INDIANOLA, Iowa (DTN) -- "I can't afford to retire" takes on a different twist in today's ag world. It's not a matter of income, it's a matter of income taxes. A farmer with unsold grain and depreciated machinery who wants to retire may be looking at hundreds of thousands of dollars in income taxes on an average-sized farm operation.
"Without offsetting input expenses, retiring farmers face a huge tax bite," said CPA Nick Houle, a tax partner with CliftonLarsonAllen LLC in Minneapolis who specializes in estate and transition plans for family businesses. It's not unusual for retirees to be thrown into a 40% tax rate when they exit and that exposure could be worse once high-income taxpayers calculate the impact of recent fiscal cliff tax increases, Houle and his tax partner Andy Biebl have found.
Such tax overload has a partial solution: a Charitable Remainder Trust (CRT). "It's an effective exit tool that allows you to lower your federal estate tax, avoid self-employment tax and gives you a steady income stream," Biebl advised.
The "charitable" part means you donate your assets to a recognized charity. The "remainder" means the charity keeps only the remainder of the original assets after paying you and possibly other beneficiaries at a set rate over your lifetime or up to 20 years. The "trust" is an irrevocable trust. You can't remove assets once you put them in the trust, although you do retain the right to the income.
Biebl gives this example: Let's say you transfer your crop to a CRT which sells the grain for $500,000. The money is invested and the annual payout rate to you is $50,000 for 10 years. "This lowers your tax by only having $50,000 income in one year, not $500,000 from the sale of your grain. And the income is no longer subject to self-employment tax," Biebl said. "By leveling out the income, we can often reduce the income tax rate by 5% or so and the self-employment tax savings add more benefit."
REWARD YOUR COMMUNITY
When Iowa farmer Charlie Gilbert retired this past fall, he and his wife, Carol, knew their tax situation would change. "Neither of our daughters wanted to take over the farm operation, so the sale of farm machinery and grain made a CRT a perfect fit for our family," said Carol Gilbert, who has also been involved in the Hardin County Community Endowment Foundation since 2005. "We could combine a charitable donation, reduction in taxes and help the local community."
The Gilberts, of Iowa Falls, Iowa, donated grain to their CRT which will eventually benefit a donor-advised fund created through their local community foundation. When the assets in the CRT revert to the charity at the end of the trust, the Gilbert family can decide how to distribute the funds from their donor-advised fund. "We're leaving this as a legacy for our children as a family philanthropy to help meet the future needs of our local community," said Charlie Gilbert.
In the case of grain with zero tax basis, you don't get a charitable deduction on your tax return. However, you can save taxes because you only report income as the trust pays you over the term set up in your CRT. Stretching your taxable income up to 20 years allows you to be in a lower tax bracket and it avoids the current 15.3% self-employment tax.
A Charitable Remainder Trust also is a good strategy for someone who wants to sell highly appreciated land but does not want to pay capital gains tax.
Selling land inside a CRT avoids the capital gains tax, since the trust would pay no tax on the sale. That leaves more money inside the CRT to offer a higher income stream to the beneficiary, and/or a higher charitable deduction, depending on how it is established.
For those who donate appreciated capital gain property such as land to a CRT, you can get a charitable deduction based on IRS tables calculating the present value of your gift at the end of the term of the trust. The deduction can be used in the year you set up the CRT and any unused portion of the deduction can be carried forward up to five years.
Walt Mozdzer, a certified financial planner with Syverson Strege and Company in West Des Moines, Iowa, favors CRTs for his small business clients because of their flexibility. You can be your own trustee -- deciding when the asset in the CRT is sold and how the proceeds are invested. Also, you can set up how you want the income stream calculated and how it will be distributed.
You may receive income for life or, if you choose, a certain term of years (not to exceed 20). In fact, the income can be paid over your life, your spouse's life and even your children's and grandchildren's lives (although there will be a gift tax measurement if income is shared with a younger generation).
But there are some things to avoid: Don't make the income stream too high. You could end up cannibalizing the principal of the trust. The charity needs to end up with at least 10% of the original value, according to the actuarial calculations.
Don't tie up all your assets in a CRT. You may have different financial needs down the road and may want to sell some assets outside the trust to finance those needs.
You may change your mind on the charity you want to give to. With a CRT, the charity receiving the proceeds at the end of the trust can even be your own donor-advised fund (such as a family foundation) that a successor, such as a child, can manage.
Be careful how you design the income stream. "One of our clients came to us after he had set up an income-only CRT. He only got income based on the investment in the trust. When interest rates dropped, he got almost nothing," explained Mozdzer. "Unfortunately, we couldn't help him because the trust was already set up. It would have been better to fix a flat 6% return per year when the trust was first established. Or, if you want an inflation hedge, you could set it up as a fixed percent of asset value in the trust and as the asset value increases, the payout would increase."
It's important to get good advice. Find out how many Charitable Remainder Trusts your adviser has put together. Does he or she just use a boiler-plate form or explain all the options available to you?
"It was a relatively painless process," said Charlie Gilbert. "Our adviser made the process understandable and laid out all the options. We set up the CRT with our attorney, financial planner and us, so it felt like we were true partners in planning for retirement, producing a legacy for our children and creating a vehicle to support our local community in the future."
For more help:
DTN's on-going Senior Partners series examines the financial, legal and emotional hurdles families face as they transition farm ownership from the senior to junior partners. To read other features in the package go to DTN/The Progressive Farmer In-Depth site at http://www.dtn.com/…
DTN University's "Pass It On!," with Andy Biebl and Nick Houle's two-hour, pre-recorded webinar, offers in-depth tax solutions to ease senior partners' retirement. Case studies apply to those transitioning with on-farm heirs and those without. Registration of $85 includes course materials and repeat access to the online course. http://www.dtn.com/…
Copyright 2013 DTN/The Progressive Farmer. All rights reserved.