Jeanne Bernick, Top Producer Editor
Many farmers who structure their operation simply as a sole proprietor may be losing several thousand dollars each year since all of their farm income is subject to self-employment tax, says Paul Neiffer, a CPA with HansenNvOPS in Washington.
For successful young farmers, this tax can be several times larger than their income tax burden, Neiffer adds. For example, if a farm couple has four kids and earns $75,000 from their farm, they will pay $10,597 in self employment taxes and $629 of income tax for a total tax burden of $11,226.
Neiffer recommends that farmers split up their operation into two separate entities: (1) an operating entity and (2) a land holding entity. "To provide the best legal protection and provide tax savings, we will use either a limited liability company (LLC) or corporation for the operating entity,” Neiffer says. "With an LLC, the farmer would elect for this to be taxed as a corporation.”
In this situation, Neiffer says all of the farm operations would be handled through this entity and a farmer would be paid in the following way:
- A salary based upon what fair market values are for these types of services (the farmer wants this to be a low as is possible, yet not unreasonably low),
- Fringe benefits such as health insurance, groceries and other expenses related to the household if it qualifies as on-farm housing (all of these benefits are deductible by the corporation and are not income to the farmer),
- Dividends from the corporation (if S election is made).
"The only payments that are subject to payroll taxes are the salaries,” Neiffer says. In many cases, the farmer with proper planning can get their payroll tax burden (equivalent to self-employment taxes) to under $3,000.
C Corp taxes. If the corporation is taxed as a C corporation, it will pay tax on its taxable income and as long as the income is less than $50,000 the tax rate is 15%, adds Neiffer. The after-tax income paid to the farmer in the form of a dividend is subject to a special dividend tax rate of 15%, however if the farmer is in the 15% tax bracket, then this rate is zero (which may change starting in 2011).
If the corporation elected to be taxed as an S corporation, the payroll taxes of $3,672 would apply, the remaining income earned by the corporation of $51,000 would flow through to the farmer, their income tax liability would be about $1,424 for net taxes owed of $5,096, Neiffer says. The farm family would save about $6,000 under this situation.
If a farmer owns land, the farmer will transfer the land into an LLC or limited liability partnership that would hold the land and rent it to the operating entity. The net rental income is not subject to self-employment taxes if structured properly.
So, if the farm nets $75,000, pays a salary to the farmer of $24,000, pays health insurance premiums of $10,000 and pays other qualified fringe benefits for the farmer of $15,000, the net income to the corporation would be $26,000. The tax to the corporation would be $3,900 (plus state taxes if applicable).
On the farmer's side, they would be taxed on the salary of $24,000. This enables them to potentially qualify for an earned income tax credit of $5,108 and child tax credit rebates of $3,150 for a net refund to them of $8,258. Therefore, the total taxes paid are $3,900 of corporate tax plus $3,672 of payroll taxes less the $8,258 individual refund equals a net tax refund of $686.
If the corporation pays out a dividend to the farmer equal to the net income remaining of $22,100 (net of the income taxes paid), the farmer would not qualify for the earned income tax credit, but would still get a $3,150 child credit refund, so the net taxes in this case would be $4,422. In the best case, the farm family would be almost $12,000 ahead and in the worst case about $7,000 ahead per year.