As I meet with clients and prospects post-tax season, one of the topics of conversation is entity choice. Sometimes, the entity choice does not match the client’s needs. When asked why they picked that type of entity, I typically hear “because.” This is followed by “my accountant,” “my attorney” told me to do it. One thing is obvious, there is a lot of confusion about entity choice. Choosing an entity should be based on the client’s specific needs, not what others are doing.
There are many entity types, but the most common in agriculture are sole proprietor, single member LLC (SMLLC), multimember LLC (LLC), general partnership (GP), S corp and C corp. So, what is the right type for youSOLE PROPRIETOR/SMLLC
Sole proprietors and SMLLCs report income and expense on the taxpayer’s Schedule F. They allow a great deal of flexibility while letting the taxpayer add complexity at a later date. I prefer SMLLCs, but if the taxpayer understands the risks and has sufficient liability insurance, he or she can go with sole proprietor.
Many agricultural businesses use the LLC structure because of its flexibility. On the producer side, we typically see LLCs for land holding and farm operations. When used to hold land, it provides asset protections and bolsters the self-rental agreement. On the operations side, the LLC provides liability protection while opening up a few succession options. The LLC allows discounted valuation for purchasing or gifting. You do have to manage the LLC more closely, however. Basis limitations and negative capital account issues can creep up in LLCs.
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I typically recommend the GP if there are Farm Service Agency (FSA) payment limitation issues, first determined at the entity level rather than individual level. Therefore, if you had an LLC in place, the payment limitation would be limited at the entity level. This is cured by having a GP with individuals underneath it. With liability concerns, the individuals typically own the GP through SMLLCs.
People set up S corps to limit self-employment tax (SE tax). An S corp owner must get paid reasonable wages. Thereafter, S corp pass-through income is not subject to SE tax. Another tax benefit is when the S corp interest is sold, the owners get capital gain treatment. However, the tax savings come at a hefty price. Distributions from the S corp must be proportional, and you can’t distribute assets out of an S corp without incurring tax. The reason I shy away from the S corp is that with a little planning, the LLC can accomplish most of the same benefits while providing much more flexibility.
Earlier this year, the IRS gave agricultural C corps the death blow. C corps are not allowed to take advantage of 199A. As a result, most of my producer clients have switched to an S corp.
This is a very brief look at entities. My advice is to speak with a CPA/attorney who understands your situation. Start off basic and work your way into complexity.
Tax Columnist Rod Mauszycki is a CPA and tax partner with the accounting firm of CliftonLarsonAllen, in New Ulm and Minneapolis, Minnesota.
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