One of the most tragic failings of traditional forestry is an unreasonable emphasis on profitability. Although woodlands are capable of producing a sustained flow of products, the shorter the planning horizon of any particular owner, the less sustainable woodlands become (Landsberg and Gower 1997). The root of this unreasonable emphasis is a ridiculously antiquated system of property taxation based on “highest and best economic use.” It is hard enough for a woodland owner to keep up with property taxes in areas where the highest and best use is for forestry purposes. Near urbanizing areas, forests are assessed – by law – at highest and best use for development.
Property taxes and other expenses of owning forest land force the hands of many owners to cut timber more frequently than is prudent, or to liquidate timber at a fraction of its maximum value. But the situation is dire in forest ecosystems located within a few hundred miles of cities. In these areas “highest and best economic use” is defined not in terms of ecosystem values – for both private and public benefits that forests provide – but for the number of housing units land is capable of supporting. Where taxes are onerous and there is little incentive for owners to manage and protect forest ecosystems, owners are forced to harvest all merchantable timber using non-sustainable practices before lands are sold for development. The calamity of property tax policies is in their failure to account for the enormous public benefits forests provide: from clean water to buffering runoff from storms that, if not for forests, would cause flooding and serious loss of property downstream; scenic vistas that support tourism in many forest areas; habitat for wildlife that is owned by the state; filtering pollution and sequestering carbon from autos, home heating and manufacturing; and recreational opportunities for millions of people who do not own the forests they enjoy.
Framers of the Constitution intended to allow local governments to use the property tax as an inviolate source of revenue for local services, especially education. To this day, it is the principal means of paying for services that local citizens understand and use, but it is based on an indicator of ‘wealth’ that no longer applies. Not too long ago – the equivalent of a millisecond in ‘forest time’– land ownership was a good indicator of wealth and means. But no longer; socioeconomic patterns shifted during the first half of the 20th century (probably coincidental with the Great Depression) placing wealth in the hands of those closer to consumers. A widely dispersed agricultural economy gave way to a more centralized industrial one, obviating wealth on which local communities depend. But in the interest of maintaining ‘state’s rights’ and local control, mechanisms that could have shifted tax burden were avoided by local officials who feared federalism.
It is quite likely that one day the destructive effects of property taxes on parcelization of farm and forest lands – causing fragmentation of habitat and other forest values – will become enough of an issue to effect changes. But until then, no woodland owning family should have to liquidate timber or land to pay property and/or estate taxes. All states offer programs to owners that tax lands based on ‘current use’ and/or on actual ‘yields’ from forests that can substantially reduce property tax burden. Unless ‘fair market values’ are low in a community, it is virtually impossible for owners to practice positive impact forestry without some form of property tax relief.
Some owners avoid these special valuation programs out of mistrust, or because of penalties associated with converting forests to other uses. Local officials tend to disfavor current-use taxation out of a mistaken belief that it severely limits a community’s ability to raise revenue; their reasoning being developed lands bring in more taxes. Study after study, however, have demonstrated that increased tax revenues fall far short of the eventual costs of development. There are a number of alternatives available to woodland owners who intend to keep forests intact and pass them on to succeeding generations. Each, however, comes with two requirements: 1) long-range planning must extend far beyond the 10- to 20-year planning horizon of most traditional forest management plans; and 2) Forest owners and their families must accept the fact that truly sustainable forests are measured in terms of centuries, not decades. Families that subscribe to the concepts of positive impact forestry are willing to forego current income opportunities to create a legacy for the future.
Forest Parcelization and Fragmentation of Purpose
One of most insidious problems facing forest areas is parcelization of land: the division of larger tracts into smaller ones. According to one source, about 3 million acres are converted every couple of years into parcels that are less than 100 acres in size, and during the same time-frame, about 2.5 million acres of forests are ‘developed’ into other uses (DeCoster 2000). Forest land conversion and diseconomies created by parcelization cause erosion of the forest land base; and less woodland means less timber and higher stumpage prices. So serious is forest parcelization that it makes the sum of every other economic threat to forest utilization pale in comparison (with the possible exception of economic impacts from pernicious invasive species, discussed earlier). Moreover, it is impossible to lay blame for the effects of parcelization; there are no environmental groups to excoriate, no federal programs to criticize, no laws to condemn. Forest owners, or prospective forest owners, are the cause of parcelization and there is almost nothing short of major policy changes that will turn things around.
But how did it get to this? Why has parcelization been allowed to proceed unabated with no regard for the future of forests or agriculture. It is a long story, but one worth telling.
Private property law in the U.S. is mostly based on English common law, the first codification of which was known as ‘feudal law.’ Under feudal law the King owned everything, but his lands were managed by lords who were responsible for keeping the peace among vassals and for collecting taxes. A lord could pass within his family the privilege of managing the King’s lands, but to only one heir: usually his first-born son.
Eventually the King realized that, with a system of taxation, he did not need to own land to extract its wealth. Thus, feudal law evolved into the allodial system, which is the precursor of common law in most of North America. A lord owned land in the allodial system (provided he paid his taxes), but his ability to divide the estate was limited. Upon his demise, the lord’s entire estate passed to only one heir: his first-born son, or to the closest consanguine male (father, brother, uncle, cousin and so on). Known as ‘primogeniture,’ it was not uncommon for an eldest daughter to see her father’s lands inherited by a late-born, five-year old brother; or – if her father never sired any sons – the land might go to her uncle. If the uncle predeceased her father, the estate might end up in the hands of a male cousin.
It is primarily for this reason that kings and other nobility were so hung up about fathering sons. Since determination of a child’s sex resides with the male’s chromosomes – a fact that was not known to science until much later – it is ironic that the wife was blamed for being barren of sons, when in fact it was her husband who was responsible. It is quite likely that primogeniture would have never developed if nobility had been aware of this, and women would have enjoyed a higher social status much earlier in the human experience than proved to be the case. Primogeniture evolved in feudal times as a way for the King’s lands to pass within families of nobility, but since the King was under no obligation to share his interests, the lords had no rights to divide the estates entrusted to them. Primogeniture survived evolution to the allodial system because it prevented fragmentation of productive lands and also maintained a relatively easy method of gathering taxes.
With a growing population of noble-born, second sons the King was faced with the question of what to do with the disinherited whose choices were few. Colonialism was a result of primogeniture and the Americas were settled mostly by sons who were expatriated to the colonies. For this reason, primogeniture was one of the first concepts abandoned by the separatists and in doing so, the Continental Congress added rights to the bundle of private property rights: the right to divide and the right to bequeath. Llittle did they know it would lead to a quiet crisis of epic proportions in less than 300 years.
A totally capricious, unfair and unreasonable method of passing land to prevent parcelization (primogeniture), became a reasonable alternative with now dire consequences. One can only wonder what the founding fathers would think of the situation today. Although it is doubtful they would have embraced primogeniture as a way of keeping lands intact, conversion of productive lands to idle or unproductive uses would have been unacceptable. “Highest and best use” in an economic sense was for agricultural purposes when the Constitution was drafted, not residential housing or retail space as is the case today. Who could have foretold that productive land would be worth more for housing than for timber and crops? Anyone suggesting a future such as this in the late 18th century would have been branded a heretic and a fool.
Under our current system, land is a capital asset that has the same status as any other form of capital, except that it cannot be moved from place to place. land ownership is defined by rights, in exactly the same context as originally claimed by the King. One can easily argue the State has taken the King’s place under our current interpretation of real property rights. The State reserves the same rights as those reserved by the King: the right to tax, the right to eminent domain, the right to escheat (to claim land when an owner dies intestate and without legal heirs), even the rights to wildlife. But the one deviation from the old English allodial system is the right to divide land however the current title holder sees fit. It is this deviation from a course that was obvious to the King of England hundreds of years ago, when the only true wealth was measured in land that makes parcelization one of the most difficult issues of our time.
Families who measure a substantial portion of their wealth in forest land face a major dilemma: How to pass wealth from generation to generation without dividing up the forest? Fortunately there are many alternatives to keep land intact, discussed earlier. The bad news is, parcelization is proceeding at rate that exceeds the ability of alternatives to make even a small dent in the urbanizing of America’s forests. With the median age of forest owners still increasing, most parcelization and conversion will take place over the next 20 to 30 years as lands are passed to heirs, many of whom want nothing to do with managing forests.
When a surviving parent dies, heirs are concerned not with land, but how quickly the estate is settled. In the near term, liquidation of forest assets can result in a windfall for local primary wood-using companies. But as conversion to other uses proceeds, or as forested parcels get smaller and smaller, there is less timber available and the cost of doing business increases. What does the effect of parcelization hold for the future of forests? less harvesting on public lands has already led to increasing reliance on private lands. This trend will continue, especially as more public lands are taken out of production. Some local wood-using companies will profit from probate of family forests, but where there is one owner now, expect to see five, ten or more owners in the future. These new owners will have almost no connections to the land and they will be less willing to manage lands for periodic timber production. Those who do agree to harvest will expect high stumpage rates and impeccable extraction methods.
Wood-using companies that rely on local timber supplies need to develop ways to thwart the impacts of parcelization within their procurement areas. Forestry professionals need to have candid conversations with clients about the long-term disposition of woodlands. And they must also be prepared to suggest estate planning alternatives, discussed earlier, that keep forest lands intact.
Some other changes that may help keep lands intact: * States (with federal grants) will offer local taxing authorities ‘payments in lieu of taxes’ for forest lands owned by families that have agreed to effect a long-term easement (300 years or longer) that passes forest lands within the family, or to heirs that agree to maintain practices for the requisite period. In exchange, forest lands are exempt from all forms of taxation – property, estate – even income tax, but on a ‘scaled’ basis (i.e., the longer timber is held, the lower the tax on income from its sale).
* Owners who agree to establish ‘ecological reserves,’ by effecting an easement in perpetuity, are also exempt from taxation (under the same concept described above). As a condition of benefits, owners must allow qualified research projects on the property. And, if an owner (now or in the distant future) violates the easement, title is forfeit in addition to monetary penalties.
* local communities in forest areas wanting to expand opportunities for commerce may offer packages of incentives to forest owners who agree to supply raw material for processing facilities that provide local employment opportunities. The same incentives are available to owners who agree to protect ‘view-sheds’ that support tourism, finally allowing a method to share tourism wealth with those who provide the view.
* Generally, wood-using businesses have been distrustful of land trusts because of the misperception that trusts take forests out of production. Mills may want to consider establishing long-term relationships with local land trusts to help woodland owners sell or give development rights that maintain traditional forest uses. Working with a land trust may seem like a foreign concept to some mill owners, but the key to keeping productive lands intact lies with separating the bundle of rights and disallowing the possibility of future development.
Finally, an idea that has less to do with parcelization than with ending a long-standing practice of liquidating timber assets when the owners begin to feel they’re too old to continue holding forests, and their kids have no interest in the land. Those families that cannot afford to wait for social change may finally be able to ‘liquidate’ their timber resources without actually cutting trees. A federal banking authority (or federal grants to fund the establishment of state banking authorities), will buy stumpage (or, the rights to stumpage through an easement) providing the family with needed cash. The ‘authority’ manages timber and other ecosystem values – using positive impact practices – paying the family an annual ‘lease’ (possibly equal to the value of annual increments, property tax liabilities or by some other measure). Such a program can end the non-sustainable practice of cutting-off woodlands before selling them, while allowing families to cash in on equity. The result: forest ecosystems are protected, timber is left to grow in volume and value, and all the while forests provide a complement of public services and benefits society expects of forests but for which it has yet to discover a way to reimburse woodland owners.
Planning for Woodlands in the Estate
Good planning to maintain land through many generations requires a long-view that extends far beyond an individual’s life. It is so for all land, but especially true for forests because managed woodlands change slowly. One of the first realizations of a conscientious forest manager isthat the fruits of his or her labor will most likely ripen for the next generation. And yet there are alarmingly too few instances where forest owners have planned for the disposition of land in their estates; probably less than 10 percent, possibly as low as 5 percent.
Some refuse to confront their own mortality, others figure they “will leave it to the kids to deal with.” In these instances it is the forest and the family that suffer when siblings are left to fight over an estate that must be divided, and on which a federal and state estate tax may be looming. The result: forest ecosystems are abused, timber is sold before it reaches maximum value, and/or land is sold to the highest bidder who often intends to develop. On top of all that, a destructive federal tax may be due on the fair market value of the decedent’s estate, and the children – held together by parents who are now gone – never talk to one another again after the estate is settled.
There are lots of reasons people put off estate planning, but high among them is an unwillingness of families to communicate. Children are reluctant to bring up the subject for fear parents will think them greedy and wish them dead, and parents don’t discuss it because the subject is uncomfortable. Notwithstanding, if spouses do not resolve matters involving forests between them, and engage their children as to their plans, chances are slim important issues will ever be resolved. Other reasons to delay include mixed feelings about children, an unstable marriage, or a mistaken belief that the estate is too small to worry about.
Good planning requires open and candid conversations between spouses. Even if only one or the other has been the principal decision-maker; when it comes to long-range forest planning in the estate, both should be of one mind since it is almost a sure bet one spouse will predecease the other. An easy way to initiate these conversations is by making lists of things about the land that are important to both, including values like; a quiet knoll where wind whispers through crowns even on a calm day, a young stand of timber on rich soils that has veneer potential 150 to 200 years from now, a favorite trail, a scenic vista or a special habitat. Couples should view this exercise as a chance to leave a living memory of the combined efforts of both partners. The goal is to ensure future decisions are made with the land in mind. It is remarkably easy to do so without hamstringing future generations. Any practices that are detrimental to forests, or decisions solely predicated on quick financial gain, are disallowed.
When spouses have established priorities, it is time for a candid conversation about heirs; who among them is best suited to the task of seeing to it that ideas, concerns and objectives for the land are fulfilled and passed on to future generations? This is often more difficult than it sounds, particularly when the couple discovers that none of their closest relatives meets the test. Choosing a son or daughter to assume responsibility for managing forest ecosystems should not be a process of picking the lesser of evils. If none of the prospective heirs is suited to the task, there are other options discussed later. It is, however, essential that children understand and accept the ‘will’ of parents; and this is the next step – communicating with family.
Assuming prospective heirs are most likely children, if they have reason to feel as though they have a stake in the estate, they must understand – in the most certain terms – their parent’s goals for the forest. It is not essential they agree, but they should understand and accept what parents want. Obtaining this acceptance early on gets children used to the idea that their control over the land may be limited after parents are gone. Knowing this in advance, children are less apt to dispute the provisions of the estate plan when it goes into effect. If necessary, there are also ‘disincentives’ that parents can declare making it risky for an heir to actively dispute the estate when parents have passed.
After details are resolved between spouses, and with the rest of the family, it is time to locate a qualified estate planner. This person is most apt to be a lawyer, but not just any lawyer will do. Estate planning is still a relatively new area of law, except among the very rich who have been planning their affairs to avoid taxation ever since the estate tax was levied. In fact, most people never think of estate planning because of its association with the wealthy. Most attorneys will offer estate planning services if a client makes such a request. But locating someone who can do estate planning for forests is another matter and it may require some shopping around.
A general guideline is to locate a person who has some experience with forests and devotes at least half-time to estate planning, working with three to five families, or more, each month. Another thing to look for is someone who develops his or her own forms for easements, wills, trusts and other documents, as opposed to using standard documents – also known as ‘boilerplate’– with fill-in-the-blanks capabilities. If at all possible, try to find someone who has experience working with woodland owners. A good source of information on attorneys with these qualities is the local land trust.
Aside from the fact that it is good business practice to plan for the disposition of forest land in an estate, the estate planner may suggest some alternatives that can result in estate tax savings. In 2010, the estate tax is eliminated. But in 2011 it is reinstated unless Congress votes to continue the repeal.
Keeping Forests in the Family
The sad fact is most children will end up selling the family forest to settle an estate, unless the parents have set up an alternative that prevents such a sale. Everyone likes to think children will not quibble about money after they are gone, but the facts are they do. leaving well-managed forest land to children in the hope that they will carry on the parent’s forest management ideals is more often than not a prescription for failure. There are more than a few instances where the best laid plans of mom and Dad were discarded the first time the children argued about ‘their share.’ Soon after, the woodland is sold to the highest bidder, who is usually thinking about where to put houses rather than how to protect and sustain healthy forest ecosystems.
So what can parents do? Some woodland owners have formed legal ‘entities’ that own the land, and gradually ‘vest’ children into ownership and decision-making positions. Doing so keeps the land intact and passes not only the land but the value of good management on to children who will eventually benefit from dad’s or grandpa’s or great-grandpa’s good decisions. There are basically three choices: 1) a limited family partnership, 2) a closely held ‘S-corporation’ or 3) a limited liability company.
Until just a few years ago only the first two options were available. Family partnerships and the S-corporation have served many families that have passed managed forest to heirs. But both strategies have limitations that may kick in years after the founders pass away. For this reason, the newest of the three – the limited liability company, or LLC – holds a great deal of promise for woodland owners who are looking for a way to pass forests to children, and have children continue to manage the forests using positive impact practices.
Although the concept of a limited liability company (LLC ) has been in existence for more than 100 years, first in Germany then throughout Europe spreading in the 1900s to Latin America, it has only been in the last few years that every state in the U.S. has developed a statute that allows this form of organization.
An LLC combines the most favorable aspects of a partnership with the best characteristics of a corporation. In a partnership, decisions are made exclusively by the partners. But the partners are liable for those decisions, jointly and individually. The bottom line is that partners are responsible for each other’s mistakes. This liability, or potential liability, far exceeds one of the primary benefits of a partnership: the profits, losses and credits are passed directly to the individual tax returns of the partners and are taxed only once.
A corporation, on the other hand, is set up as a separate entity – just like another taxpayer but without a body. The shareholders, or owners of a corporation, are for this reason protected from liability: if someone screws up the corporation is responsible, not the individuals who own the corporation. But since the corporation is a separate entity it is taxed as such, and profits paid out to owners are taxed a second time on each individual’s return. Congress created the S-corporation to allow small businesses and non-profits to incorporate providing owners protection from liability while eliminating double taxation. But – as is the case with most things involving the IRS – it is not as simple as that. There are many rules an S-corporation must abide by in order to maintain its status. For example, an S-corporation can not have more than 75 shareholders and it can have only one class of stock. A ‘closely held’ S-corporation can develop rules about who can hold stock (which is one of the reasons it is favored by families that want to pass forest lands), but it can have no more than 30 shareholders. An S-corporation that breaks the rules will end up being viewed by the IRS as a regular corporation, with the threat of back taxes and penalties.
The LLC structure assumes at least two of the following four conditions of a corporation are not true: 1) limited liability for the owners, 2) centralized management, 3) no restrictions on ownership interests (anyone can hold stock), and 4) continuity of existence. In other words, the IRS will tax the LLC in the same manner that a partnership is taxed if it lacks at least two of the above conditions. Most often those two are items 3 and 4, since an LLC by nature is intended to protect owners from liability (item 1 is true), and there is usually (but not necessarily always) a centralized management (item 2 is true). Item 3 is false for an LLC because the owners, like partners, want to restrict ownership and decision making.
It would be to the advantage of a founding woodland owner who sets up an LLC to have it exist irrespective of the current owners ( like a corporation), but to meet the conditions of an LLC , item 4 must be false: a family woodlands LLC can not have a continuity of existence. It must either have a finite existence, or exist at the will of its owners. On the surface, this condition appears to be a problem for a long-term family woodlands enterprise, but it needn’t be. Although it may be possible to demonstrate that a family forest LLC lacks centralized management (item 2; which means the LLC could have “continuity of existence”), it would be exceedingly difficult, perhaps impossible, for the company to do business if all decisions were handled ‘by committee.’
An LLC is composed of two parts; one public, the other private. The founder of an LLC must file Articles of Organization, usually with the Secretary of State. The ‘articles,’ in its simplest form, is a series of questions. In an LLC (the name of the company must include LLC , or LC, indicating a ‘limited liability company’), the owners or principals are called “members” and one of questions has to do with whether the company is to be managed by ‘members’ or by a ‘manager,’ who may or may not also be a member. Another question has to do with the issue of ‘continuity of existence.’ The founder must choose whether the company has a fixed ‘term’ or it exists ‘at-will’ of the members. Resolving this aspect of an LLC (does it exist for a fixed term, or at the will of the members) is worth paying for good legal advice.
Given the long-term nature of forest ecosystems and forest investments, and the need to protect the forest LLC from dissolution, it is fairly easy to argue for a fixed term of 150 years or more; but a knowledgeable attorney might advise otherwise. When a ‘term’ LLC expires, the statute assumes that it becomes an ‘at-will’ LLC until the members decide to dissolve the company or establish a new term.
The second – private – part of an LLC is the ‘Operating Agreement.’ It sets forth in detail the purpose of the LLC, who its members are, and all the conditions of the company. The agreement details important matters of governance and also regulates the affairs of the company and how it does business. For a family woodland owning business, it should also include the founder’s management plan that clearly spells out how management decisions are made in the future. The Operating Agreement also describes how members will handle the ‘expiration’ of the term (presumably by specifying a new term) and how ‘managers,’ or the member-management team, will operate. The Operating Agreement is a proprietary document of the LLC. It is not filed with the Secretary of State, but each member should have a copy. The agreement is like a contract between the members and it clearly spells out all the conditions the members support. For example, it is probably a good idea to identify all of the positive impact practices the LLC insists are used by managers, now and in the future. And it should specify a method for handling disputes, or differences of opinion, especially as knowledge of forest ecosystems and markets change with time.
When the LLC is set up, woodlands are appraised so the parents can use the annual IRS gift exclusion to vest children with undivided interests (member shares) in the LLC. For example, under current laws a husband and wife can give annuals gifts of up to $22,000 to each child, tax-free. In fact, if the Operating Agreement restricts the way children can handle these shares – as it should – then the gift can be considerably more on the grounds that the value of the gift is ‘discounted’ because its marketable value is limited by the Operating Agreement.
Income from the family woodlands LLC can be distributed to the members (or in trust for children), much as a dividend is paid by a corporation. If a future family member wants out of the LLC, the Operating Agreement describes how that member’s shares are purchased, and whether or not a former member’s offspring are eligible to buy back in to the LLC . When the family forest LLC ‘term’ expires 120 years after the founding family set the company up, the Operating Agreement describes how members are to proceed to set up a new ‘term.’
The LLC is perfectly suited to passing forest lands and carefully considered forest management plans to family members. It is easy and cost-effective to set up, can be amended, and the ‘manager’ controls the property and decision-making, whether or not the manager is also a member. The primary disadvantage is that it may be difficult to effect continuity without sacrificing the pass-through tax benefits. If the IRS determines that an LLC exists independent of its members, it may view the arrangement as a corporation resulting in back taxes and penalties. Good legal advice can help prevent this from happening.
Source:
McEvoy, T.J. 2004. Positive Impact Forestry
- A Sustainable Approach to Managing Woodlands. Island Press, Washington DC.
268. [Excerpt from chapter 10 - no updating necessary] |
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