I didn’t get the cash but I got the tax bill- careful estate planning need for FMDs

Farm management deposit accounts, or FMDs as they are commonly known, can be an effective tax tool available to farmers and graziers for averaging their income over the good and bad years.  So how do they work and what happens to FMDs in the event of your death?  Read on to find out more.

What are FMDs?

FMDs allow primary producers to put away funds in the years where their income is high (which therefore reduces their tax payable in that financial year), and then draw upon them in the less profitable years and pay tax on those funds at a lower rate.

How are FMDs dealt with following death?

An FMD is an asset of the individual primary producer (as opposed to an asset of the farming business entity).  As such, it is important that the terms of your will are drafted in such a way to ensure that the FMD goes to the right beneficiary as intended.  Depending on how the terms of your will are drafted, the gift of your interest in the farming business may or may not include the FMD.

Any FMD held by a primary producer when they die must be withdrawn and will be assessable income in the deceased’s final tax return.  This could have negative tax consequences for the deceased’s estate, particularly if the balance of the FMD is high.

The tax will be paid by the estate, and not necessarily the beneficiary who actually receives the funds from the FMD. The payment of this additional tax could significantly impact (and have the effect of drastically reducing) the value of another beneficiary’s gifts from your estate.

Complications that can arise from poor estate/succession planning

If care is not taken when drafting the terms of your will, the following scenarios may occur:

  • an adult child involved in the farming business inherits the FMD funds when in actual fact, it was intended to be used to support the “off-farm” adult child.
  • the “off-farm” child gets the funds as intended, however the child involved in the farming business is left with the tax bill.
  • the child involved in the farming business was intended to get the funds, but because the FMD is a personal asset of the deceased primary producer and due to a poorly drafted gifting clause in the will, the funds end up with the “non-farm” child.

What is the best way to use FMDs in the context of estate/succession planning?

When considering how to deal with your interest in a primary production business in your estate plan, be aware that any FMDs you may hold at the date of your death will not automatically be included with any gift of your interest in the primary production business.

Consider how the tax will be paid, and whose gift in your will may be impacted by the payment of a large tax bill – it will not necessarily be the beneficiary of the FMD unless you include a specific clause in your will to make this clear.

Plan the timing of your FMD withdrawals.  Ideally, FMDs should be regularly withdrawn over time which will allow for a lower average tax rate as the funds come out and ultimately means that by the time of your death at an old age, all the funds have been withdrawn.

Obviously this does not account for a sudden unexpected death at a younger age.

In the case of an intergenerational family business, you may plan for the majority of FMDs to be held by the younger members of the family rather than the older members.

Don’t forget that if you cease being a primary producer, your FMD must be withdrawn within 120 days.  This needs to be considered when planning your retirement.

If you have an FMD or are considering depositing funds to an FMD, it is very important that you consult an experienced estate planning lawyer to ensure the FMD is appropriately dealt with in your estate plan.

For more information, please contact a member of our estate planning team at Fox and Thomas.