05-Tax Considerations.2007.11.06

05-Tax Considerations.2007.11.06 - Tax Considerations Tax...

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Tax Considerations Business Arrangements Page 1 Tax Considerations of Farm Transfers (Revised 6 November 2007) Introduction There are alternative methods of transferring farm assets from one generation to the next. The most common methods are by sale, by gift, by transfer at death, by trade, or by transferring to a business entity. The income, gift and estate taxes differ among the alternatives. This section discusses the tax impact of the alternative methods. However, taxes are only one of several factors that should be considered when choosing a method for transferring the farm. Good business management, equity among heirs, security for the exiting generation and other personal and family goals should be considered as well. Several different taxes are imposed on owners and operators of farm businesses such as local property taxes, state sales taxes, state and federal employment taxes, self-employment taxes, state and federal income taxes, federal gift taxes and state and federal death taxes. The method of transferring the farm business has a bigger impact on the income, self- employment, gift and death taxes than on the other taxes. Consequently, this section discusses the effect of each method of transferring the farm on those taxes. The tax rules are illustrated by using Bella Acres as an example. A snapshot of the FMV and basis and assets owned by members of the Bella Acres family is in the appendix to this chapter. Sale If the farm is transferred by sale at the fair market value of the assets, there are no gift or death tax consequences. However, the seller must report the sale for state and federal income tax purposes. The income from the sale of some of the assets is also subject to self-employment tax. Measuring gain or loss . Sale of farm assets is an event that requires the seller to recognize gain or loss realized from the sale of the assets. Gain or loss is the difference between the amount realized from the sale and the seller’s income tax basis in the asset. The seller’s income tax basis is generally the amount the seller paid for the asset, reduced by any part of that cost the seller has deducted as a business expense. Example 1. If Grandpa sold his cows to Bill and Carl for their $130,000 fair market value, he must report the full $130,000 sale price on his federal and state income tax returns. That is the difference between the $130,000 sale price and Grandpa’s zero basis in the herd. His basis is zero because he raised all of the animals in the herd and deducted the cost of raising them in the year he incurred the expenses. Grandpa has not made a gift, so there are no gift or death tax consequences from the sale. Example 2. If Dale sold one-half of his machinery to Bill and Carl for its $58,934 fair market value, he must report the $50,500 of gain as calculated below on his federal and state income tax returns. Sale price (50% of $117,868)
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05-Tax Considerations.2007.11.06 - Tax Considerations Tax...

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