AGRI 1623 Farm Management III Corporations AGRI 1623 Farm Management III

Corporations Consists of a completely separate legal entity The business and its owners are separate from each other Corporations can: be taxed differently be sued own property enter or exit contract agreements How it is taxed depends on the type of corporation

Corporations Consists of one or more owners Owners are called shareholders A board of directors can be formed A manager can be selected The owners become employees of the corporation Decision making is done by Board of Directors, by a manager, or by shareholders

Corporations Requires filing paperwork with the government to set up Need Articles of Incorporation Can be costly and complex Need to involve a lawyer or accountant Used for general operating and for asset ownership Land and other longer term assets are almost always left out Reason? Putting assets in is tax free. Taking them out is taxable. Acquiring capital can be easier

Corporations Liability Limited in all types of corporations Personal assets are almost always protected It is one of the main reasons people use them

Corporations Continuity and Asset Transfer The business does not end with the death or exit of a shareholder Exception: an LLC may end Shares can be bought, sold, gifted, and passed through inheritance Can be an excellent estate planning tool

Corporations 3 Main Types of Corporations S Corporation C Corporation Limited Liability Corporation (or Company)

S Corporations It is a completely separate entity from its owners Owners must be individuals, not other businesses or a trust It is a corporation, but allows income to be shown on individuals tax return Limits liability while showing income on personal tax returns

S Corporations Land is generally left out Must have fewer than 100 shareholders Must have only one type of stock Can convert to a C Corp at any time at a minimal expense Has some flexibility in the tax year

S Corporations Taxes Taxed very similar to partnerships All income is shown on individuals tax return according to the amount of ownership Shareholders are considered employees and are paid a salary Must pay SE taxes on salary Salary is deductible for the business Must pay tax on business profits not distributed Must pay income tax, but not SE taxes Not deductible to the business

S Corporations Taxes Must own more than 2% of the business to follow regular tax laws What is deductible? Salaries to shareholders and employees are Some benefits such as health insurance and retirement accounts are Fringe benefits are not Unless it is for business use in your personal house (can claim that) Tax Forms File the same as a self employed individual, plus Form 1120S and the Schedule K-1

S Corporations Liability Limited under the S Corp Personal assets are protected The most a person could lose is the amount of their investment in the business This is true for both debts and adverse legal actions Exceptions: Lenders may require a personal obligation You can be held liable for your neglect (if on business time, both personal and business assets may be at risk) If a shareholder loses a lawsuit, the winner could claim their portion of the business assets

S Corporations Farm Transfer Can sell, gift, or pass shares through inheritance Fairly flexible

C Corporations Completely separate entity from its owners Has fewer restrictions than an S Corp. May face limits on FSA loans and in government programs Is it a family farm? Can have different types of stock Example: nonvoting and preferred Need an accountant or attorney to set it up Shareholders must have an annual meeting

C Corporations Taxes The C Corp actually files a tax return Taxed under corporate rules at corporate rates Income of the corp. is not shown on owners individual tax return Shareholders can be employees Wages are deductible to the corp. Employee pays income taxes and their half of SE taxes

C Corporations Taxes Fringe benefits can be paid tax free to the corp. and employee (in most cases) Health and Life Insurance Medical bills Electricity Water Phone Lodging Meals Clothing Etc.

C Corporations Taxes Dividends Tax Forms Paid out to shareholders Not a deductible expense to the corp The corp still must pay taxes on that income Shareholder must pay income tax, but doesn’t have to pay SE taxes This is where it is double taxed Tax Forms C corp files Form 1120 Individuals still file normal forms Has complete flexibility in the tax year

C Corporations Liability Very similar to S Corps Limited under the C Corp Personal assets are protected The most a person could lose is the amount of their investment in the business This is true for both debts and adverse legal actions Exceptions: Lenders may require a personal obligation You can be held liable for your neglect (if on business time, both personal and business assets may be at risk) If a shareholder loses a lawsuit, the winner could claim their portion of the business assets

C Corporations Liability In order to keep limited liability status you must: Keep it fully funded or build a “cushion” Be formed properly Follow laws

C Corporations Farm Transfer Can sell, gift, or pass shares through inheritance Continues after death or exit of a shareholder Very flexible Can be very expensive to completely exit or end the business

Limited Liability Company (LLC) Can have one or more owners, called members The portion each member owns is called Membership Interest or Ownership Interests Treated as a separate entity from its owners It is similar to an S Corp in many ways

Limited Liability Company (LLC) Combines pass through income taxation of a partnership with the limited liability of a corporation Setting one up is more complex than a partnership, but operating it is easier than a C or S Corp Using an accountant or attorney to set up is recommended Must file Articles of Organization You will want to create an Operating Agreement Defines the benefits, rights, and obligations of the members

Limited Liability Company (LLC) Managing the business Can be managed by the members or by a manager Gives the most management flexibility Make sure you identify this in the Operating Agreement Need to make sure it is fully funded

Limited Liability Company (LLC) Benefits Member wages cannot be a business deduction Some benefits such as health insurance and retirement accounts are deductible Fringe benefits are generally not deductible

Limited Liability Company (LLC) Taxes Taxed similar to a partnership The owner is the taxpayer and is held personally liable for his/her share Owner combines income or loss from business with other income such as personal income Amount of taxes paid vary on tax bracket Owner must pay self-employment taxes 15.3% for Social Security and Medicare Tax year usually follows calendar year Tax forms used: Form 1040 Schedule F (Profit or Loss from Farming) Schedule SE Usually will have a depreciation schedule Need to file Form 1065 for LLC income/loss Can elect to be taxed as a C Corp

Limited Liability Company (LLC) Must not have more than two of these characteristics to be taxed as a partnership: Limited liability Continuity of life Centralization of management Free transfer of membership interests Otherwise, corporate tax forms will have to be used and it will be taxed as a C Corp

Limited Liability Company (LLC) Continuity/Farm Transfer LLC can continue forever, can end with the exit of a member, or for a set number of years; it should be defined when set up Can pass membership interests by gifting, selling, or through inheritance May not be as easy as transferring shares of a corporation Still is a good estate planning tool

Limited Liability Company (LLC) Limited similar to a C or S corporation Personal assets are protected Offers protection from legal actions and business debts The most a person could lose is the amount of their investment in the business Exceptions: Lenders may require a personal obligation You can be held liable for your neglect (if on business time, both personal and business assets may be at risk) If a member loses a lawsuit, the winner could claim their portion of the business assets You break the law

Limited Liability Company (LLC) In a nutshell, an LLC is a partnership with the limited liability of a corporation Note! LLC’s have not been tested in court yet.

Corporations and LLC’s Advantages Shareholders/members have limited liability for debts or lawsuits (Note: exceptions do exist) Corporations can raise additional funds through the sale of stock May be able to deduct the cost of wages and benefits to owners/employees Can use different taxation methods Offer management flexibility Can be easy to enter or exit when planning farm transfer Business continuation

Corporations and LLC’s Disadvantages Often complex and costly to form Probably more paperwork to comply with regulations Double taxation of C-Corps Learn more tax laws Can be costly to exit structure May be easy to lose limited liability status Potential disagreements with other owners