I've had conversations with several clients recently. Because of the stress and uncertainty, they would like to transition out of farming.
Sometimes, this means transitioning to the next generation, and sometimes, it means selling off inventory/equipment and collecting rent checks. If you farm as a sole proprietor, it's relatively easy. However, in many cases, family members farm together. Farming in a partnership or S corporation may add complexity (and tax) when you transition out. Although this is a very complex topic, I will briefly touch upon four scenarios to illustrate potential issues.
MULTIMEMBER LLC: ONE MEMBER EXITING
In some instances, only one member of an LLC may want to exit. There are multiple ways to structure the exit, including distribution of assets, purchase of LLC interest or redemption of LLC interest. The trap goes back to debt and the dreaded negative capital account. If the exiting member is relieved of debt, he or she may experience forgiveness of debt income.
If the exiting member had a negative capital account, it may trigger unexpected (and substantial) taxable income.
MULTIMEMBER LLC: LIQUIDATION
When liquidating, the LLC may distribute certain assets to members or sell all assets and distribute the proceeds. In some cases, because of debt or inaccurate accounting, the members may be left with a negative capital account. In that case, they must contribute cash to the LLC or pick up phantom income in order to get the negative capital account back to $0. There also is the issue of liquidating distributions that must be in accordance with capital accounts. Therefore, one member may get more money from liquidating distributions.
S CORP: ONE MEMBER EXITING
S corporations are more restrictive than LLCs and may cause more issues. If there are assets the exiting shareholder wants, the S corp can either sell them to the shareholder or distribute the assets. In either case, the S corp must treat it as a sale of assets at fair market value (however, a loss would not be realized), and shareholders must recognize the gain. Also, remember that in an S corp, there must be proportionate distributions. So, distributions of cash or assets to the exiting shareholder must be closely examined.
S CORP LIQUIDATION
Sometimes, the best solution is to liquidate the S corp and part ways. If liquidation includes distribution of certain assets to shareholders, the distribution is treated as a sale, and gain must be recognized. It is important to liquidate and dissolve the S corp in the same year. That way, if there is any basis remaining, the shareholders could take a capital loss on their tax return to hopefully offset some gain.
I just skimmed the surface and avoided discussing C corp spin or splits. Exiting or liquidating an LLC or S corp is not as easy as most people think. With a little time and planning, your CPA can help you mitigate the tax issues.
DTN Tax Columnist Rod Mauszycki, J.D., MBT, is a tax principal with CLA (CliftonLarsonAllen) in Minneapolis, Minnesota. Read Rod's "Ask the Taxman" column at www.about.dtnpf.com/tax. You may email Rod at firstname.lastname@example.org.
(c) Copyright 2020 DTN, LLC. All rights reserved.