As more children return to farming, a conflict sometimes arises over the younger generation’s compensation. Parents and children can be miles apart on perceived compensation needs.
One key to reducing or eliminating this pinch point is to write down estimated after-tax compensation values for all wages and tax-free fringe benefits provided to the child. A farming entity, in many cases, can provide substantial tax-free fringe benefits to employees that other businesses cannot.
I will provide a fictional example that might help provide guidance on this subject. Please note we are assuming the following fringe benefits are all tax-free. Care must be taken in your operation to ensure this treatment is achieved.
Calculate Tax Impacts. Let’s assume Junior graduates from college at age 22 and goes to work for a seed company. He returns to the farm at age 26 at a salary of $2,000 per month plus all fringe benefits. One day, he meets his buddies for lunch and the topic of wages comes up. All of his friends work for non-farm companies, and they are all making about $75,000. Junior feels a little sheepish when he says his dad is only paying him $24,000 per year. When he returns, he lets Senior know all of his buddies are making a lot more than him and he needs a raise.
Senior says, “Wait up a second. Your buddies’ wages are taxable. They do not have the tax-free fringe benefits we provide. Let’s review your compensation and see how it stacks up on an after-tax basis.”
To do this, Senior must first determine how much Junior’s buddies are netting on an after-tax basis. Suppose, like Junior, each is married with two children. This means all of their wages are subject to a FICA and Medicare tax of 7.65%, or about $5,700. Next, they are subject to federal income tax of about $6,000 less their child credit of $2,000. Thus, net federal income tax comes to $4,000. They are also subject to state income tax of about the same amount. Thus, their after-tax net wage has been reduced by total payroll and income taxes of about $14,000, bringing net after-tax wages to $61,000.
Benefits Boost Value. Senior must also factor in Junior’s other compensation items. For example, he is paid wages of $24,000 per year in the form of grain wages. None of these wages are subject to FICA or Medicare tax. Additionally, when Junior files his income tax return, he is entitled to an earned income tax credit of about $4,000 because he has two children. Because he has a low taxable income, he receives not only the earned income tax credit but also the $2,000 child tax credit, and he pays no state income tax. That raises Junior’s annual wage to $30,000.
Further, Junior’s parents provide a house for him and his family along with meals. The value of the house is about $1,500 per month. The value of the meals is about $1,000 per month. That raises Junior’s total annual wage to $60,000 on an after-tax basis.
Next, the farm business provides Junior and his family with qualified group health insurance—not a cheap investment. It runs about $1,000 per month for a total after-tax compensation increase to $72,000.
Additionally, the farm provides a pickup that Junior drives for the farm as well as for personal use. Almost all of the miles he puts on the pickup relate to the farm, and Junior reimburses Senior for personal miles. The farm estimates the value of the vehicle at $750 per month. This adds another $9,000 to after-tax compensation for a total of $81,000.
Finally, the farm also has a profit-sharing plan. It elects to put into the plan 25% of Junior’s salary on an annual basis. This results in $6,000 going into the plan each year, resulting in total after-tax compensation of up to $87,000 per year.
Town Versus Country. For most families in situations like this one, actual after-tax compensation is higher than wages. If it isn’t communicated in writing, friction arises. Let’s make sure that doesn’t occur.