Best business structures for young producers
As a young producer, you might feel your operation is lacking—not enough land, too little experience or maybe your role isn’t completely defined yet. But your strengths might be just what a seasoned operation needs.
"It’s really hard to be good at everything," says Chris Barron, director of operations and president of Carson & Barron Farms Inc. in Rowley, Iowa, and author of the AgWeb.com blog "Ask a Margins Expert." "If you work at those things you’re not as good at, you become mediocre in everything."
Paul Neiffer, a CPA with LarsonAllen LLP and author of the Top Producer blog "The Farm CPA," agrees. "Once you identify your strengths and weaknesses, ignore your weaknesses. Find someone else who has that strength."
You want to either find a partner who can help you fill in any capital, equipment or management gaps or be the person to fill in the gaps in another operation.
"Determine what key competencies you have to offer," Barron says. "Agriculture is a unique industry, where you have to be good at numerous things."
Similar to large companies, farming operations should rely on certain people to be in charge of certain responsibilities, Barron advises. "As soon as you can compartmentalize your operation and have experts in each department, you will leapfrog in front of the competition," he adds.
Start Slow. Barron likens the first few years of a farming partnership to dating. "You don’t go out on a date then get married the next day," he says. You must build up trust.
A common mistake is wanting to join the equipment fleet first. "For that to work, you have to know that the personalities involved mesh."
Spend a year sharing equipment or making marketing or agronomic decisions together, Barron suggests, in order to develop the necessary personal connections and work through any differences that might exist in operational style.
Bring in third parties to help facilitate and further develop working relationships. "Sometimes families get along better when you bring in nonfamily moderators. It will change the dynamics of the meetings," he adds.
Choose the Right Business Structure. Once you find the right people to enter into an official
business agreement with, you must determine the proper ownership structure. Neiffer says farmers will realize advantages in tax management, estate planning and other business goals by choosing the correct business structure.
Here are the common business structure options:
Sole proprietorship. Neiffer says a business is automatically considered a sole proprietorship if there is only one farmer. A sole proprietorship is basically a business with a single owner and requires few business formalities. But it doesn’t have many tax advantages and has limited options when transferring the business to the next generation.
Partnership. A partnership is similar to a sole proprietorship, except it involves more than one owner. Partnerships can be set up as general or limited, which requires a formal agreement.
Corporation. A more complex business structure is a corporation, which requires shareholders,
directors and officers. Farmers can set up a C corporation or an S corporation, which are taxed at the corporate rate and the shareholder’s rate, respectively.
Neiffer says C corporations have several tax advantages and fringe benefits for young producers. "If a house on the farm is put into the corporation, the corporation can provide that house to the farmer as a tax-free fringe benefit," he says. "It can deduct the utilities and depreciate the house." Meals can also be turned into a deductible expense. (See Neiffer’s column on page 24 for specifics.)
The two major drawbacks of a C corporation, Neiffer says, are that you’ll have to file another tax return and you’ll receive a double taxation on your profits. The corporation will pay taxes on corporate profits and the owners will have to pay personal income tax on the money drawn out of the corporation in the form of salaries, bonuses and dividends. For 2011 and 2012, dividends are subject to a maximum federal tax rate of 15%. After 2012, they might return to regular rates.
Neiffer says this isn’t a huge issue for farmers who continually reinvest in the operation.
Limited liability company (LLC). An LLC includes features of a corporation and partnership and has specific accounting and reporting requirements. An LLC gives you extra legal protection like a
corporation but is still taxed like a sole proprietorship or a partnership if there is more than one member, Neiffer says.
If a farmer sets up an LLC to operate the farm and own the land, Neiffer says, all the profits will be considered active business income. The disadvantage is that if you don’t properly structure the LLC, all the income is subject to self-employment tax. "Your best option might be to have an LLC that you elect to be taxed as a C corporation strictly for the farm operation," Neiffer says.
Having both an LLC and corporation also provides benefits, especially when it comes to land. "With an LLC, you can easily transfer land in or out," Neiffer says. "You don’t want a corporation to own land because you can’t transfer the land to the next generation." Any farmland that a young producer acquires should most likely be in an LLC, not a corporation.
When you try to sell or will land out of a corporation, it is handled as if you sold it at fair-market value. You will have to pay taxes at the corporate and shareholder level for the gain in value of the land. In many cases, the tax on the transfer of land can easily exceed 60% when you combine all federal and state taxes.
Neiffer suggests meeting with your tax and business advisers to determine the best model for your farm operation. An attorney will be needed to draw up the official legal documents.
Pick the Right Partner
The most important aspect of a business partnership or alliance, says Farm Journal succession planning expert Kevin Spafford, is having common and clearly defined objectives. He offers these guidelines:
1. Clearly define your objective. What do you want to accomplish, and how will this business arrangement facilitate your goals?
2. Know your partner(s) both personally and professionally. You should learn as much as possible in terms of organizational history, ethics, financial position, credit history and goals of each prospective partner.
3. Pay attention to your own intuition. Through school, work and other experiences, a person acquires the abilities to reason through a variety of issues. Don’t ignore your gut reactions when making important decisions.
4. Weigh all of your options. A partnership or business alliance is only one of many development options. Focus on your objectives and be certain that the relationship is helping to achieve your goals.
5. Know the organizational culture. If your prospective partner is an organization, learn about the structural integrity and management personalities of the people with whom you will be affiliated.
To help you assess your strengths and weaknesses and define your farm operation’s goals for the future, take some time to work through the "Goals Clarification Worksheet" and "Leadership Skills Inventory" at www.farmjournallegacyproject.com/tools.