(This article will be one of several over the coming months that will discuss the use of a Limited Liability Company (LLC) for farming purposes.)
The LLC originated in Wyoming in 1977, and has since been authorized in all 50 states. In the beginning, it was unclear initially whether this entity could be considered for tax purposes as a partnership.
As such, the tax law was somewhat of a barrier. However, in 1988 the IRS ruled that LLCs could qualify for partnership-like tax treatment.
The result of the flexible tax treatment for the LLC has led to explosive growth of companies operating as an LLC. The LLC has become the choice entity for real estate investment, estate planning, and small business. In most states, more LLC’s are now formed than any other legal entity.
In simple terms, the LLC is a hybrid between a corporation and a partnership. It is an entity that enables you to have limited liability like a corporation, but provides the potential for more flexible management and ownership structure than a corporation. In addition, an LLC allows the owner to be taxed like a partnership, meaning income passes through to the owner and is taxed at the owner’s personal income level.
The advent of the LLC has been a real game-changer when compared to corporations. Gone are the days of double taxation, cumbersome ownership structure and possibly rigid corporate requirements. Rather, an LLC is relatively simple and inexpensive to create and maintain, provides much flexibility, and offers less administrative paperwork and recordkeeping.
•Asset Protection: Transferring real estate from personal ownership into an LLC is an excellent way to obtain an additional level of insurance. With farm estates growing larger, farmers are finding premiums for such insurance becoming very expensive. Thus, if total coverage (meaning your coverage is equal to or greater than your net worth) is not possible, having asset protection by way of an LLC may help offset any lack of insurance coverage.
Many farmers have an LLC that conducts the farming operations (the “operating entity”), and one or more other LLCs that hold the assets (the “holding entities”). The operating entity then leases the assets from the holding entities. Under this structure, farm assets are then separated from farm activities, as well as personal activities. That way, farm real estate and other assets are protected from lawsuits arising from personal activities.
Another benefit of an LLC is that even if a creditor gets a judgment against a member of an LLC, the creditor normally is not allowed to step into the shoes of the member. Nor does the creditor get the right to vote with the member’s membership interest. Rather, the creditor obtains a “charging order,”, which allows the creditor to only receive distributions, if any are made.
•Tax Advantages: LLCs are afforded numerous tax advantages. First, unlike subchapter C Corporations, which pays taxes on corporate income and then the shareholders pay dividend tax, LLCs are only taxed once. Better yet, “check-the-box” taxation is allowed, meaning an LLC can elect to be taxed as a sole proprietor, partnership, or S-corporation.
Having an LLC hold farm real estate separate from the operating LLC can provide additional tax benefits. The LLC holding the farm real estate may be able to reduce its tax burden by characterizing more of its funds as “rent,” paid by the farm operating entity, rather than as salary, which is subject to employment tax. The rental payments would then be deductible to the farm operating entity.
•Estate Planning: In my opinion, LLCs are the entity of choice when it comes to farm estate planning. First, an LLC allows the ability to obtain discounted valuation of the assets held by the LLC. Having the ability to “shrink” the value of the assets in the LLC, by way of discount valuation, can reduce a tremendous amount of estate or inheritance tax liability.
Often times, a farm estate consists of assets with wildly different values and income earning potential. The estate may have a land parcel that is 200 acres, with excellent soils, and all tillable. It may have a 40 acre tract consisting sandy soil for the tillable acres and the other half non-farmable. And, the estate may have all different sizes of real estate in between with varying productivity.
Transferring all the land into an LLC and leaving it to the heirs can insure uniformity of value and income among the heirs.
The LLC also enables gifting of assets to be simplified by the gifting of membership in the LLC. Many times clients will want to do yearly gifts of farm real estate. However, this requires yearly surveys, appraisals, deed work, etc, all which can be costly. With an LLC, simple assignment of membership interest is all that is necessary.
The purpose of this article has been to provide information on what exactly an LLC is, and how it can help farming operations.
Many farmers tend to feel that forming an LLC for their farm will subject them to the un-pleasantries associated with corporations. However, as discussed above, an LLC is much different than a corporation, and can offer many benefits to a farming operation.
Farmers seeking more asset protection, estate planning options, and yearly tax advantages should consider utilizing and LLC for their farming operation. Your estate planner and/or accountant should be able to assist you in making this determination.
John J. Schwarz, II, farms 2,500 acres with his family near Stroh, Ind., and is an agricultural law attorney and farm estate planner. He can be reached at 260-351-4440 or at John@Schwarzlawoffice.com Readers can find more information at www.farmlegacy.com
These articles are for general informational purposes only. If you have a specific legal question, you should consult an attorney. The views and opinions expressed in this column are those of the author and not necessarily those of Farm World.