Charitable Remainder Trust as a Retirement Strategy
One of the primary challenges for a retiring farmer is the large tax burden that retirement may cause. Throughout their farming careers, farmers do a good job of managing income taxes, in part, by delaying sales and prepaying expenses. This strategy works well while the farm is operating but can cause significant tax liability upon retirement. The combination of a large increase in revenue from the sale of assets and little or no expenses to offset the revenue can cause a retiring farmer to be pushed into high tax brackets. It is not unusual for 40% or more of the sale proceeds from a retirement sale to go to taxes. One strategy to reduce income tax liability at retirement is a Charitable Remainder Trust (CRT). A CRT can be an effective way of managing income taxes at retirement, but it is not for everyone.
A CRT is a charitable trust because at least some of the assets in the CRT must eventually pass to a qualified U.S. charitable organization such as a church or 501(c)(3) corporation. This charitable nature of the CRT is central to the CRT strategy. As a charitable trust, the CRT may sell assets without paying tax on the sale. So, instead of the retiring farmer selling assets in their own name, they donate the assets to the CRT and then the CRT sells the assets. The retiring farmer then receives an income stream from the CRT. After a period of time, the income stream stops and the remaining trust assets are contributed to the named charity. The following are the steps of the CRT strategy:
- Assemble a team of advisors and develop a CRT strategy.
- Donor establishes a CRT. The trust document declares the income beneficiaries and the charitable beneficiaries.
- Donor determines the assets to be contributed to the CRT.
- Donor contributes assets into the CRT, typically grain, machinery and/or livestock.
- The CRT sells the assets but does not pay tax.
- The Trustee of the CRT uses the sale proceeds to establish an annuity. The annuity must be designed to provide at least 10% of the sale proceeds to the charity.
- The annuity pays out to the Donor over a number of years. The Donor pays income tax on the annuity distributions.
- When the trust is terminated, the charity is paid the remaining assets.
Consider the following example to help further explain how a CRT strategy works:
Farmer decides to retire at the end of the 2023 crop year. After harvesting the 2023 crop, Farmer owns $1 million of grain and $1.5 million of farm equipment. Farmer’s accountant tells him that if he sells all the grain and machinery in one year, he will pay around $1 million in taxes. Farmer decides to implement the CRT strategy. He establishes a CRT and names himself and his spouse as the income beneficiaries and the local children’s hospital as the charitable beneficiary. Farmer transfers his grain and machinery into the CRT. The CRT sells the grain and machinery and receives $2.5 million in sale proceeds.
The CRT establishes an annuity that will pay out $125,000 for the next 20 years. Farmer pays income tax on each $125,000 payment which results in $20,000 of annual income taxes. After 20 years, the trust is terminated, and the children’s hospital receives the remaining funds in the CRT.
As the example shows, the strategy avoids a large, up-front tax payment in the year of the asset sale. Farmer pays taxes on each annual $125,000 payment which allows him to stay in a lower tax bracket. In the example, instead of paying $1 million in taxes in 2023, Farmer spreads the payments out and ultimately pays $400,000 over 20 years.
The primary disadvantage of a CRT is that it is an irrevocable trust. Once the CRT is set into motion, it cannot generally be undone. A CRT may not be the best option for farmers who wish to keep flexibility with managing their assets or who are transitioning the farming operation to family members. While a CRT provides many tax and business benefits, it is not an adaptable plan that can be changed in the future.
Another disadvantage of a CRT is the cost. It is usually a rather complicated process to establish the trust, calculate the potential tax savings, file a tax return, and establish an annuity. Legal and other professional fees will often be tens of thousands of dollars. It is important early in the planning process to weigh the potential tax savings against the cost of establishing the CRT.
For more information on CRTs, see the newly published bulletin Charitable Remainder Trusts as a Retirement Strategy for Farmers available at farmoffice.osu.edu. This bulleting provides details on how a CRT strategy is implemented and its advantages and disadvantages. Be sure to consult with an attorney, tax advisor and financial advisor before deciding on a CRT for your retirement strategy.