Farm Management
Chapter 14
Farm Business Organization and
Transfer
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Chapter Outline
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Life Cycle
Sole Proprietorship
Joint Ventures
Operating Agreements
Partnerships
Corporations
Limited Liability Companies
Cooperatives
Transferring the farm business
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Chapter Objectives
1. Describe the primary forms of business
organization
2. Discuss the organization and characteristics
of each form
3. Compare their advantages and
disadvantages
4. Show the effect on income taxes
5. Summarize the factors to consider when
selecting a form of organization
6. Compare the different forms for estate
planning
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Life Cycle
Each farm business has a life cycle
with four stages:
1. entry
2. growth
3. consolidation
4. exit
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Figure 14-1
Illustration of the life cycle of a farm business
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Sole Proprietorship
• The owner owns and manages the
business, assumes all risks, receives all
profit
• No special legal permission required
• Advantages: simplicity and freedom
• Disadvantages: personal liability, size
may be limited, lack of continuity
• Taxes on profit paid at tax rate of owner
(individual or joint for couple)
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Joint Venture
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•
•
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Operating agreements
Partnerships
Corporations
Limited liability companies
Cooperatives
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Operating Agreements
• Two or more sole proprietors carry on
some activities jointly while maintaining
individual ownership of resources
• Operating expenses usually shared
among the parties in some fixed proportion
• Income is shared in same proportion as
fixed assets and expenses are contributed
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Table 14-1
Example Budget for a Cow/Calf Joint Enterprise (One Head)
Item
Value
Operating expenses
Hay
Supplements
Salt and minerals
Pasture maintenance
Veterinary & health expense
Livestock facilities
Machinery & equipment
Breeding expenses
Fuel and lube
Labor
Miscellaneous
Interest on variable costs
90.00
16.13
3.20
70.00
7.00
8.00
16.00
5.00
11.00
40.00
10.00
13.82
Ownership expenses
Interest on breeding herd
68.00
68.00
Livestock facilities
Depreciation & interest
10.00
10.00
Machinery & equipment
Depreciation & interest
37.50
37.50
Land charge
60.00
60.00
Total expenses
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Percent contribution
Party A
35.00
Party B
90.00
16.13
3.20
35.00
7.00
8.00
16.00
5.00
2.40
465.65
225.90
Companies,
100% 2008 49%
11.00
40.00
10.00
11.42
239.75
51%
Figure 14-2
Distribution of income from a joint venture
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Partnerships
• An association of two or more persons
who share ownership of a business
• General partners contribute to the
management of the business and are
exposed to unlimited liability
• Limited partners do not participate in the
management and are liable only for what
they have contributed to the business
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General Partnerships:
Organization and Characteristics
1. Sharing of business profits and losses
2. Shared control of property, with possible
shared ownership of some property
3. Shared management of the business
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Written Partnership Agreements
1. Management: who is responsible for
which decisions and how they shall be
made
2. Property: list the property each partner
will contribute and how it will be owned
3. Share of profits and losses: carefully
describe how these will be divided
4. Records: designate who will keep the
records
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Written Partnership Agreements
(continued)
5. Taxation: include a detailed account of tax
basis of property and copies of the
partnership information tax return
6. Termination: state the date of termination if
one is known
7. Dissolution: method of division of property
in case of dissolution of partnership
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Termination
• At a particular time, as indicated in written
agreement
• Upon the incapacitation or death of a
partner, although the partnership may
continue if the written agreement contains
provisions for passing on the estate and
continuing the partnership
• Bankruptcy
• Mutual agreement
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Advantages of Partnership
• Easier and cheaper to form than a
corporation
• A carefully written agreement can allow
the partners to maintain much of their
freedom
• Flexible form of business that can
accommodate many different situations
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Disadvantages of Partnership
• Unlimited liability of each general partner
• Any partner individually can act for the
partnership in legal and financial dealings
and the other partners will also be held
responsible
• Poor business continuity
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Partnership Taxation
A partnership does not directly pay taxes.
It files an information income tax return
reporting income and expenses. Each
partner’s share of income from the
partnership is reported on his or her
own tax return.
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Corporations
• A corporation is a separate legal entity
• It is formed and operated in accordance
with laws of the state in which it is
organized
• Shareholders in a corporation are liable
only to the extent of their investment
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Forming a Farm Corporation
1. File a preliminary application, reserving a
name for the corporation
2. Draft a pre-incorporation agreement outlining
major rights and duties of the parties
3. Prepare and file the articles of incorporation
4. Turn property or cash over to corporation in
exchange for shares of stock
5. Shareholders meet to organize and elect
directors
6. The directors elect officers, adopt bylaws,
and begin business
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Two Types of Corporations
• C corporation: a “regular” corporation
• S corporation: a “tax-option” corporation
1. No more than 75 shareholders
2. Shareholders must be U.S. citizens,
estates, or certain types of trusts
3. One class of stock
4. All shareholders must agree to form
an S corporation
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Advantages of Corporations
• Limited liability for shareholders
• This advantage may be negated if a
shareholder is required to personally sign
a note to borrow funds
• The corporation, like a partnership, allows
for several individuals to pool resources
• Business continuity
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Disadvantages of Corporations
• Costly to form and maintain
• Legal advice needed
• Shareholder and director meetings must
be held
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Taxes and C Corporations
A C corporation pays taxes on its earnings
before dividends are distributed. The
shareholders then pay taxes on the dividends,
at their individual rates. (“Double taxation”)
If shareholders are employees, their salary and
benefits (e.g., health insurance) can be
charged as expenses to the corporation, but
these expenses must be reasonable.
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Taxes and S Corporations
An S corporation is taxed like a partnership.
The corporation files an information tax
return, but shareholders report their share
of income on their own tax returns and
are taxed at their own rates.
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Table 14-2
Personal and Corporate Income Tax Rates
(2006)
Personal
Corporate
Marginal
tax rate (%)
Taxable Income
Single
Married filing jointly
$0 to $7,500
$7,500 to $30,650
$30,650 to $74,200
$74,200 to $154,800
$154,800 to $336,550
Over $336,550
$0 to $15,100
$15,100 to $61,300
$61,300 to $123,700
$123,700 to $188,450
$188,450 to $336,550
Over $336,550
10
15
25
28
33
35
Taxable Income
Up to $50,000
$50,000 to $75,000
$75,000 to $100,000
$100,000 to $335,000
Over $335,000
Marginal
tax rate (%)
15
25
34
39
34 to 38
Check current tax rates for changes
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Limited Liability Companies
• A limited liability company (LLC)
resembles a partnership but offers
members the advantages of a corporation
• Liability is limited to the assets of the LLC,
not the individually owned assets of
members
• An LLC can have any number of
members, all of whom can participate in
management
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Limited Liability Companies
(continued)
• Ownership distributed according to fair
market value of contributed assets
• Net farm income from an LLC passed to
members, who pay taxes at their individual
rates (no “double taxation”)
• An LLC does not automatically continue in
the event of a death of a member
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Cooperatives
• Cooperatives are a special type of corporation
• They require articles, bylaws, and detailed
records
• Members who contribute capital enjoy limited
liability
• Net income is passed to members and taxed at
their individual rates
• Return to members cannot exceed 8%, with
remaining profits distributed as “patronage
refunds”
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Table 14-3
Comparison of Forms of Farm Business
Organization
Category
Sole Proprietor
Partnership
Corporation
Ownership
Single Individual
Two or more individuals
A separate legal entity that is
owned by its shareholders
Life of business
Terminates on death
Agreed on term or
at death of partner
Forever, unless fixed by
agreement; in case of death
stock passes to heirs
Liability
Proprietor is liable
Each partner is liable for all
partnership obligations even
to personal assets (except
limtied partners)
Stockholders are not liable for
corporate obligations; in some
cases, individual stockholders
may be asked to co-sign
corporate notes
Sources of capital Personal investments, Partnership contributions,
loans
loans
Shareholders' contributions,
sale of stock, sale of bonds,
and loans
Management
decisions
Proprietor
Agreement of partners
Shareholders elect directors
who manage the business or
hire a manager
Income taxes
Business income is
combined with other
income on individual
tax return
Partnership files IRS information
report; each partner's share
of partnership income is
added to individual taxable
income
Regular C corporation:
Corproration files a tax return
and pays income tax; salaries
to shareholders are dedcutible;
shareholders pay tax on
dividends received
Tax-option (S) corporation:
Shareholders report their
share of income, operating
loss and long-term capital
gain on individual returns;
IRS information report filed
by corporation
© Mcgraw-Hill Companies, 2008
Transferring the Farm Business
1. Is the business large enough to
productively employ another person or
family?
2. Is the business profitable enough to
support another operator?
3. Can management responsibilities be
shared?
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Stages of Transfer
1. Spin-off: separation of operators into
individual operations
2. Takeover: older generation retires and
rents or sells farm to younger generation
3. Joint operation: both generations wish to
continue farming together and either use
an operating agreement or form a
partnership or a corporation
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Figure 14-3
Alternatives for farm business transfer
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Summary
A farm or ranch business can be organized
as a sole proprietorship, a partnership,
a corporation, a limited liability company,
or a cooperative. Each form of business
organization has advantages and
disadvantages.
© Mcgraw-Hill Companies, 2008