A defined salary can provide saving discipline, tax benefits
How much did you earn last year? Not the farm, but you? Depending on your operation’s setup, size and intent, allocating yourself an official salary can bring financial advantages and create opportunities.
"Salaries are a gray area for farmers," says Andy Zenk, agribusiness consultant for AgCountry Farm Credit Services in Fargo, N.D. Most farmers only allocate themselves family living expenses.
Zenk says he understands wanting to invest as much profit as possible back in the operation, but a designated salary can help fund retirement accounts and other saving options.
"When you put money in other places than the farm, you have more opportunities and flexibility in terms of retirement," Zenk explains.
Some of his younger clients have a different mentality than the reinvest-every-dollar mindset. "They want to have a standard of living that is more balanced with work and life," Zenk says. For younger farmers, a defined salary can provide security and funding for vacations, hobbies and other nonfarm expenses.
Tax Advantages. Similar to purchasing new equipment or gifting assets, taking cash out of the farm each year in the form of a salary has tax benefits. The tax filing status of your farm will determine the magnitude of these benefits, says Jerry Pierce of the Kentucky Farm Business
For sole proprietors and partnerships, he says, the Internal Revenue Service (IRS) treats all funds as belonging to the operator, so there is no requirement for the farmer to pay himself a salary. But personal expenses cannot be reported as farm expenses on the tax return. Pierce advises creating separate accounts for farm expenses and personal expenses.
Those with a limited liability company must separate personal funds from farm funds. "In most cases, the owner is an employee of the farm and can receive wages, rent and a distribution of the net earnings above operating expenses," Pierce notes.
Wages are subject to payroll taxes and it’s important to pay a reasonable wage, even though there are no guidelines for farmer salary amounts. "The IRS investigates cases where they suspect a business pays unreasonably low salaries to avoid payroll taxes," Pierce says.
Labeling farm profit as a salary doesn’t eliminate it from being taxed. "All net income is taxable to farmers at the end of the year, whether they took it as ‘salary’ or not," Pierce says.
Hire Family. Pierce and Zenk say tax benefits exist for putting your spouse and children on the payroll. Hiring your spouse can provide Social Security earnings and make family health insurance coverage a deductible employee benefit, Pierce explains. The farmer must treat his spouse as an employee, which includes a formal job description, a time log, regular compensation and a separate account for the spouse’s income and spending.
In the case of children, Zenk says, the senior generation can generally pay the younger generation a salary, assuming they are of legal age and actively work in the operation. This allows members of the younger generation to start a qualified retirement account, which is a good way to begin saving for large expenses and, ultimately, retirement.
Zenk suggests visiting with your CPA, attorney and financial adviser to determine the best options.