Whether to use a corporation is a question that will come up in the conversation when discussing business entities for farm operations.
A corporation is formed under state law. The corporation operates the farm and is legally liable for the farm activities. The shareholders own the corporation.
A corporation must formally follow the statutory requirements, otherwise the corporation is not effective. A corporation must keep up with annual meetings, corporate minutes and the appointment of corporation officers and directors.
A corporation can be designated as a C corporation or an S corporation. In a C-corp, income earned by the farm is taxable to the corporation at the corporate rate. The corporation will take all the deductions and expenses against the income including payroll expenses. The remaining income is taxable to the corporation. If the corporation is classified as an S-corp, the remaining income flows through to the shareholders. This means the income tax is not paid by the corporation. Rather, the income is attributed to the shareholders and the tax is paid by the shareholders on their personal tax returns.
Whether to choose an S-corp or C-corp depends on factors such as the number of shareholders, the amount of expected income, and the involvement of the owners in the operation. Most farm operations or farm-related business that choose to operate as a corporation versus a limited liability company or partnership will choose to be an S-corp because of the flow-through income.
A corporate shareholder who takes part in the farm operation does so as an employee. The corporation must pay employees a regular wage and all employment taxes and income taxes must be paid on those wages. When choosing to operate as a corporation, it is important to ensure the farm would be able to cover the regular wages. Another factor is corporations can provide fringe benefits, such as meals and lodging for employees.
The shareholders are investors in the farm, and they receive a share of the farm earnings through dividends. These dividends are taxable to the shareholder as investment income. When choosing between entity types, corporations are often used if there will be investors in the operation who are not actively involved in the business.
Also, it is often best to use a corporation if there is expected to be high amounts of income in order to make use of the distinction between earned income and dividend income for shareholder who are also employees.
A disadvantage to consider is that assets held by the corporation will not have step up basis on the death of a shareholder. If assets are sold after the death of the shareholder, there will be a capital gain or income recapture on these sales. It often best that corporations not own assets that are likely to appreciate. Also, a corporation will only have a single farm program limit. Other types of entities can have multiple limits based on the number of members and partners.
Balzarini is an attorney at law with Miller Legal Strategic Planning Centers, P.A. Contact him with questions and comments at firstname.lastname@example.org.