."

Imagine two brothers trying to operate a business if their sister owned a one-sixth interest and each of two cousins owned a one-fourth interest. The sister and cousins have no strong ties to the farming business.

It probably wouldn't work well in most families simply because they all have different goals. Farmers often plow their cash back into the business. Off-farm heirs usually like cash.

When George and Wil Groves started farming with their father, Bill, and Uncle Dick near Kamrar, IA, they had already had a history of planning ahead. Bill and Dick's father helped them get started and designed an estate plan that helped assure they could continue after his death.

"All the land that Dick and Dad had accumulated (some of it inherited), was owned by them in an undivided interest, titled in tenancy in common," Wil explains. "That was pretty scary. We could have become co-owners with our sister and two cousins."

Co-owners of land can demand a division. Trying to make an equitable split when some of the parties don't know much about farming can, to put it mildly, be difficult.

"With the help of a good lawyer and two brothers who always tried hard to be agreeable, the split-up of the land was pretty easy," says Groves. "Dad got the home farm with most of the livestock buildings. The division of land reflected the difference in values."

Wil and George worked for wages for the first several years after they started farming with Bill and Dick. After that "testing" stage, they started buying partnership assets.

"George and I were wide open for risk since we had no equity," Wil explains. "The big concern was if Dick died.

"We owned life insurance policies on both Dad and Dick," he explains. "There was also a buy-sell agreement. When Dick retired, we bought the rest of his partnership interest on contract. Once that was paid down to a comfortable level we dropped the life insurance on him.

"We appreciate the things Dick did to help us get into the business," George adds. "We couldn't have got into farming on the scale we did without the help he and Dad gave us."

Of course, having the business continue had value for Bill and Dick, too.

Now, Wil, 52, and George, 45, are well into their own structure to make sure this farming operation can live on. They have both a partnership and a "C" corporation, plus buy-sell agreements funded by cross ownership of life insurance.

"If either of us were to die or the business was to be dissolved, the buy-sell agreement spells out how it would be done," Wil explains. "It also gives the remaining partner time to buy out the heirs if he wants to."

That allows some transition time and money to replace the management gap if one of the partners left the business for whatever reason.

George's best advice: get the right people working for you - people you have confidence in. His list includes an attorney, an accountant and an insurance agent.

"We were fortunate to have a very good team working with us," says Wil. "They were the ones who got Grandpa to do estate planning and Dad and Dick to get the land divided. We think they also guided us well on the life insurance to fund buy-sell agreements. Their help has made the transition from generation-to-generation a lot smoother."

When two partners broke up their farming operation, the "getting out" or corporate taxes meant double taxation.

In this case, the farm operation was incorporated including the land. When the partners decided to dissolve their farming arrangement, their corporation was likewise dissolved because neither partner chose to continue farming.

Don't get it wrong. Incorporation can be an excellent business structure. It probably saved the partners a good amount of income tax and social security tax during the time they were incorporated.

However, income taxes at dissolution is probably the biggest disadvantage of incorporating a farming business, especially if land is put into the corporation.

Here's what happens: Even though the land was not actually sold (each kept some), when a corporation is dissolved, the tax law treats it as if it is sold. Then, the owners report, as income, the taxable gain on the land from the time they bought it to the time of dissolution.

If the land has a low income tax basis, that can result in a tremendous amount of additional income tax when the corporation is dissolved.

Partners need to plan for the dissolution of the corporation before they incorporate. In doing so, they can avoid the high tax if they need to end the corporation.