Farmer reaps tax liability when CRT could have harvested tax benefits

A Charitable Remainder Trust (CRT) can be a great way to defer income tax and obtain a charitable deduction. A CRT works especially well when funded with a highly appreciated long-term capital asset, such as publicly traded stock or real estate.

A CRT is a special trust that is generally exempt from tax. The CRT pays an annuity to the non-charitable beneficiary for life or for a term of years and the remainder interest passes to charity. The income tax character of the annuity depends on the categories of income earned by the CRT. If the CRT’s only income is capital gain recognized on the sale of the appreciated asset, then the annuity will be taxable to the beneficiary as long-term capital gain until the capital gain is fully distributed. Also, an income tax charitable deduction is generated equal to the present value of the remainder interest.

In Furrer v. Commissioner, T.C. Memo 2022-100, the taxpayer, an Indiana farmer, attempted to use a CRT to avoid paying income taxes. There, the farmer contributed bushels of corn and soybeans to a CRT. The CRT sold the crops for $469,003 and used the proceeds to purchase a single premium immediate annuity, which paid the farmer $84,368 each year. The CRT then paid $47,000 to the charitable remainderman. The CRT correctly did not report gain on the sale of the crops, but the farmer incorrectly took the position that the annuity constituted a tax-free return of corpus.

The Tax Court ruled that the crops constituted ordinary income property because the crops were inventory to the farmer. Further, the basis in the crops was zero because the farmer had fully expensed all costs of growing the crops. Therefore, the CRT realized $469,003 of ordinary income on the sale of the crops. Under the ordering rules, the annuity amounts distributed by the CRT to the farmer is treated as ordinary income to the extent of the CRT’s ordinary income. Accordingly, the annuity was taxable to the farmer as ordinary income in each year until all ordinary income is distributed.

While Furrer is an example of how not to use a CRT, please contact us on how to properly use a CRT to defer income tax and obtain a charitable deduction. 

Client alert authored by: David B. Shiner (312 855 4319), principal.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.