One size does not fit all, at least when it comes to taxes and the payments North Carolina tobacco growers and tobacco quota owners will receive as a result of the tobacco buyout.
Beginning this year, approximately $3.9 billion will pour into North Carolina over a 10-year period. The money will come to tobacco growers and tobacco quota owners as the tobacco price support system that dates to the depression comes to an end. Assessments on tobacco companies will pay for the buyout.
Approximately 75,000 North Carolinians will receive payments. Nationwide, the buyout will pay tobacco growers and quota holders approximately $9.6 billion over 10 years.
Tobacco growers will receive $3 per pound of quota grown, while quota owners will receive $7 per pound of quota owned. Quota is sometimes described as a license to grow tobacco. Quota owners do not always grow tobacco; they often rent their quota to others, who actually grow tobacco.
For both growers and quota owners, the money, which comes from tobacco companies, will be paid in equal installments over a 10-year period.
Growers and quota owners who receive buyout payments should carefully consider the tax implications of the payments, says Arnie Oltmans, an Extension tax specialist at North Carolina State University.
“They need to work closely with their accountant, tax preparer, lender or other professional advisers to determine the specific tax impact on their individual situation,” says Oltmans.
For example, Oltmans points out that payments made to tobacco growers will be taxed as ordinary business income, while the payments that go to quota owners will be taxed as capital gains.
Tobacco growers who receive buyout payments should have an easier time with their taxes than quota holders, according to Oltmans, but growers must still consider a number of tax implications.
For example, the buyout payments will be considered farm income, so even if a grower retires and stops farming, he or she will continue to earn income over the next 10 years.
“They're coming out of retirement for tax purposes,” is the way Oltmans puts it.
And growers who receive large buyout payments may want to consider farm income averaging to lessen their tax burden. Oltmans adds that older growers should consider the impact buyout payments could have on Social Security payments. In some cases, receiving buyout payments may reduce Social Security payments.
Quota owners must consider a different set of tax implications. Oltmans says quota is considered an interest in land, so the buyout payments are subject to capital gains tax. In order to determine a capital gain or loss, quota owners must determine the basis for the quota they own. Basis is the value of the quota when the owner acquired it. The capital gain or loss is the difference in the value of quota when first acquired and the amount received through the buyout.
Oltmans points out that determining the basis of quota may be a challenge in cases where quota was inherited or included in a land purchase without being separated from the value of the land. And if quota was received as a gift, the basis is the value of the quota when the gift giver first acquired the quota.
On the bright side, capital gains tax rates are lower than for ordinary income and the buyout payments received by quota holders will not affect Social Security payments. However, quota holders are not eligible for farm income averaging.
Both quota holders and producers may want to consider two other options — what Oltmans called like-kind exchanges and securitization.
Oltmans explained that a like-kind exchange involves exchanging or trading buyout payments for a piece of property, which can affect taxes.
“This is absolutely not a do it yourself project,” Oltmans says, adding that people wishing to pursue this option should do so this year and should consult a tax preparer or other financial consultant, preferably one familiar with farming.
Securitization is a way to receive a lump sum payment rather than 10 payments over 10 years. Financial institutions will pay a lump sum in return for the 10 years of payments. The lump sum will, of course, be lower than the total of the 10 payments.
Again, Oltmans says buyout recipients should talk to a qualified financial adviser before making a decision. People who chose this option will receive all their buyout money in 2005, so all the taxes will be due. That could mean they'll be paying a higher tax rate. However, Oltmans says that in some cases, taking payments as a lump sum may actually lower taxes.
In fact, the key to making wise tax decisions about buyout payments, no matter the circumstances of the individual receiving the payments, is to consult with a qualified and trusted financial adviser first.
More information on decisions related to the tobacco buyout can be found at http://www.tobaccobuyout.cals.ncsu.edu/, a Web site created by the College of Agriculture and Life Sciences at North Carolina State University, and at http://www.ces.ncsu.edu/depts/agecon/tobacco_econ/Buyout.html; http://www.ces.ncsu.edu/depts/agecon/tobacco_econ/Buyout.html.