Ask the Taxman by Andy Biebl

DTN Tax Columnist Andy Biebl is a CPA and principal with the accounting firm of CliftonLarsonAllen LLP in New Ulm and Minneapolis, Minn., and a national authority on agricultural taxation. He'll address more detailed tax strategies for retirement at an Ag Summit workshop in Chicago Dec. 7 www.DTNAgSummit.com. To pose questions for upcoming columns, email AskAndy@dtn.com.

QUESTION:

We have been very fortunate in our farming business, both with our irrigated farming and our cattle feeding operations. In addition, we have some oil revenues producing significant income. We read something you wrote about making gifts of commodities to charities. Can we also make gifts of grain to our children, and possibly to a few siblings, to share our good fortune now rather than having them wait for an inheritance?

ANSWER:

There are old IRS rulings from 60 years ago that clarify the ability of a farm producer to make gifts of unsold commodities to family members (Rev. Rul. 55-138 and 55-531). The fundamentals are much the same as gifts of commodities to a charity, in the sense that there must be a two-step process:

-- The farm producer conveys the title to the unsold commodity to the donee; and the donee separately and independently sells the commodity.

But there are several additional caveats associated with family gifts that are not an issue with charitable gifts.

1. Gifts to family members should be made after the end of the year in which the costs of raising those commodities have been deducted. If the gift is made in the same year as the commodity is raised, some of the farmer's costs of production must shift to the donee. This is not the case with charitable gifts, which can be made at any time.

2. If gifts to any one individual exceed $14,000 within a calendar year, a federal gift tax return must be filed. Gifts in excess of the $14,000 amount will consume a portion of your estate tax exemption.

3. Farm proprietors, partnerships and corporations can make charitable gifts of unsold commodities. But generally, only farm proprietors and partners (who have received distributions of grain from their partnership) can make gifts to family members. If a corporate entity owns the grain, the corporation is taxable on the value of any grain distributed for use as a gift to a family member of an owner.

The family members who receive the unsold grain will pay tax, of course, when they sell the grain. But assuming they are not engaged in the farming business, they only pay income tax, not self-employed social security tax. And if any of those donees are under age 19 at year end or college students under age 24, the "kiddie tax" will apply the parental tax rate rather than the child's rate to this income. The recipient reports the sale of the grain on Schedule D as a short-term capital gain, reporting the sale price of the grain against a zero tax cost.

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QUESTION:

My wife and I are in our mid-50s and have begun looking into long-term care coverage. There is a considerable range of options, including inflation-adjusted coverage, shared care policies, return of premium policies and more. Recently we were approached about buying life insurance to fund long-term care by borrowing against the life policy. There are life insurance benefits that eventually pass to our heirs tax-free. I am convinced some kind of plan is needed to guard against the costs of long-term care, but am confused by which is the best option.

ANSWER:

I cannot speak to all of the variations in long-term care contracts. You should seek insurance advisers or financial planners with expertise in those products. But I can add a few comments about the tax side, and a few general thoughts about insurance.

It is important to remember that insurance is primarily about risk protection. Long-term care insurance, of course, is to protect against the risk of excessive nursing home costs. Generally, those on the very low end, with few assets and low income, do not have this risk due to assistance programs, and those on the upper end with strong income can weather the costs. It is those of us in the middle, where a spouse's income would be depleted or assets that are targeted for the children will be lost, who need the protection.

From an income tax standpoint, there is a limit on the annual deduction for these premiums that is age based. For those ages 51-60, the annual limit is $1,400, and from ages 61-70, the limit is $3,720. If you are a self-employed proprietor, partner, or more-than-2% S corporation shareholder, this deduction is claimed on page 1 of your Form 1040 with other health insurance, and is deductible even though you may not itemize medical deductions. For those with a farming C corporation, long-term care insurance could be added as a fringe benefit, and in that case there is no annual limit applicable to the corporate deduction. Rather, the total compensation package must meet the standard of reasonableness.

I am skeptical of the merits of investing in a whole life insurance policy to build cash value against which loans can be drawn to pay long-term care premiums. The post-death life insurance benefits can be outside of your estate, but that is only efficient if you are exposed to the 40% estate tax (this requires individual net worth in excess of $5.34 million for you, or about $10.7 million for you and your spouse). Otherwise, the dollars into the life policy are being consumed with mortality costs, and further you are paying non-deductible interest on the policy loan for the privilege of using your own money. Unless there is a separate need for more life insurance, this is not an efficient manner of funding long-term care premiums.

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QUESTION:

In your writings in early July, you mentioned life insurance and the point about its use for risk protection. Over the years, I have accumulated 8 or 10 life insurance policies. They were to protect against the risks of an early death or the debt on the various land parcels we acquired. But now my wife and I are age 65, our children are grown and established, the debt on the land is negligible, and the estate tax does not look to be a risk. I am thinking that we should probably cash in the surrender value on those policies, and maybe use the cash for our grandchildren for their education. What would you consider as our best options and any positives or negatives? I am concerned about advice from insurance agents who only seem to want more investment in their product.

ANSWER:

Your assessment looks solid. If there is no longer a risk of any financial detriment from an early death, there is no reason to let the cash surrender values sit and bear the charges of ongoing maintenance and mortality costs of those policies, but each policy should be examined. Some old contracts may have guaranteed minimum growth rates that are lucrative in terms of today's market yields. That benefit needs to be compared with the costs of maintaining the policy.

If the conclusion is, as you suggest, to terminate and extract that cash value, a key point is to check on the income tax costs. Each insurance company can tell you the amount of gain associated with each contract. To the extent the cash surrender value exceeds your tax basis, the excess is ordinary income. If the numbers are large, you may want to consider stretching the terminations of these policies out over several tax years.

Another option is to consider exchanging the life policies into an annuity contract that pays out a guaranteed lifetime income to you and your spouse. That will spread the income out over many tax years, and insure against another risk: a very long lifetime. A joint and survivor annuity pays as long as one of you survives, so you shift the risk of excessive longevity to the insurance company. On the other hand, if you both go together in a car accident in a few years, the insurance company wins the bet!

If your land rental income and other resources are such that you do not worry about outliving your income, then the concept of considering those grandkids could make great sense. One idea would be to cash in those life policies and move the funds, after paying the income taxes, into 529 plans for each grandchild. The funds inside these 529 plans grow without any income taxes, assuming the proceeds are eventually extracted for higher education costs.

(MZT/AG/CZ)

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