This article continues the series on Limited Liability Companies (LLC) and the benefits that a farm can obtain from utilizing one or more LLCs.
Most people agree that if your farm is currently operating as a sole proprietorship, changing to an LLC for your farming operation is likely going to give you better tax benefits. As farmers, when it comes to taxes, we employ the “kick the can down the road” approach.
This means that towards the end of the year, we get a sense how much profit has been made. We then may visit our tax preparer and find out what our likely tax liability will be. Depending on how much we recoil in our seat after seeing the number, we then decide whether or not to buy inputs for next year and expense them for the current year, or purchase machinery.
The can kicking comes in because we no longer have those expenses for the following year. Thus, we’ve merely kicked the tax problem off onto the next year. The cycle can continue until it comes to a head in a year where, without being able to have the necessary expenses, the tax liability becomes quite large.
If an LLC is set up by a single person, the LLC will generally be taxed as a sole proprietorship. This means the LLC retains important tax benefits of the sole proprietorship, which would include owner compensation in the form of distributions of profit.
These are taxed at the owner’s potentially lower marginal tax bracket. The LLC also retains the ability to have pass-through of business losses. An LLC set up by multiple owners will generally be taxed as a partnership.
Often it is the use of multiple LLCs that allows a farm to save on taxes. For example, let’s say an LLC is set up as the farming operation. This entity plants the crops, buys all the inputs, sells the grain, and so forth. Income from this LLC will generally subject the farmer to self employment tax.
However, if another LLC is set up to hold the land, monies made from the land holding LLC is taxed as investment income. So, in our example, the farm operation LLC pays cash rent over to the land holding LLC.
After paying the expenses associated with the land, profits made by the land holding LLC are taxed less than profits made by the farm operating LLC. Having to pay rent to the land holding LLC is an expense to the farm operation LLC, so it lowers taxable income that would likely be subject to self employment tax.
As demonstrated, using one or more LLC’s in a farm operation will generally allow a farmer to have more options when it comes to minimizing tax liability. If you believe your farm could benefit in this matter, you should consult with your tax preparer.
These articles are for general informational purposes only and do not constitute an attorney-client relationship. John J. Schwarz, II, is a lifelong farmer in Northeast Indiana and has been an agricultural law attorney for 12 years. He can be reached at 260-351-4440, firstname.lastname@example.org, or visit him at www.farmlegacy.com