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October 4, 2022

Farmers may not claim charitable deductions for donating crops to CRATs, and income from annuities purchased with crop proceeds is taxable to them

  • The Tax Court held that a couple could not claim charitable contribution deductions for crops transferred to their charitable remainder annuity trusts (CRATs) and were liable for income tax on annuity payments from the CRATs.
  • The case explains a set of ordering rules regarding the taxation of annuity payments from a CRAT.
  • Under the ordering rules, the annuity payments were taxable as ordinary income to the couple because the CRATs purchased the annuities with proceeds from the crops, in which the couple had a basis of zero.

In Donald Furrer, et ux. v. Commissioner, the Tax Court has held that a farming couple may not claim charitable contribution deductions for in-kind contributions of crops they made to their two charitable remainder annuity trusts (CRATs), which then sold the crops and used the proceeds to buy annuity plans that paid cash distributions to the couple. Further, the Tax Court held the couple must include the annuity payments in income for the years at issue.


Donald and Rita Furrer farmed corn and soy beans. Spurred by an ad in a farming magazine, the couple formed the Donald & Rita Furrer Charitable Remainder Annuity Trust of 2015 (CRAT I) in July 2015, with their son as trustee. The trust instrument designated the couple as life beneficiaries and listed three IRC Section 501(c)(3) charities as remaindermen. Upon forming CRAT I, they transferred 100k bushels of corn and 10k bushels of soybeans grown on their farm to the new entity. In August 2015, CRAT I sold the crops for $469k; the grain marketing and storage company that stored the crops handled the sale. CRAT I distributed $47k to the three charities and used the rest to buy a Single Premium Immediate Annuity (SPIA) from an insurance company. The SPIA then paid annual annuity payments to the Furrers of $84,368 in 2015–2017, reporting each payment on a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., listing the annuity payment as "gross distributions" and a small amount of interest as taxable.

The Furrers repeated this pattern in 2016, creating CRAT II to which they transferred homegrown corn and soybeans. CRAT II sold the crops for $691,827, distributed $69,294 to the charitable remaindermen and used the rest to buy another SPIA, which in turn made $124,921 in annual payments to the Furrers in 2016 and 2017 and reported the transaction in the same manner as CRAT I had.

When the Furrers filed timely joint income tax returns for 2015–2017, they claimed charitable contributions for cash gifts but did not claim deductions for their in-kind crop transfers to the CRATs. They reported income in keeping with the income reported on the Forms 1099-R and did not report the balance of the annuity distributions, which they asserted was nontaxable return of corpus under IRC Section 664(b)(4).

Donald filed generation skipping transfer tax returns on Form 709 for 2015 and 2016, reporting the couple's (1) 2015 contribution to CRAT I of corn and soybeans with a fair market value (FMV) of $469,003 and a zero cost basis and (2) 2016 contribution of crops to CRAT II with a FMV of nearly $667k and a cost basis of zero.

The CRATs' trustee filed a Form 5227, Split Interest Trust Information Return, and Form 4797, Sales of Business Property, for each pertinent year, reporting the crop sales as follows:

  • 2015: $469k in proceeds offset by a $471k basis, resulting in a $1,997 loss
  • 2016: $691,825 in proceeds offset by a $666,975 basis, resulting in a $24,850 gain

An IRS audit of the Furrers' 2015–2017 income tax returns concluded that the taxpayers had improperly characterized the SPIA distributions as nontaxable returns of corpus and that the distributions were proceeds from the sale of the farmers' crops and thus taxable to them as ordinary income.

As a result, the IRS increased the Furrers' Schedule F farm income by $83,220 in 2015 and $206,967 in 2016 and 2017. While under exam, the Furrers asserted that they should have claimed noncash charitable contribution deductions for the crops transferred to the two CRATs and asked the examining agent to allow deductions equal to the proportion of the FMV of the donated crops given to the charitable remaindermen. Although the taxpayers had not obtained an appraisal for either donation, the examination agent agreed to allow charitable contribution deductions of $67,788 for 2015 and $106,413 for 2016.

The IRS issued deficiency notices for 2015–2017 and Furrers timely petitioned the Tax Court. After the parties settled some issues, the two remaining issues were: (1) whether the Furrers could claim noncash charitable contribution deductions for 2015 and 2016 and (2) whether the annuity distributions were taxable to them as ordinary income for . The IRS moved for summary judgment on both issues.

Law and analysis

Charitable deduction

Before the Tax Court, the IRS contended that the examining agent had erred in allowing charitable deductions for the crops transferred to the CRATs. As this was a "new matter" before the court, the IRS bore the burden of proof on this question and carried its burden. The court agreed that the deductions were impermissible because the taxpayers had not substantiated the value of the crops by obtaining an appraisal or by maintaining written records substantiating the contribution.

Even if the taxpayers had substantiated the value of the contributed assets, the Tax Court determined, IRC Section 170(e)(1)(A) requires a deduction for a contribution of property to be reduced by the gain that would not have been long-term capital gain if the taxpayer had sold the property at FMV. The crops were inventory that the taxpayers primarily held for sale to customers in their business, and thus generated exclusively ordinary income. Because the deduction for a contribution of ordinary income property is limited to the donor's cost basis in the property and the Furrers' basis for the crops was zero (they had already fully expensed their costs associated with growing the crops), any charitable deduction would be zero as well.

Annual distributions

The Tax Court explained that a CRAT is a type of charitable remainder trust (CRT) and thus allows annual distributions to the grantor or other non-charitable beneficiary while retaining an irrevocable remainder interest for at least one IRC Section 501(c)(3) charity. The donor typically does not recognize gain when transferring appreciated property to a CRT or CRAT, but income the trust earns is taxable to the income beneficiaries upon distribution. A set of ordering rules organizes how this income is distributed and taxed:

  • First as ordinary income, to the extent of the CRAT's current and previously undistributed ordinary income
  • Second as capital gain, to the extent of current and previously undistributed capital gain
  • Third as other income, to the extent of current and previously undistributed other income
  • Fourth as a nontaxable distribution of corpus

Each class of taxable income must be exhausted before moving on to the next (lower taxed) class, so the beneficiary may only receive a nontaxable distribution of corpus after all taxable income has been distributed. To ensure compliance with these ordering rules, CRATs must comply with strict reporting requirements.

The Tax Court noted that Donald had conceded in his 2015 and 2016 gift tax returns that the taxpayers had zero basis in the crops transferred to the CRATs. The Furrers did not pay gift tax when they transferred the crops to the CRATs; therefore, the CRATs' basis in the property received was the same as the Furrers' basis (IRC Section 1015(a)). The court noted that the "FMV of the transferred crops is irrelevant in determining the CRATs' basis because petitioners' basis was lower than the FMV of the crops."

The CRATs then realized ordinary income ($469,003 and $691,827) when they sold the crops. Because all of this ordinary income must be distributed first, the annuity distributions ($83,440, $206,967, and $206,967) must all be characterized as ordinary income to the Furrers.

The court easily dispensed with each of the Furrers' arguments, ruling none had merit. The Furrers' contention that the CRATs acquired a stepped-up basis "does not pass the straight-face test," the court wrote. "Equally unpersuasive" was the trustee's reporting on Form 4797 of bases exceeding or nearly equaling the FMV of the crops. "Petitioners have supplied no factual support for the basis numbers reported by the trustee, and those numbers are utterly implausible," the court stated. The court also rejected the petitioners' assertion that the annuity distributions constituted a nontaxable return of corpus.

Finally, the court rejected the petitioners' contention that distributions from the SPIAs should be taxed under IRC Section 72, noting that IRC Section 664(b) provides specific rules for annuity distributions from CRATs and that both Code sections allow for income to be excluded only to the extent the taxpayer has an "investment in the contract." Because both annuity contracts were purchased with proceeds from the sale of crops with a zero basis, the petitioners had no investment in the contract, the Tax Court concluded.


It is somewhat surprising that the examining agent would have allowed the charitable deductions because the property was considered inventory to the taxpayers and the taxpayers had previously filed returns in which they reported that the bases they had in the inventory was zero. IRC Section 170(e)(1)(A) is clear on the issue, and the taxpayers had not taken charitable deductions for the remainder interests in the CRATs when they filed their 2015 and 2016 returns. The fact that the charitable deductions were not properly substantiated is irrelevant because IRC Section 170 excludes a charitable deduction for property that is considered inventory to the donor.

Regarding the inclusion of the annuity payments in gross income, the taxpayers took the position that IRC Section 72 trumped IRC Section 664 regarding the taxation of annuity payments. The court determined that IRC Section 664 controlled. Under IRC Section 72, the taxation of annuity payments is based on a ratio of the amount invested in the annuity contract and the expected return on the contract, with only the expected return on the contract being subject to tax. Based on IRC Section 72, the proceeds from the sale of the grain (i.e., the investment in the contract) would never be subject to income tax. However, under IRC Section 664, the sale of the grain is 100% taxable as category one income that is carried out first when determining the character of annuity payments from a CRAT.

The facts state that the taxpayers initiated the CRAT transactions as the result of an advertisement they responded to in a farming magazine. The transactions are similar to transactions marketed to the public by a firm (or firms) that were the subject of a previous GLAM (2020-006 (Feb 11, 2020)). The result in this case regarding the taxation of the annuity payments will likely be the result in other cases involving similar transactions. As with other tax transactions that seem to be "too good to be true" — they generally are too good to be true.


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