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Business Structures and Taxes
Legal and Tax Considerations
December 7, 2016
What are your goals?
Ease of operation
Transferability
Tax benefits
Liability protection
Reduce Self-Employment tax
Fringe Benefits
Flexibility
Real Estate Basis
Handout: Long Term Planning Goals
Other Considerations
Life/stage of business
Sources of capital
Inter/intra family issues
Taxes
Risk management
Preparing for next generation
Estate planning implications
Management or control
Termination of business
Multiple entities
Key Employees
Using Entities in Farm Planning
Business Purpose
Liability Protection
Organize Operation(s)
Greater Flexibility
Better profitability analysis
Estate Planning Purpose
Protect Farm Assets from family or creditors
Greater flexibility in planning
Easier transfer of assets
Types of Entities
C Corporation
S Corporation
Limited Liability Company
Partnership/Family Limited Partnership
Other Entity types
Sole Proprietor (Schedule F)
Trust (Revocable – Irrevocable)
Handout: Comparison of Entity Types
Typical Scenario – Preferred Choice
Limited Liability Company or S Corporation
Flexibility, Tax benefits, taxed at owner rate
Multiple Entities – greater flexibility
Equipment and labor pool
Land
Livestock
Operations
When To Choose Other Entity Types
C Corporation
Need for control at the top
Shareholders who would have trouble with pass-through income
Special needs shareholders, “stranger”
shareholders
Limits movements of assets and cash
WATCH – Dividends are double-taxed.
When To Choose Other Entity Types
Partnership
Well-suited for short-term project
Can be adapted or evolved into LLC
Can be terminated at end of project
Highest liability issues and joint-partner risk
When To Choose Other Entity Types
Sole Proprietor
Greatest liability risk – both business and personal assets at stake
LLC versus S Corp
Limited Liability Company
Tax free in-and-out (mostly)
Easy to change as circumstances change
Can have many layers
S Corporation
Prevents de-capitalization of Corp by young owners
Stronger mgmt control in officers
Structure
LLC versus S Corp
Limited Liability Company
GENERAL (Active) Members pay SE Tax
LIMITED (Passive) Members are exempt from SE Tax
S Corporation
Can be exempt from SE Tax if salaries are paid to SH
SE Taxes
LLC and Trusts Land
LLCs and Land Ownership
LLCs – “easy-in, easy-out” flexibility
Basis locked at formation
Can change structure at any time
Can organize as Business
Trusts and Land Ownership
Locked-in for duration of Trust
Basis locked at formation
Cannot change structure
More difficult to operate as “business”
LLCs and Tax Form
Partnership LLC
Pass-through income, depreciation, etc.
Humans usually lower tax rate than corps
Corporation LLC
No pass-through tax
Corps taxed at higher level than humans
Entity Structure and Risk Management
Liability Insurance – adapted for every entity type, but does not make you “risk-proof”
Entity structure can either “keep in” or “keep out” risk
You cannot insure against your own bad behavior
Does not protect against financial liability (bad debt, bad business decisions, over-extended credit)
Entity Structure and Risk Management
Keep Risk Out
Liability for outside events limited to assets in LLC –cannot get at your personal assets
Can protect real estate from operational liability
Keep Risk In
High-risk elements (equipment, labor) in one LLC
Liability limited to assets in one LLC (not entire operation)
Insurance
Basic liability insurance
Basic casualty insurance
Crop insurance
Vehicle insurance
Workers Comp
Umbrella/Operations insurance
Life insurance
Entity Choice and FSA/Farm Program
No more “3-entity Rule”
Now – payment limit falls to individual owners
Critical factor is “active participation” by owners
Careful structure of “cash rent” entities
Watch issues of Seniors and Minors
Death and Taxes
Indiana Inheritance Tax – repealed 2013
Federal Estate Tax
2016 - $5.45M per person
2017 - $5.49M per person(adjusted for Inflation)
Portable between spouses ($10.5M per couple)
Unified Gift/Estate/Generation Skipping Rate
Capital Gain Taxes
Beware Discount Valuation for 2017 – IRS denies
future family use of discount valuation
“Stuck” Entity Structures
What is a Stuck Structure?
C Corporation
S Corporation
Irrevocable Trust
Why Stuck?
Low basis/High Value Land
High Retained Earnings
Cannot change entity without significant tax
“Stuck” Entity Structures
What do you do when you can’t get out?
Built-in Capital Gains
Low basis – High value real estate
Cash in the entity – not in your pocket
Planning ahead – looking out 10+ years
Restructure business operations away from “stuck” entity
Odd and Unusual Factors
Conservation easements
Shared well (water or gas)
Water, Mineral, Gas rights to 3rd parties
Hunting Rights
Cell Towers – long term leases
Wind Towers – long term leases
Air Space/Overhead encroachment
General easements and other Deed restrictions
Fair – vs – Equal
Planning should consider the needs of both “farm” and “Non-farm” heirs
Whether “farm” heir should have preference for land over cash or inventory inheritance
Whether all heirs can cooperate for operating an entity
Fair – vs – EqualFarm and Non-farm heirs
Whether “Non-farm” heirs can incorporate farm income into their personal financial picture
Use of “non-farm” planning tools to equalize an estate and leave more “farm” assets to “farm” heirs
Life Insurance, Cash investments
Special Needs – Special Heirs
Physical/mental infirmity – qualification for Gov’t entitlements
Legal issue
Residence issues
Plan for Transition – Gen 1
QUESTIONS
What will be the most effective and fair way to
pass the farm business to the next generation?
When should the change take place?
OPTIONS
Buy out
Rent out
Other Family
Gift
Bequest
TIMING OF TRANSITION
During Life
After Death of Spouse 1
After Death of Spouse 2
Case Study Goodacre Farms LLC
A&B Goodacre Farm Management LLC
Goodacre Hogs LLC
Bill & Ann Goodacre
Mary – Tom – Jane
Assets
Farm Assets
Owned Acres
Rented ground
$3M machinery, buildings, bins
Personal Assets
$500,000 Savings
$500,000 Retirement
Value of Estate (March 2016)
RE = $ 9.8M
Farm EQP = $ 3.0M
Cash assets = $ 1.0M
Total Estate = $12.8M
Organizational Structure
Go
od
acre
Farm
s, L
LC • Farm Real Estate
• Cash or Share Rent
A&
B G
oo
dac
reFa
rm
• Machinery
• Labor
• Contract Farming
• Key Employee
Go
od
acre
Ho
gs L
LC • Livestock contracts
• Animal buildings
Enti
ty R
elat
ion
ship
sReal Estate LLC
• Contract with MGMT LLC
• Liability insulation
• Estate Plan – Ownership to all children
Management LLC
• Contract Farming
• Production “stake” for sweat equity (Son & Key Employee
• Liability insulation
Livestock LLC
• Production stake
• Liability insulation from Real Estate
CrossContracts
Fam
ily R
elat
ion
ship
sReal Estate LLC
• Starting out - Owned by Parents
• Gifted to/inherited by children
• Rental income to owners
• Downside – Basis lock!
Management LLC
• Starting out - Owned by Parents
• Sweat Equity and gradual “buy in” by farming child
Livestock LLC
• Opportunity for start-up by Gen 2 (Son)
• Can be co-ownership by parents/son
Considerations
Income tax effect of LLC on off-farm owners
K-1 and personal tax rate
Unwelcome complications to Gen 2 taxes
Issue of locked-in basis for real estate
Yes, but is that important? Will there be liquidation?
Estate Tax
Planning for entity discount
Minimizing estate taxes in high value real estate market
Factors in Farm Planning
Entity structure
Risk Mgmt
Fair v Equal
Transition
Taxes
Business Operations
Farm Entity Structure
Flexibility is KEY
Goals suggest structure
Estate Planning – Will there be an Estate Tax Risk?
Transition to Gen 2
Consideration of on-farm and off-farm children
Needs of Gen 1, Gen 2 and Gen 3
Liability protection/insulation of assets
Business Structures and Taxes
Questions?
Contact information:
Miriam Robeson, Attorney at Law
Email: [email protected]
Website: lawlatte.com
