Are you using the right business entity for your farm or other agribusiness? I have worked with too many clients who have paid additional tax dollars or have been unable to achieve their succession planning goals due to their entity structure. Learn from their mistakes. Selecting and using the right entity is essential to a successful, profitable business. An entity structure impacts legal liability, taxation, management or control, succession planning or transfer options, and a number of other issues. Therefore, it is prudent that careful consideration be given to each of these issues before selecting an entity structure. These issues should also be regularly re-evaluated to ensure the entity selection remains appropriate for ongoing business operations.
What are the entity structure options?
In Wisconsin there are several different legal entity structures generally available to agribusinesses. Only two of those structures, however, are generally recommended for use by agribusinesses – the business corporation and the limited liability company. Both of these entity structures offer the most liability protection, receive favorable tax treatment, provide flexibility with respect to management, and furnish a variety of business planning or transfer options.
How can an entity structure protect me from liability?
Protection from legal liability is one of the greatest advantages of using a legal entity, but not all entities provide liability protection. Certain entity structures can protect your personal assets from the creditors of your business operations. For example, if an employee or independent contractor is injured on your farm, a proper legal entity could protect your personal assets from an injury lawsuit against your farm. Again, business corporations and limited liability companies are best suited to provide legal liability protection. Business owners should steer clear of sole proprietorships and certain partnerships as they do not provide any liability protection.
The key to liability protection for business corporations and limited liability companies is adherence to the entity structure. To adhere to the entity structure, the owners must engage in activities that show the business operation is separate from the owners, such as (1) keeping separate bank accounts so personal assets/fund are not co-mingled with business assets/funds; (2) making business decisions in accordance with the procedures set forth in the entity documents; and (3) keeping and maintaining records concerning those decisions and other business activities. If the entity structure is not respected, the business will simply be treated as an “alter ego” of the owner and the liability protection will cease.
Which entities provide favorable tax treatment?
The most favorable tax treatment depends on the activities of the business and the desires/wishes of the owners. Some entities are eligible for pass-through taxation in which only the owners pay the tax on the business’s income. Other entities are subject to double taxation (i.e., both the entity and the owner pay tax on the income), but those entities may have more favorable tax rates, tax deductions, or fringe benefits. For example, owners of pass-through entities generally pay self-employment tax on all business income, while double taxation entities pay lower employment taxes on salaries paid to owner‑employees.
Again, flexibility is key and both business corporations and limited liability companies may be taxed as either pass-through or double taxation entities, and which tax status is best depends on your particular circumstances.
How can an entity help control management decisions?
Management of a business is one of the largest factors in selecting an entity structure because the entity’s structure determines who has power over decisions, the amount of decision-making power of each owner, and what decisions, if any, can be made by non-owners. For example, some owners may only own non-voting interests and have no ability to participate in management of the business. Ownership structures with limited control can aid in the education and development of future owners of an agribusiness without putting the business at risk. Careful consideration should be given to the management structure of an entity to ensure that the business is protected from poor decision-making.
Succession planning or transfer options.
Planning for the transition of an agribusiness is a complicated process that requires weighing legal, economic, and family dynamics factors. Unfortunately, the transition process can be further complicated by the entity structure currently utilized by the business. Certain entities provide more flexibility when transferring ownership from one generation to the next. Selection and continued use of an entity structure should be carefully reviewed as current owners age and consider succession planning options and/or transfers to the next generation.
In the end, choosing an entity structure is a thoughtful process that requires weighing the pros and cons. Do not pay additional tax dollars or be forced to liquidate your operation because of your entity selection. Choose carefully and seek the assistance of your trusted advisors when necessary.
Reprinted with permission by Badger Common'Tater