FINANCE
Every industry ’ s demands are unique , but those in farming grow in clusters . Ken Oneto is the second-generation president of family farm KLM Ranches , based in Elk Grove . They raise cherries , walnuts , wine grapes , cherry tomatoes and more on about 2,000 acres .
Two years ago , they lost half their cherry crop in heavy spring rains . Lower labor rates abroad mean cheaper foreign imports are rolling in that are tough to compete with on price . The supply chain is out of whack — for starters , the labels that go on their cherry boxes are on a 6-month back order . And always , water woes and new state regulations mean they ’ re paying an extra $ 10 an acre to make sure their groundwater isn ’ t sinking , costs they can ’ t pass on because of the price competition . In farming , margins are usually 2 or 3 percent . “ Or you make nothing or you lose ,” Oneto says . “ It ’ s not for the faint of heart .”
In late July of this year , he learned about another looming storm cloud : a dramatic change in the capital gains tax proposed by the Biden administration that could take effect next year — or even be retroactive to 2021 .
Two provisions of the proposal stand out . Individuals with an adjusted gross income of more than $ 1 million would see their long-term capital gains rate nearly double , rising from the current 20 percent to 39.6 — the idea being to equalize the capital gains and ordinary income tax rates . It also would eliminate the “ step-up ” in cost basis that lets an appreciated asset pass to children without their having to pay capital gains on the increase in value . Lots of family firms could be affected . Because a one-time sale of an asset could generate $ 1 million in income for that year only , a million households nationwide eventually could be hit with the 39.6 rate , estimates tax attorney and former state tax auditor John Goralka of the Sacramento-based Goralka Law Firm . A June 2021 analysis out of Texas A & M University concluded that eliminating the step-up basis under a proposal similar to that in the Biden plan would target 92 of 94 representative farms in the study , with an average additional tax liability of more than $ 700,000 .
“ Most business owners don ’ t even have the fundamentals in place — let alone an advanced tax structure — to exit their business on the terms that they want to . So the tax man wins .”
EDWARD COTNEY Founder and principal Olympus Tax , Business and Insurance Solutions
It ’ s not clear if family businesses thinking of selling should scramble to get it done this year in advance of the changes — it may already be too late if the proposal is passed with the provision making it retroactive to the date of announcement . And avoiding taxes shouldn ’ t be the sole driver of decisions about selling and succession , say tax professionals . But the most important lesson to glean involves the longer term : Family firms should always be ready with a plan for what happens when their business is sold or transferred . A tax strategy keeps you prepared no matter what happens in Washington , D . C ., say family business proponents .
Why the tax collector wins
Tax experts say it doesn ’ t take much imagination to see how a familyowned enterprise could lose control of what they ’ ve built , especially under the current proposal . Say a parent owns a $ 10 million family business . At the time of the parent ’ s death , the next-generation owner would owe $ 3.9 million in taxes but might not have the required cash . Borrowing it would weaken the business ’ balance sheet and thus the value of the business , says Elizabeth Leet Jackson , a partner at Delfino Madden in Sacramento . “ So it creates opportunity for big corporations to buy the small family businesses at a lower price ,” she says . Two clients planning to sell told her their deals wouldn ’ t work under the proposed 40-percent rate .
Another adviser has watched sales like that up close . “ I ’ ve seen this happen more than once with fairly small family businesses , especially if they own capital assets like land and buildings ,” says Brent Morrison , founder and principal at Chicobased business consulting firm Morrison . “( Taxes ) often force sales to larger organizations .”
Between the proposed federal rise and California ’ s 13 percent tax on ordinary income , more than half of any sale could go for taxes , says Dave Lucchetti , executive chairman of the board at Rancho Cordova-based Pacific Coast Building Products , which is on its third generation of family owners .
If area family farms end up selling , Oneto says the effects could be felt beyond those involved . “ The only people buying ag ground are pension funds and insurance companies looking for investments ,” he says . With returns low in farming , investors will eventually
60 comstocksmag . com | October 2021