We are getting signs that more and more older farmers are planning on retiring, but one of major delays is the large build-up in grain inventories that have not yet been taxed. When a farmer retires, they typically have incurred all of their expenses in the year of harvest, but will usually push grain sales into the following year. This results in a large amount of net farm income subject to income tax and in many cases a large amount of self-employment tax.
One option to help mitigate this tax liability is for the farmer to use a charitable remainder annuity trust (CRAT). Although it is a "charitable trust", in most cases, there is no charitable deduction. We are simply creating the CRAT to effectively get installment sale treatment for the farmer's grain or equipment. The best asset to put into the CRAT is grain since there will be no self-employment tax owed on the sale of the grain by the CRAT and the farmer will only owe income tax as they receive payments from the CRAT. The CRAT can be created by any type of entity including a regular corporation.
This is how a CRAT operates:
- A farmer contributes grain to the CRAT (there is no tax cost to this and the farmer can deduct all of their farm expenses).
- The CRAT then sells the grain for cash (no tax is owed since this is a charitable trust).
- The CRAT will then provide an annuity to the farmer. This can be for the life of the farmer and their spouse or for two - twenty years. We typically like to use a term certain since if the farmer passes away, the remaining annuity can continue to the heirs. The farmer will owe ordinary income tax on this annuity payment each year.
- At a minimum, the expected amount going to charity is 10% of current value put into the CRAT.
- At the end of the annuity term, the remaining assets will go to charity.
We typically see a farmer purchase an annuity from an insurance company to provide the annuity. This locks in the payment to the farmer who does not have to worry about the ups and downs of any investment returns. Remember, the CRAT locks in an annuity payment to the farmer based on the applicable IRS interest rate in effect at the time of the gift. The farmer can not get a greater or lessor annuity payment based on investment gains or losses.
A CRAT will usually save the farmer about 10-15% above and beyond what they would receive from cashing in the grain (or equipment). In addition, there will be money being transferred to the charity at the end of the term. Many farmers are charitably minded and this is a way of getting additional funds to charity.
A CRAT is an effective method of reducing tax at retirement. If you are interested in this method, make sure to review this with a tax advisor that is familiar with CRATs. It can be easy to mess it up.
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