Two farms may look alike, but if one is incorporated and the other is not, their owners may experience vastly different fates.
The business structure you choose can make a difference in taxes, how much cash is available to plow into the farm, and whether you will lose your personal property if the farm gets hit with a big legal judgment. Also, certain government crop payments may be impacted by the business structure a farmer chooses.
There are numerous business structures to choose from. One is the sole proprietorship, which most farmers choose. Another is the standard incorporated farm, known as the C corporation for tax purposes. Other options include the partnership, limited partnership, limited liability company and S corporation.
Picking the right one involves an analysis of numerous variables. A farmer must know how each might impact federal and state taxes, cash flow, business tax deductions, profitability and the relationship between the farm and its lenders.
The bottom line: each farm is different. One size doesn't fit all when it comes to choosing a business structure. Paul Wright, a Columbus, OH, attorney specializing in agricultural law, advises farmers to consult a tax specialist and an attorney specializing in business organization before proceeding.
Everywhere, the legal landscape is filled with mines. For instance, switching business structures may prompt banks to demand new terms on outstanding loans, or it may entail new taxes.
And every option has good and bad points. For example, incorporation allows farmers to fully deduct health insurance premiums as a business expense on federal taxes. But incorporation may also subject them to new taxes.The right c hoice today may be the wrong one five years from now, as state and federal tax laws evolve.
"There are farmers incorporated today who wish they never saw it," says Wright.
If you make the wrong choice, it can be difficult and costly to change to a different business structure. Take, for example, the farmer who dissolves his farming corporation and switches to a sole proprietorship. If farmland is part of the corporation, he must pay capital gains taxes on the land's appreciation, even though the property wasn't sold, says Wright.
"A tract is subject to federal taxes, then what's left is distributed to the corporation's stockholders and treated as dividends or capital gains on their personal income taxes," he says. "We often recommend they just leave the corporation as it is."
Another word of caution: If you incorporate, think twice before putting land in the corporation's assets. The land will be subject to double taxation if you put it in the corporation, then sell it. First, Uncle Sam will levy corporate capital gains taxes on the sales proceeds. Then you will pay individual income taxes on what's left.
Another problem arises when a corporation holds property and a stockholder dies. If the land is later sold, heirs will face much higher taxes than if the land were kept separate from the corporation.
Wright suggests the farm owner keep the land in his own name, then simply rent the property to the farming corporation. That will cut the tax bite if the land is sold outright by its owner, or sold later as part of his estate.