Education and medical expenses are exempt from gifting rules

By: Robert Moore, OSU Extension

Gifting can be an important part of a farm transition plan but it is important to understand the tax implications of gifting.  Taxable gifts refer to the total value of gifts given to others during a calendar year, which may be subject to gift tax under the U.S. tax code.  These gifts can include various types of property, money, or assets.  The determination of taxable gifts considers the fair market value of the transferred assets and any applicable exclusions or deductions provided by the tax code.  Currently, an individual may gift up to $17,000 each year to an unlimited number of people.  These annual exclusion gifts are not subject to gift tax.  Gifts made in excess of $17,000 are either subject to gift tax or reduce the lifetime gift exclusion by the amount of the excess gift.  For a detailed discussion of gifting, see the Gifting Assets Prior to Death bulletin at farmoffice.osu.edu. 

In addition to direct gifts, the payment of a bill or expense on behalf of someone else is usually considered a gift.  However, there are two specific exceptions.  The IRS allows education expenses and medical expenses to be paid for someone without being considered a gift.  These exemptions may present opportunities for those who are limited by the $17,000 annual gift limit.

Education Expenses

Paying tuition directly to a school is not considered a taxable gift.  There are two important points to remember regarding tuition payment.  The tuition must be paid directly to the institution, the payment cannot go directly to the student.  Second, the exclusion applies only to tuition payments.  Other school-related expenses like books, supplies, and room and board costs are not eligible for this exclusion.

Consider the following example:  

Dale has a grandchild who attends Harvard.  The tuition at Harvard is very expensive and Dale would like to help his grandchild.  Dale sends a check to Harvard for $50,000 to be applied to tuition.  The $50,000 that Dale paid for his grandchild’s tuition is not considered a gift and therefore does not count toward the $17,000 annual exclusion gift.  Dale could still gift up to $17,000 directly to the grandchild and still not exceed the annual gift exclusion.   

Medical Care

Payments that qualify for the medical exclusion are those made directly to a healthcare provider, medical institution, or medical insurance company for someone’s benefit.  Transportation and lodging costs related to the person’s medical care can also be covered, but there are specific rules, so it is best to consult with a tax professional.  The payments must go directly to the care provider or insurance company, not to the individual receiving care, to avoid it being considered a taxable gift above the annual exclusion amount. 

Consider the following example:  

Waylon and his neighbor Tom are lifelong friends.  Tom is at Waylon’s house for dinner when he begins to have extreme stomach pain and nausea.  Waylon calls 911 and an ambulance takes Tom to the hospital.  Once at the hospital, Tom is rushed into surgery to have his appendix removed.  A few weeks later, Tom receives a bill from the hospital for $25,000.  Waylon knows Tom has been down on his luck financially and he does not want Tom stressed about the cost of the life-saving surgery.  Waylon pays the full $25,000 directly to the hospital for Tom’s surgery.  Additionally, Waylon gifted Tom $10,000 to help cover his lost wages while he recovered.  By using a combination of the medical expense exemption and the annual gift exclusion, Waylon was able to help out Tom with $35,000 without having to pay gift taxes or adversely affecting the lifetime gift exemption.

Estate Planning Implications

Farmers who may wish to transfer wealth to others during their life should keep in mind the annual gift exclusion and the education and medical payment exclusion.  These strategies allow money or other assets to be transferred without negative gift or estate tax implications.  Using these exclusions can help farmers plan their estates by passing on assets, supporting education, and managing healthcare expenses with fewer tax issues. 

Agricultural easements can address farmland preservation and farm transition goals

Questions from farmers and farmland owners about agricultural easements are on the rise at the Farm Office.  Why is that?  From what we’re hearing, the questions are driven by concerns about the loss of farmland to development as well as desires to keep farmland in the family for future generations.  An agricultural easement is a unique tool that can help a farmland owner and farming operation meet goals to protect farmland from development or transition that land to the next generation.  Here are answers to some of the questions we’ve been hearing.

What is an agricultural easement? 

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A Comparison of Business Entities Available to Ohio Farmers

By: Robert Moore, Barry Ward, OSU Extension

Ohio farmers have many choices when selecting a business entity for their farming operations. Choosing the right entity is important, as it can impact issues such as how the business functions, ownership rights, personal liability, and taxation. What should a farmer consider when deciding which type of entity to use for a business? We provide an overview of business entities used for farm operations in this bulletin, compare ten important factors to consider when making the entity selection decision, and highlight the advantages of using a formal business entity. A Business Entity Comparison Chart at the end of the publication summarizes entity characteristics. As with all legal issues, consultation with an attorney is critical to making a successful decision.

Types of business entities

Sole Proprietorship. A Sole Proprietorship is a business owned by a single person who is referred to as the “sole proprietor.” The sole proprietor and the business are one and the same—there is no separate legal business entity. The sole proprietor owns all business assets, is responsible for all liabilities, and reports income as individual income.

Partnership. A partnership exists when two or more individuals or “partners” jointly own and conduct a business for profit. A “General Partnership” consists of partners who each have management authority and personal liability for the partnership and who report income from the partnership as individual income. A different type of partnership, the “Limited Partnership,” allows investors to enter a partnership as “limited partners” without involving them in management and exposing them to personal liability for the partnership.

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Federal Legislation Introduced to Address Farm Estate Taxes

Source: Robert Moore

On July 26, 2023, Representatives Jimmy Panetta of California and Mike Kelly of Pennsylvania introduced legislation related to farm estate taxes.  The proposed bill seeks to increase the limit on the deduction that can be taken by farmers under Section 2032A of the Internal Revenue Code (IRC).  The 2032A provision in the IRC allows farmers to value their land at agricultural value, rather than fair market value.  However, the current law limits the deduction to $1.16 million.  This relatively small deduction can limit the usefulness of 2032A for some farm estates.

Consider the following example:

Farmer’s estate includes 500 acres with a fair market value of $5,000,000.  The agricultural value, allowed by 2032A, is $4,500/acre or $2,250,000.  The difference between the fair market value and the agricultural value is $2,725,000.  So, by using 2032A valuation, the land value can be reduced by $2,725,000.  However, 2032A limits the deduction to $1,160,000.  Therefore, Farmer’s estate can actually use less than ½ the reduction in land value.

The newly introduced legislation would increase the 2032A deduction limit to the federal estate tax exemption, currently $12,900,000.  Applying the proposed legislation to the above scenario, Farmer’s estate would be able to deduct the entire $2,725,000.

The farm value of farmland is determined by a formula included in the IRC.  The value is the net cash rent of comparable land less real estate taxes divided by the Farm Credit System Bank interest rate, which is 4.57% for a 2022 Ohio estate.  Let’s assume the fair market cash rent for a farm is $220/acre less $50/acre for taxes.  Dividing by the interest rate, we get a value of $3,720/acre.  The 2032A rate (farm value) is usually 1/3 to ½ of the fair market value. Continue reading

Is a Handwritten Will Valid?

By: Robert Moore

 

You may have seen the news story about Aretha Franklin’s will.  Aretha, the famous singer, died in 2018.  A will executed in 2010 was originally thought to be her last will and the document that controlled the distribution of her assets to her heirs.  The 2010 will appears to have been a formal will, prepared by an attorney, and properly executed by Franklin.  However, a 2014 handwritten will was later found in a notebook in Franklin’s couch.  Some of the heirs of Franklin’s estate disputed the validity of the 2014 will.  The 2010 left Franklin’s home to three sons while the 2014 will left her home to only two sons.  The issue was recently resolved by a Michigan jury.  The primary issue was: can a handwritten will be a valid will?

The answer in most states, including Ohio and Michigan, is yes.  Known as a holographic will, a person can write their own will and the will can be valid provided it is signed and witnessed by two adults.  Generally, the holographic will must be in the person’s handwriting to confirm that they did, in fact, write the will themselves.  So, even a will written by hand on notebook paper found in someone’s couch, like Aretha’s will, can be valid.  Presumably, two witnesses were present when Franklin signed the handwritten deed.  A few lessons can be learned from Aretha Franklin’s situation:

  • Revoke the prior will.  When executing or updating estate planning documents, the new or updated documents should clearly revoke the prior relevant documents.  If Aretha’s 2014 will would have expressly revoked her 2010 will, the matter may not have gone to court because her intent to use her 2014 will would have been much clearer.
  • Every requirement of a will matters.  If Aretha’s will would not have been signed, it would not have been valid.  The law vigorously enforces the technical requirements of estate planning documents.  An unsigned will is typically not enforceable even if it is clear the person intended to use the will but did not sign it in error.  Aretha’s will met all the requirements of a holographic will in Michigan and was deemed valid.
  • Secure your estate planning documents in a safe location and make sure someone knows where they are.  Whether a desk drawer, safe or filing cabinet, your estate planning documents should be held in a protected location and the executor and/or heirs should be aware of the location of the document for easy access.  Also, the law firm drafting the documents usually retains a copy in their files.
  • Put a “No Contest” clause in your will.  A No Contest clause disinherits any heirs who challenge the validity of a will.  If Aretha’s 2014 will had included a No Contest clause, the son disputing the will may have not initiated the lawsuit in fear of losing his inheritance in her valuable song royalty rights.
  • Every change in an estate planning document should be a formal change.  Scratching out a line on a will or adding a provision by hand will likely not be effective.  If a change needs to be made to a document, a formal amendment should be drafted and executed or the document should be changed and re-executed.
  • Casual execution of documents can cause conflict among heirs.  Because Aretha took a more casual approach to her 2014 will, heir heirs ended up in a lawsuit and family relations are likely strained.  Have an attorney assist with your documents so that formalities are followed and conflicts among heirs are minimized.
  • Take the time to visit with an attorney for your documents.  No one likes spending money on legal fees but a modicum of legal fees preparing estate planning documents can save heirs many thousands of dollars in litigation fees.

Not All Trusts Protect Assets

By: Robert Moore

How Do Retirees Define A 'Comfortable Retirement' And Should That Matter To You?

A common misperception is that all trusts protect assets from creditors, lawsuits, and nursing homes.  While some trusts do protect assets, many trusts do not.  In fact, most trusts are not designed to protect assets but instead to only transfer assets at death.  Knowing the difference between the different types of trusts is important to ensure that your trust meets your expectations for asset protection.

There are generally two different types of trusts – revocable and irrevocable.  A revocable trust is the typical estate planning trust most people use.  Because the revocable trust can be changed and assets transferred into and out of the trust, it provides no asset protection.  Essentially, if the owner/grantor can access the assets of the trust, then so can creditors.  If you can make changes to your trust and transfer assets in and out of the trust, you probably have a revocable trust.

An irrevocable trust can protect assets.  The concept of an irrevocable trust is to establish a trust that cannot be changed (with a few exceptions), transfer assets to the trust and then relinquish the right to withdraw the assets back out of the trust.  Additionally, someone else serves as the trustee to manage the trust assets.  Since the original owner of the assets no longer has access, control, or ownership of the assets, then creditors cannot access them.

It is important to keep in mind the five-year lookback rule for Medicaid.  This rule causes ineligibility for Medicaid for gifts that were made within five years of Medicaid application.  Due to this rule, establishing an irrevocable trust to protect assets from nursing home costs must be done well before the assets become at risk.

While an irrevocable trust is useful to protect assets, the irrevocable nature of the trust is a significant negative feature.  Once the irrevocable trust is established and the assets transferred, it cannot usually be undone.  Even if circumstances or goals change over time, the irrevocable trust stays in place and the assets stay in the trust.  A revocable trust, on the other hand, is flexible and can be changed as circumstances and goals change.

Sometimes a trust will include “revocable” or “irrevocable” in its name, making it obvious the type of trust.  However, many trusts do not indicate in the name if it is revocable or irrevocable.  In that case, the trust document must be reviewed to determine the type of trust.  Typically, within the first few paragraphs of the trust document, the trust will be clearly identified as either revocable or irrevocable.

Some estate plans include both a revocable and irrevocable trust.  Assets to be protected are transferred to an irrevocable trust and assets the owner wishes to retain control over are transferred to a revocable trust.  Having two trusts increase the costs of both setup and administration but it is an option for many people.

Anyone with a trust should verify the type of trust they have.  It is common that someone believes their assets are protected by their trust only to find out too late that they actually have a revocable trust and their assets are subject to nursing home costs.  A revocable trust can be converted to an irrevocable trust at any time prior to death.  If there is any doubt as the type of trust, review the trust with your attorney to be sure it meets your estate planning and asset protection goals.

Your Trust and Retirement Accounts

By: Robert Moore

How Do Retirees Define A 'Comfortable Retirement' And Should That Matter To You?

Revocable trusts are an important estate planning tool that is utilized in many estate plans.  Most assets can be held in a revocable trust but there are exceptions.  One such exception is retirement accounts like an IRA, 401k or 403b.  These types of accounts should not be owned by a trust and a trust should only be the beneficiary in limited circumstances.

A qualified retirement account can only be owned by an individual.  There are many rules and restrictions related to changing the ownership of a retirement account.  If you transfer a retirement account to your trust, there will likely be penalties assessed and income tax due.  Do not transfer ownership of your retirement account without consulting your tax advisor and financial advisor.  Generally, transferring a retirement account to a trust is not advised.

A trust can be made the beneficiary of a retirement account but, again, caution should be used.  Trusts usually pay higher income tax rates than individuals.  Also, it is often easier for an individual to manage an inherited retirement account than it is for a trustee to manage a retirement account on behalf of a trust.  So, it is usually best to have retirement accounts inherited directly by the beneficiaries rather than be held in trust for beneficiaries.

There are times when naming your trust as the beneficiary of a retirement account is appropriate.  The potential for higher taxes and more cumbersome administration can be offset if the retirement accounts should be managed by the trustee due to concerns with the beneficiaries.  Some situations that might justify using a trust as a retirement account beneficiary include minors as beneficiaries, concerns with marriage of beneficiary, the beneficiary’s inability to manage assets and providing creditor protection.  Particularly when a retirement account may involve large amounts of money and concerns about the beneficiary, naming the trust as the beneficiary may be warranted.

In all situations, the retirement account should have at least one beneficiary named.  If no beneficiaries are named, the account will go through probate and the administration burden on the executor and trustee will be significant.  Be sure to double-check all retirement accounts to be sure a beneficiary is named.

The integration of retirement accounts in estate planning is an important component of most people’s attempt to transfer assets to the next generation.  Be sure to discuss your retirement accounts with your attorney, tax advisor and financial advisor.  Making changes to the beneficiary designations of retirement accounts is a relatively easy process but knowing whom to name as the beneficiary should include careful analysis and consultation with your advisor team.

What Assets are Subject to Divorce?

by: Robert Moore, Attorney and Research Specialist, OSU Agricultural & Resource Law Program

A well-known statistic is that one-half of all marriages end in divorce.  While there is some debate as to the accuracy of this statistic, there is no doubt that many marriages do end in divorce.  According to Ohio law, all marital assets are to be divided equitably in the event of a divorce.  Equitable does not necessarily mean equal although an equal division of assets between the spouses is often the result.  It is important to note that only martial assets are subject to the equitable division between the spouses.  Non-marital assets, or separate assets, are retained by the spouse who owns the asset.

Separate assets include the following:

  • An inheritance received by a spouse during marriage
  • A gift received by a spouse during marriage
  • Property acquired by one spouse prior to the date of marriage
  • Passive income and appreciation from separate property by one spouse during marriage

The above list would seem to make it an easy exercise to determine what are marital assets and what are separate assets in a divorce.  However, like many legal issues, this is often not the case. Determining whether an asset is a marital assets or a separate asset can be complicated.  For example, Ohio law also provides that the following is a marital asset:

“… all income and appreciation on separate property, due to the labor, monetary, or in-kind contribution of either or both of the spouses that occurred during the marriage.”

So, it is possible for an asset to be partially a marital asset and partially a separate asset.

Consider the following example: Continue reading