I know that many of our readers currently have jobs not related to farming but would like to leave those jobs and start farming on a full-time basis. One of the major drawbacks of doing this is the lack of capital. However, many of you could have a substantial asset that you can tap to create the working capital needed to get started in farming. This asset is your 401(k) plan.
Here is how it works:
- You will need to create a corporation (generally taxed as a C corporation).
- This corporation will establish a 401(k) plan.
- You will roll over your current 401(k) at the old employer into this new 401(k) plan.
- The new 401(k) plan will then purchase shares in the new corporation and will become an owner of the corporation (this is very similar to an ESOP).
- The money put into the corporation becomes the working capital that the corporation can use to purchase equipment, plant crops, etc.
There is no limit on how much stock the 401(k) can purchase. This means that, unlike borrowing money from a 401(k) plan which is limited to $50,000 or cashing in the plan and paying taxes and a 10% penalty on the funds received, you are able to maximize the amount of capital you can put into the farm business.
There is a recent article in Bloomberg Businessweek concerning this type of transaction. The primary point of the article is that the IRS has noted some abuses in this type of transaction. Some taxpayers have set up a corporation simply to purchase a motor home, etc. This will most likely get disallowed on an audit. However, if you are using the cash to create a farming entity and will be actively farming, there should be no issue with using your 401(k) to fund it.
As in all cases, you need to discuss this with your tax adviser. The article refers to a company that has helped do several hundreds of these transactions.