Farm Progress

Choosing the right business form for your farm

The right business structure for your farm will help reduce risk.

August 18, 2016

4 Min Read

Farmers, as well as other business owners, have various options when it comes to choosing a form of business organization.

Choosing the correct form depends on many considerations, including income tax implications, flexibility, ease and expense of recordkeeping, exit strategy and liability protection. I will focus on using an entity for liability protection in this column.

Speaking broadly, farmers can choose to organize their business by using an organizational structure without built-in liability protection or by using an entity that does provides a liability shield.

Non-limited liability organization

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The two most common ways to organize a business without pursuing an additional level of liability protection are as a sole proprietorship and as a partnership. A sole proprietorship is owned and managed by one individual, whereas a partnership has two or more individuals associated as owners and controllers. In both a sole proprietorship and a partnership, the sole proprietor and partners are responsible for all the obligations and debts of the entire business, even if the debts exceed the sole proprietor’s or partner’s investment. Thus, a sole proprietor’s and a partner’s individual assets are at risk for all liabilities incurred by the business. There is no ceiling and the liability of the owner sole proprietor or partner is unlimited. This is a significant cause for concern in a partnership, because the farmer with more personal assets risks losing far more than the farmer with limited personal assets. For both sole proprietorships and partnerships, having adequate insurance coverage is imperative to protecting assets, as insurance provides the sole means of liability protection.

Limited liability organization

If shielding personal assets from potential liabilities of the business is a priority, there are various options for forming the business. In a limited partnership, the limited partners share in liability only up to the amount of their investment in the partnership, while general partners are fully liable for the debts and obligations of the partnership. In a limited liability partnership, personal assets of the partners are shielded against the liabilities of the partnership. A corporation is a separate legal entity that will insulate (usually) the shareholders from a claim against the corporation. Similarly, in a limited liability company, the debts and obligations of the entity rest with the entity itself, not with the owners. It is important to note that no entity structure will insulate the owner from liability for his or her own personal acts. Which business model entity is right for your farm will depend on a variety of factors beyond the scope of this article.

The pros of a limited liability entity

The main benefit of organizing a farming operation as a limited liability entity is the extra layer of protection for the farmer’s personal assets provided by the entity. If a liability-triggering event occurs in the course of operation of a limited liability entity, the creditors can only reach the entity’s assets or owner’s contribution. The owner’s personal assets are out of reach from the creditors. Thus, owners may be able to participate in active management of the farm without risking loss of liability protection.

Farmers can further limit liability by diversifying their risk. Some business operations are inherently more risky than others. For example, if you have a large farming operation and eight employees work for you, there’s a much higher possibility that one of those individuals could get injured or cause injury on your property than if you run a sole proprietorship.

Similarly, some assets carry more inherent risk than others. While farmland is not considered as risky as a rental property, it does carry much more risk than a checking or savings account. As a general rule, if you have an asset that comes with a significant amount of risk, it is advisable to keep that asset isolated from your other assets, often in its own separate limited liability entity. To illustrate, assume you have a hog operation and a dairy operation. To segregate the risks, you might form two separate limited liability entities that would separate the operations from your real estate and personal assets (retirement accounts) and contain the risks of each operation to the operation itself.

Managing risk is just one aspect of business formation, but it is an essential one. If you have concerns about your risk exposure with regards to your farm operation, meet with your attorney to review your business plan.

Gunsolus is an associate attorney with Miller Legal Strategic Planning Centers, P.A., in Rochester. Contact her at [email protected].

 

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