Tax reform made several changes to the tax rules about businesses operating as a C corporation. Let’s take a look at the pros and cons of this option for your farm operation.
The most important change from tax reform was dropping the top tax rate from 35% to 21% (a 40% reduction). However, for most farmers who already farmed as a C corporation, their tax rate was 15% (on the first $50,000 of taxable income). The new rate for these farmers is now a 40% tax increase because the 21% rate starts at the first $1 of taxable income.
Even though the top rate has dropped, there’s a potential double tax from having assets in a C corporation. At some point, the farmer will want those assets out of the corporation (for retirement or transfer to the next generation). This transfer will likely result in additional tax. Current law provides for a special tax rate (zero if the income is in the 15% or lower tax rate), but future tax law changes might increase this rate.
If the farmer transfers the C corporation through their estate, there is a step-up in basis of the stock; however, all the assets inside the corporation receive no step-up and this can cost the heirs.
For example, a farmer owns $2 million of machinery and $2 million of grain at death. If this is held as a sole proprietor, the heirs get a full step-up. They can sell the machinery and grain for $4 million and owe no tax. But, if the assets are inside the corporation, there is no step-up and the corporation will owe close to $1 million in federal and state taxes when the assets are liquidated.
The Pros. The main reason we use C corporations is not the lower tax rate, but the ability to provide tax-free fringe benefits for items such as housing and meals to the farm family and employees. Tax-free fringe benefits allow a full deduction to the farm C corporation (except meals) and the fringe benefits are tax-free to the farm family. To provide these benefits, it must be for the convenience of the employer and on the business premises. Livestock operations meet this requirement fairly easily. Grain operations qualify only if the housing is located on or very near the farm.
The tax-free benefits for housing are likely still the biggest advantage for farm families operating as a C corporation. The farmer can build a house on the farm and depreciate it over 20 years; the farm can also take 100% bonus depreciation on the house. All farm buildings are depreciated over 20 years, even the house.
All the costs of operating the house are 100% deductible by the corporation and tax-free to the family. These costs include real estate taxes, insurance, repairs, improvements, furnishings, supplies, etc.
Tax reform did reduce the benefit in providing meals. Beginning last year, a farmer can now only deduct 50% of any meals provided to employees and starting in 2026, there is no deduction. But the meals are still tax-free to the family.
The Cons. A potential drawback to using the corporation for housing is if the farmer wants to sell the home. Because it’s an asset of the corporation, this sale results in full taxation, at the 21% federal rate, whereas, if the home was owned by the married farmer individually, the first $500,000 of gain would be tax free. However, the farmer still had the tax savings from depreciating the house and expensing housing costs.
We usually don’t recommend having all farm assets in a C corporation. Instead, we use the C corporation to provide tax-free fringe benefits to the farm family and maintain other farm operating assets inside an LLC taxed as a partnership (or general partnership if we need to maximize FSA payments) with the corporation as the manager of the LLC. This allows for a full step-up in partnership assets, can reduce self-employment taxes and provides tax-free fringe benefits to the farmer.
As always, review this with your tax adviser before making any decisions.
Read more analysis and insights to tax questions on Paul’s blog at AgWeb.com/farm-cpa
Paul Neiffer is a tax principal with CliftonLarsonAllen and author of the blog, The Farm CPA. He recently purchased a 185-acre farm. Driving his cousin’s combine is his idea of a vacation.