For farming operations, LLCs are particularly useful as follows:
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 personal assets are protected from lawsuits arising from the farming 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. The creditor does not 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.
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.
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 of blow sand 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. How do we transfer these hard to divide assets to multiple heirs? Even more so, who gets the productive land and who gets the non-productive land? Transferring shares can ensure uniformity among heirs, as well as ensure that the heirs all receive equal income off of the assets in the future.
The LLC also enables gifting of assets to be simplified by the gifting of shares. Many times clients will want to do yearly gifts of farm real estate. However, this requires yearly surveys, appraisals, deed work, etc, which can be costly. I ask clients to consider merely having to sign shares over and save a money.
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.
If you would like more asset protection, estate planning options, and yearly tax advantages… and you are willing to spend a few hundred dollars setting up an LLC, maintain a checking account for that LLC, and follow a few simple yearly requirements, exploring an LLC may be helpful to your farming operation. Your estate planner and/or accountant should be able to assist you in making this determination.
John J. Schwarz, II, is a lifelong farmer and farms with his family near Stroh, in Northeast Indiana and has been an agricultural law attorney for 12 years. He can be reached at 260-351-4440, our contact form, or visit him at www.farmlegacy.com. These articles are for general informational purposes only and do not constitute an attorney-client relationship. This article and others can be found on Farm World Magazine.