Ask the Taxman by Andy Biebl

QUESTION:

In a recent Progressive Farmer column about Charitable Remainder Annuity Trusts (CRATs), you said grain could be given to a charity to sell. Is it possible to give equipment to a charity to sell in the same manner?

ANSWER:

Short answer: Yes. The CRAT technique has potential benefit to retiring farmers who have a significant amount of grain to sell as well as those who might be conducting a machinery auction. In both situations, the first step is to create the charitable trust. Each trust is a unique entity; the terms within the trust define who receives the income interest and for what period of years, and which charity or charities receive the remainder after the income payouts. We typically use a bank's trust department to hold and manage the assets during the term of the trust.

The donor conveys unsold assets, such as grain or machinery, to the trust. The trust then conducts the sale. In the case of machinery, the trust would be the temporary owner of the machinery and arrange the auction. The proceeds from the grain sale or the machinery auction come into the trust tax-free and are held by the trustee to pay the income amount at the specified dates (e.g. quarterly, semi-annually, etc. for X years). When the income payments are completed, the remaining funds within the trust are paid to the charities specified in the document, and the trust terminates.

The CRAT is useful to stretch out income over a period of years (we often see terms of 8 to 12 years), in order to avoid a large amount of ordinary income in a single year, such as from a machinery auction. The trust must be designed in a manner that projects at least 10% of the value will remain for charity after the income payouts. If spreading out the income payouts from the machinery auction can reduce the tax bracket and save over 10%, these arrangements can be an economic winner. CRATs funded with grain by a proprietor are even more likely to be economically beneficial, because the CRAT income payments to the retired farmer are not subject to self-employed Social Security tax (whereas the direct sale of the grain incurs Social Security tax costs). As we wrote in the Progressive Farmer column, for a retiring farm proprietor facing a large amount of income from a sale of grain inventory or a machinery auction, the CRAT technique deserves consideration.

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QUESTION:

I have saved the article you wrote in the Progressive Farmer in August 2013 where you said the IRS was trying to claim SE tax on CRP rents. Was this ever resolved? We have tried to put some land into CRP but were not accepted. If we have the opportunity again, but are required to pay the SE Social Security tax, it might be a deal-breaker. We use a professional manager, and were looking at 55 acres going into CRP in Indiana. We also have another 500 acres of this Indiana farm in a cash rent lease. But we wanted to make sure that any SE tax risk is limited to just the 55 acres.

ANSWER:

The Eighth Circuit Court of Appeals issued its opinion in the Morehouse case in mid-2014, holding that a non-farming landlord is not subject to self-employed Social Security tax on CRP rents. As a result of the Morehouse case, the SE tax treatment of CRP hinges on the status of the landowner. If the landowner is an active farmer and some ground is placed in CRP in lieu of farming the ground, the CRP is part of the business income and is subject to SE tax. On the other hand, a non-farming landlord with no active farming business connected to the CRP income does not have SE tax thanks to the Morehouse decision.

There is a third category specially carved out in the Tax Code: Those collecting Social Security benefits are exempt by law from paying SE tax on CRP revenue.

While the Morehouse case represents an authoritative opinion on which taxpayers can rely, the IRS indicated its disagreement with the court's opinion. The IRS announcement noted that it would continue to litigate the issue in all circuits. If the taxpayer is within the jurisdiction of the Eighth Circuit, the court might not be patient with the IRS. The Eighth Circuit covers Minnesota, Iowa, North Dakota, South Dakota, Nebraska, Missouri, and Arkansas. In other jurisdictions, the issue is unresolved. Consequently, it is likely that IRS examiners will continue to assert SE tax on CRP receipts for non-Social Security recipients.

All that aside, if you are successful in placing those 55 acres into CRP, there should be no risk of SE tax on the other cash rent income. The Internal Revenue Code has a special exemption from SE tax for rental income derived from real estate. In the case of cash rent where the landlord is not involved in any production of grain, the cash rent is clearly exempt from SE tax.

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QUESTION:

Some of my farming business is done in an LLC where I have one full-time employee and several part-timers. The full-time employee has asked for health care coverage. In the past, I have reimbursed employees for mileage and issued a 1099 to them for those amounts. I also 1099 them for subcontract work in my hog finishing barns. Would the mileage reimbursement work in any situations where it is not put on a 1099?

ANSWER:

I see three separate issues within your question, so let's break them down.

1. Health care reimbursement: As we have explained in the past, the Affordable Care Act has essentially prohibited employers from reimbursing individual employee health insurance premiums, as well as reimbursing the out-of-pocket medical costs of employees. The penalty on the employer for violating the so-called "market reforms" is horrific ($100 per employee per day), so the short answer is that employers can not consider any reimbursement of health care costs for employees. An alternative is to provide health insurance as an employer, but that may be too costly with such a small group. Another possibility is that you may meet the "one employee" exception for reimbursements, but you will need your tax adviser to assist with whether your part-timers can be excluded.

2. 1099s for mileage: If the mileage you are reimbursing is simply the employee traveling between home and your workplace, it is not a tax-free benefit and your present approach of putting those reimbursements into income is proper. However, if these individuals are W-2 employees, the additional mileage reimbursements for commuting should be added to Form W-2 as additional wages rather than separately reported on a Form 1099. The reimbursement is additional compensation; this will cost both you and the employee more in Social Security taxes.

However, mileage can be a tax-free reimbursement if it is in connection with duties during their work day that are business-related. If you are reimbursing mileage for your employees to use their vehicle in moving between various farm work locations, it is a tax-free reimbursement. Similarly, if you send them into town for farm parts or supplies, there is no need to treat those reimbursements as income, assuming that you are reimbursing no more the annual IRS mileage rate amount ($.54 per mile for 2016).

3. Work in hog finishing barns: If I understand your situation, the employees work for an LLC involved in some farming activity (e.g. grain production) that takes most of their time. However, on occasion, they work in hog finishing barns, presumably in another entity that you own, such as another LLC or an S corporation. For their labor in the hog barns, you issue a 1099.

Unfortunately, the IRS holds the view that it is only in exceptional and narrow circumstances that an individual can be an employee of the payor for one situation and an independent contractor with respect to that same payor for other services. Presumably, these workers are under your direction and control for both business activities. If so, your risk is that an IRS exam is likely to assert that the hog subcontract work belongs on a W-2. As a result, as the employer you are delinquent with respect to payroll taxes. This is a costly assessment, because the employer is then responsible for both employer and employee Social Security taxes, and also subject to payroll tax delinquency penalties.

Employer vs. independent contractor determinations are not easy questions. All of the facts of the working relationship need to be considered. I would advise visiting with an experienced tax professional who can walk through the factors that the IRS uses in making these determinations, and help you properly categorize your workers' status before the IRS appears and raises financial havoc.

Send any questions to AskAndy@dtn.com

(MZT/CZ)

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