Trust Breached: A Hidden Estate Planning Risk
It’s important to consider all factors when making out an estate plan. Trusts are a common estate planning tool, and can provide significant value when used properly; however, trusts also lack certain important legal rights that people and corporate entities have, including the right to file bankruptcy. In 2024, Judge Thad Collins, the chief bankruptcy judge for the Northern District of Iowa, decided a case called In re: Vera Welte Testamentary Trust. When Vera Welte died, she left farmland to a trust with her will, naming her son as the beneficiary. The son needed to borrow money and had the trust pledge a mortgage on its land to secure those debts. When the son couldn’t pay those debts, the creditor sued to foreclose the mortgage. In response, the trust filed bankruptcy. Judge Collins was asked to decide whether the trust was eligible to file bankruptcy. The Bankruptcy Code says that, in general, a “person” can file bankruptcy, but then broadly defines “person” to include individuals, partnerships, and corporations. “Corporation,” in turn, is broadly defined to include entities people would generally think of as corporations, but also a “business trust.” Unfortunately, the Bankruptcy Code does not define “business trust.” To fill this void, courts have developed a six-factor test, with the most weight being given to whether the trust was created and maintained for a business purpose. It’s not sufficient for a trust to merely conduct business operations—business operations must be its primary purpose, not a side effect. The problem becomes apparent: A testamentary trust isn’t created or maintained for business purposes. It is created to facilitate the grantor’s estate planning wishes by protecting and preserving the property in the trust for the beneficiary’s benefit. That’s why Judge Collins dismissed the case—since the trust was not created for a business purpose, it was not a business trust and therefore was not eligible to become a bankruptcy debtor. Make Your Wishes Clear After the dismissal, the creditor foreclosed its mortgage and sold the trust’s land at a sheriff’s sale. Vera Welte could have prevented this outcome by prohibiting the trustee from mortgaging the trust’s land to secure other debts, even though most trusts give the trustee broad powers to pledge the trust property to secure debts. The trustee, too, could have prevented this by refusing to sign the mortgage—but perhaps she thought that the son, as the trust’s beneficiary, was only pledging land that was ultimately his, so it was his business if he wanted to do that. If the son had owned the land himself instead of being the trust’s beneficiary, then he could have filed bankruptcy himself and stopped the foreclosure. While there were several opportunities to prevent this outcome, they share a common thread: The testamentary trust. Moreover, while the business purpose test was determinative in Vera Welte, other typical features of estate planning trusts made it difficult for this trust to satisfy some of the other factors in the six-factor business trust test. Trusts are powerful tools. They can reduce taxes, avoid probate, facilitate distribution of complex assets, allow for assets to be distributed to heirs over time or based on conditions, maintain privacy, protect assets from creditors, and avoid will contests. They can serve many functions in an estate plan. But it is essential to also recognize their limits. Nobody plans to experience financial distress, become unable to pay their creditors, and file bankruptcy—but it can happen. In addition to concerns about cost and losing a step-up in basis, property owners and their estate planning attorneys who consider establishing trusts should carefully contemplate the likelihood that the trust will not be eligible to file for bankruptcy if the trust, or its property, becomes subject to debts that cannot be repaid. It may be appropriate to restrict the trustee’s powers to pledge trust assets to secure non-trust debts, set a date certain when the trust’s property will vest in the beneficiary, or use a different tool to accomplish the grantor’s goals. If your estate-planning attorney has recommended setting up a trust for your farm or business property, reach out to knowledgeable staff at Ag & Business Legal Strategies to discuss the bankruptcy implications of doing so. We can help you and your attorney account for this threat to carrying out your last wishes. or Call us at (319) 363-1641 At Ag & Business Legal Strategies, we want our clients to be honest with themselves and have a solid business plan. Our team will help you create and execute that business plan, and, if necessary, assist you with the legal, tax, and practical aspects of debt restructuring or bankruptcy. Don’t wait for the problems to become insurmountable. Connect with someone you can trust today, not tomorrow. https://www.ablsonline.com/contact/
Putting the ‘Success’ Into an Effective Succession Plan
If you’re an older farmer with land and business assets, or even a younger one who owns property and you’ve started a family, chances are you’ve worried how those you leave behind will be taken care of after you’re gone, and how your farm’s legacy will live on. While I encourage anyone to write a basic last will and testament with an attorney’s advice, farmers and business owners generally need more than that, in the form of succession planning. Its aim is to establish the means by which you will transfer your farm or business to heirs or otherwise set up an exit strategy from the operation. Among business owners, farmers particularly feel a special tie to their property and especially want to see its purpose continue, within the family line if at all possible. A succession plan is the most effective way to achieve those goals. Why a Succession Plan? Several decades ago, Mother Nature often reminded farmers at a younger age it was time to pass the reins to a younger generation. Agriculture was more taxing on older generations who didn’t have the equipment and technology we do today, plus there seemed to be fewer roadblocks and expenses for the children of older farmers to work in and then take over the family operation. The Farm Crisis of the 1980s removed a lot of generational wealth from farm families and sent many would-be farmers and ranchers into off-farm careers. Partly because of this—and the tax consequences associated with transferring property while still alive—many farmers who were able to keep their land continued actively managing it for a longer time, until a child or grandchild showed ability to take over management. If this did not happen, they sold it or they bequeathed it to heirs upon death. According to Iowa State University figures, two-thirds of the state’s farms are now owned by people over the age of 65 and almost 40 percent are owned by those over 75. Of course, emotions also play into planning for the future of one’s land and operations. There’s an old saying that if you love what you do, you’ll never work a day in your life. While this may not strictly be true when it comes to the many demands of a farm, the fact is that farmers enjoy the work and the sense of purpose and accomplishment. For this reason, many find it difficult to imagine stepping back and giving up control even to a trusted heir. This is even harder if the farmer doesn’t feel confident in a clear heir to take over. Another major factor is the requirement to face one’s own mortality, since we are not a culture that comfortably discusses death. But careful planning is necessary to ensure the legacy of your work lives on, and that your heirs are well cared-for and face fewer financial consequences as recipients of your estate. Basics of the Succession Plan Your succession plan begins with a clear balance sheet that lists your assets and liabilities. You may want assistance with this from a local financial planner or certified public accountant (CPA), if you don’t already have one with whom you work. They can also provide you a written reviewof the tax consequences of your decisions—for example, if you wish to sell or transfer any assets while still living—and an evaluation of what your assets are realistically worth. Next, what is the intent of your succession plan for heirs? This depends not only on their desire to farm or manage the operation, but also on your comfort with their ability to do so. Is there one child who is clearly qualified to take over, but you worry you cannot divide assets enough to keep the farm intact for them and still provide your other children with an equitable inheritance? Situations like this require tough conversations. I advise speaking with each of your intended heirs to make your wishes clear and ask their opinions, and perhaps even holding a family meeting to discuss options and get feedback. This is not something you should leave unsettled at your passing. I’ve worked with farmers who say, “I don’t want to deal with who gets what; they can sort it out after I’m gone.” This has led to far too many siblings seeing their last civil conversation take place across the grave. As an example, one farmer I worked with arranged for his real estate holdings to be put into a trust when he died, to be accessed and managed equally by his children. He set it up so if one of them needed to withdraw from the assets, the other three siblings received equal payouts. This gave all incentive to participate in management of the farm and its revenue stream, as well as equal say on any loans to be taken out on the properties. He understood his children had the sort of relationship for which this worked best for them, but you may need to set up your plan differently—and that’s all right. Next, consider the urgency of your need for a succession plan, and realistic financial considerations. Are you in good health that gives you time to plan? Or are you ill? Is your spouse or a child ill? Has a child passed on and left a spouse or grandchild who may need immediate assistance? Do you need to plan for any gifting or transfer of assets in your lifetime, or will you leave it all until your passing? In this vein, it may be helpful to consider your assets in separate groups rather than a mass inheritance. For instance, farmland value tends to remain evergreen, while the state-of-the-art tractor you just purchased could be obsolete in 10 years thanks to technological upgrades. Perhaps you should transfer equipment sooner than later to a farming heir, while they can use it. Another consideration might be if you mandate that the farm continue to be operated as it is under your management and, if
Death and Taxes is How We Lose It: The Importance of Succession Planning for American Agriculture
The hit TV show “Yellowstone” has achieved popularity with agricultural and non-agricultural audiences alike. Along with dramatized glimpses of ranching life, it also provides nuggets of truth with real world application. In a recent episode, while facilitating the sale of a family farm where one sibling couldn’t afford to buy the other out to retain the ranch, a real estate agent simply stated “Horses and cattle may be how the West was won, but death and taxes is how we’re gonna lose it.” Though that is certainly an oversimplification, the fact remains that failing to plan for the transition of a farm or ranch to future generations, and the tax consequences of those transfers, can result in the forced sale of some or all of the operation, many times to someone outside the agriculture field. Making a plan for the future can be intimidating, as it involves confronting mortality and making business decisions intertwined with family dynamics. Fortunately, there are steps that producers can take and resources available to make the process less overwhelming. Step 1 – Know What Makes Up a Succession Plan A common misconception is that succession planning is just a different term for estate planning. In reality, estate planning is just a portion of the process that works alongside a comprehensive plan to move the operation from one generation to the next, including the transition of decision-making power and the management and work responsibilities of the operation. In order to facilitate a successful shift, a succession plan typically includes steps that develop the next generation’s knowledge and participation in the operation, making it important to begin planning as soon as there is an indication that the next generation is interested in taking over when the current generation is ready. A thorough plan will consider the strengths and weaknesses of each of the parties to the transition, goals for the operation’s future, and potential threats or obstacles to the operation’s success. The key ingredient for a succession plan is detail, as it reduces the risk of misunderstanding, so the more that can be put in writing, the better. Step 2 – Know the Specifics of Your Operation Familiarity with one’s operation includes both quantitative and qualitative aspects. It is important for everyone involved to know the status of the operation’s finances and resources. This allows the feasibility of future operations to be assessed and also provides clarity for the successor about the situation into which they will be stepping. An accurate inventory of all resources, including tangible assets, support services, and people willing to assist is important information to flesh out the assessment. State extension programs can provide assistance in analyzing these values to gain an even better long-range picture and develop a financial plan. The qualitative specifics are more individually based and require some introspection and honesty from the parties. Each person involved in the transition should work to clearly identify their own wants and needs for the operation before sharing that information with other family members. In doing so, they will likely avoid some of the difficulty that may come from trying to voice opinions about the future of the operation and wanting to avoid “stepping on toes.” Individuals should also be aware of the strengths and weaknesses they bring to the transition and whether those characteristics lend themselves to continuing the same operation procedures or whether a change is in order. Once those individual visions and assessments are complete, all stakeholders should work together to create a central vision statement around which the succession plan will be formed. Step 3 – Formulate a Plan Once the broader vision statement is established, focus can shift to creating more specific objectives and goals that achieve that vision, while factoring in the inventory of resources available. Feasibility, attainability, and timeliness are necessary considerations when forming these goals and objectives and must remain a priority throughout the planning process. A business plan incorporates all of the stakeholder-established goals and objectives into one comprehensive plan that shows forethought and reliability to both internal clients, like family members and employees, and external clients, like lenders, investors, and partners. It should lay out the management structure of the operation, as well as the legal and financial structure of the business. Here again, state extension programs can provide resources to help develop an agricultural business plan, and the assistance of a skilled attorney can be invaluable. Once a business plan is nailed down, the focus can finally shift to estate planning and retirement planning. The chosen legal structure and financial structure of the business can affect the transferability of assets, distribution of income, and how the income and estate is taxed. The laws that govern these things are ever-changing, so here again, a skilled attorney is worth their weight in gold to not only establish initial positions that are favorable to the stakeholders but also to adapt the plan to changing laws to make sure that the succession plan continues to accomplish the intended outcomes. Step 4 – Implement the Plan Finally, a timeline must be established for implementing the changes laid out in the succession plan. Though the retiring generation may be reluctant to take a step back and let the incoming generation make decisions and learn from the outcome, whether good or bad, allowing them to do so while there is still time to teach may be the most effective option. If incoming generations remain mindful and respectful of the experiences and vast knowledge of the retiring generation, the operation can become even more competitive and successful while the transition is still underway. Hard Work Pays Off Ultimately, succession plans can be as unique as the operations they direct. In fact, the more individually tailored they are, the more successful they are likely to be because the stake-holders invested significant effort in creating a plan to accomplish their collective vision. Producers investing the time and effort to create effective succession plans will help to keep American agriculture from