To incorporate or not to incorporate?
December 28, 2017
Just before Christmas, Congress passed a tax package that would significantly overhaul current U.S. tax code. Depending on who you ask and which party the person favors, the new tax plan is either a colossal failure or a major victory. These biased viewpoints leave many Americans struggling to comb through the fine details and determine what cost savings, if any, their own families may now enjoy on their upcoming taxes.
In a press release, U.S. House of Representative Kristi Noem, (R-SD) praised the tax package saying, "In South Dakota, our number one industry is agriculture, and I'm incredibly proud this tax reform package reflects so many of the priorities shared with me by farmers and ranchers across the state. I was the only farmer sitting at the negotiating table when the final deal was made, but I made sure producers would have access to enhanced expensing tools, immediate deductibility, and like-kind exchanges. Additionally, we created a 20 percent small business deduction that will benefit many farms and ranches as well as agricultural cooperatives. While the fight to repeal the un-American Death Tax will continue, I'm glad this bill gives farmers, ranchers, and small businesses some relief by doubling the exemption levels and maintaining the stepped-up basis."
To prepare for the upcoming tax changes, what is the next best move for your ranch? An accountant and an attorney weigh in.
"With the new tax laws going into effect by 2019, many producers are looking at moving their businesses to a C corporation because these entities will have a very low tax rate compared to what normal individual rates are," said Michael P. Dell, a certified professional accountant (CPA) from Rapid City, S.D. "This is tempting for many, but I believe farmers and ranchers already have the best tax plan in America, so why mess with it? If you hardly pay in anything at all currently, why would you change the way you operate?"
“If a ranching family has formed a corporation they can create a firewall between personal and business assets as long as corporate formalities are followed,” – Drew Skjoldal, Attorney at Lynn, Jackson, Shultz & Lebrun, P.C., –
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While each individual ranch is unique and has its own tax concerns, Dell says it's important for producers to talk to a tax professional to determine the best approach moving forward; however, he also warns against placing appreciable assets like land into a corporation.
"In general, LLCs and partnerships are a good place for land to be managed for future planning purposes," said Dell. "With a corporation, perhaps cattle and equipment would make sense in a corporation, but never real estate as it opens up to double taxation — both on the income and the dividends. It just doesn't work."
Still uncertain if a corporate structure makes sense for the operation? Drew Skjoldal, attorney at Lynn, Jackson, Shultz & Lebrun, P.C., explains the difference between a C-corp and an S-corp.
"Ranching families will almost always prefer to form an S-corp, since this tax reform allows for pass-through taxation," said Skjoldal. "This means that the corporation itself is not taxed on income that it generates, and instead the income is taxed on the personal tax returns of the shareholders."
He says the biggest benefit of setting up a an entity of some kind, whether it be a corporation, LLC, or partnership, is to provide liability protection.
"If a ranching family has formed a corporation they can create a firewall between personal and business assets as long as corporate formalities are followed," said Skjodal. "Also, corporation and other entities can be a good tool for producers in their succession planning. For example, the operating agreement (if an LLC) or the bylaws (if a corporation) can dictate how the ranching operation will pass upon the parents' deaths, and can structure very specific things like the manner in which a buyout will occur between on-ranch and off-ranch children."
The process of incorporating a ranch business includes filing with the Secretary of State's Office, writing bylaws with specific provisions for how the corporation will be managed, what the shareholder's voting rights are, how and when meetings are held and how the bylaws themselves can be amended.
"Ranchers can expect to spend anywhere from around a thousand dollars to several thousand depending upon the complexity of the documentation needed for the creation of an entity," said Skjodal. "While lawyers typically charge by the hour, many attorneys that specialize in this area of law will give clients a flat-fee quote after gauging the amount of time that will be needed in an initial meeting with the clients. It is important to note that simply creating the corporation itself is only half of the work (and sometimes much less than half). After the entity has been created, the rancher must then retitle assets into the name of the corporation. This means that the title to land, ranch vehicles, brands, and other ranch assets must be transferred from the rancher's name to the name of the entity that has been created. Without retitling assets, the corporation does not provide any of the benefits for which it was created."
He warns producers about the potential drawback of creating a corporation — the anti-corporate farming restrictions that many states have in place.
"In South Dakota, our statutes contain a prohibition against corporate farming, but contain an exception for 'family farm corporations,'" he explained. "Ranching families should ensure that they are not in violation of their state's statutes prior to forming a corporation, and should seek the advice of a local attorney specializing in this practice area."
While it may take some time to sort through the hundreds of pages in this new tax reform, it's best to consult with legal counsel and a tax professional before making big changes to the structure of the ranch.