Make Sure to Follow the CRT Rules

• October 2, 2022
• Paul Neiffer

The Tax Court released the Furrer case this week and it shows that farmers must be very careful to follow the Charitable Remainder Trust rules. If not, the penalty can be very high income taxes, interest and penalties.

In the case, the farmer contributed corn and soybeans into a Charitable Remainder Annuity Trust (CRAT) in two separate years (2015 and 2016). This required two separate CRATs to be created since you can only contribute assets to a CRAT on an one-time basis. When you contribute ordinary income assets such as raised crops, the farmer has no basis in the crop and since it is an “ordinary” income asset, there is no charitable deduction allowed to the farmer.

Rather, we utilize CRATs to spread income over several years at hopefully lower tax brackets. One way of looking at it is the CRAT can sell the asset for cash and then the taxpayers report it on an installment sale basis as they receive income from the CRAT.

That did not happen in this case. The taxpayers attempted to take a charitable deduction for each year which was ultimately mistakenly allowed by an IRS auditor. That deduction was disallowed. The trustee for the CRAT (the farmer’s son) filed trust income tax returns showing a step-up in basis of the crop and showed a small loss in 2015 and a small gain in 2016. However, there is no basis in the crop to the trust and all of the proceeds would be reported as income on the trust return.

The trusts had each purchased a Single Premium Immediate Annuity (SPIA) to cover the payments to the farmer. The insurance company issued a Form 1099 to the trust showing the gross distribution but only indicating a small amount of income from interest income. The trustee assumed this was the only income of the trust other than the loss or small income reported from selling the crops.

Then, as income is being distributed back to the farmer, there are rules that indicate all ordinary income is reported first, capital gain income second, tax-free income third and then return of basis last. Since the trust had a substantial amount of ordinary income, all distributions would be ordinary income.

The taxpayer had also argued that they had in fact sold the grain to the CRAT and therefore the CRAT had basis in the crop. However, the taxpayers did not report any grain sales on their Schedule F and this would have defeated the purpose of setting up the CRAT to begin with.

The Tax Court case reinforces that the rules on CRTs need to be followed. This can be a very complicated part of the Tax Code for most tax advisors. If a farmer wants to use a CRT, they should reach out to advisors who deal with these on a consistent basis. If not, the penalty can be harsh.

The bottom line is to never take a deduction if you contribute grain to a CRT with zero basis (since you already deducted the expenses) and all distributions from the CRT will likely be ordinary income.

, Farm Taxes | Comments Off on Make Sure to Follow the CRT Rules