Grain farmers approaching retirement face an ugly reality: A lot of grain to sell but no cropping expenses to provide a tax offset. If that carryover grain is in the $500,000 to $1 million territory, spreading the sales over several years doesn't avoid high tax rates. And even when successfully spread over many years, there are multiple doses of the 15.3% self-employed Social Security tax to compound the cost.
THE CRT ALTERNATIVE
Here's an example of how a Charitable Remainder Trust (CRT) can solve the problem. Our retiring farmer, Joe, creates a CRT document of his own design, using a pre-approved IRS prototype with his attorney adding a few tweaks. A local trust department is selected as CRT trustee. When grain prices get to the right point, $750,000 of unsold corn and beans are transferred from Joe's title to Joe's CRT. A few days later, the CRT sells all of the grain, but does so tax-free. The CRT pays Joe an annuity of $75,000 each year for 10 years, turning that big pile of grain income into a stretched out annuity taxable at lower brackets, and all exempt from Social Security tax.
At the end of the annuity term, the residual goes to one or more charities per Joe's CRT document. The tax code allows up to 90% of the donated value to come back to the donor in that annuity stream, with only a projected 10% residual required for the charity. Even at today's low interest rates, a 10-year CRT will return all principal to the donor; the interest yield is enough to fund the 10% charitable residual.
AN ECONOMIC WINNER
With only a 10% projected value required for the charity, the economics are compelling. There is generally more than 10% in tax savings by eliminating the Social Security tax and lowering the tax rates via the stretched-out annuity. The trade-off is 10% to local charities in lieu of an extra 10% to 15% to the federal government.
While CRTs are unfamiliar to most, this isn't a wild tax scheme. Sec. 664 of the Internal Revenue Code authorizes CRTs and defines the boundaries. A 1994 IRS ruling described how a retiring cash method farmer can shift unsold grain, livestock and machinery to a CRT in a tax-advantageous manner.
The term for the income payback can be anywhere from 2 to 20 years. We usually find about 8 to 12 years is the right period to stretch out the income and get that big pile of grain into more manageable amounts. The Charitable Remainder Annuity Trust is the preferred version of CRT, as it has level annual payments, and a locked term that passes to heirs if the donor dies early. The plan requires careful design up front, so a retiring farmer will need to work with his tax adviser and attorney. There is charitable planning software that helps design these to optimize benefits. And finally, the economics of CRTs will get even better as interest rates rise.
Editor's Note: Andy Biebl is a CPA and tax principal with the firm of CliftonLarsonAllen LLP in Minneapolis with more than 40 years experience in ag taxation, including 30 years as a trainer for the American Institute of CPAs and other technical seminars. He writes a monthly column for our sister magazine, The Progressive Farmer. To pose questions for future tax columns, e-mail AskAndy@dtn.com.
Expect to retire in the next 10 years? Learn more about how to "Exit Agriculture Without Paying a Monster Tax" at a half-day DTN University workshop in Chicago Dec. 6. Go to www.dtnagsummit.com for details.
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