1. Chapter 14 Farm Business Organization and Transfer
Farm Management
Chapter 14
Farm Business Organization and Transfer
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Chapter Outline
Life Cycle
Sole Proprietorship
Joint Ventures
Operating Agreements
Partnerships
Corporations
Limited Liability Companies
Cooperatives
Transferring the farm business
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Chapter Objectives
Describe the primary forms of business organization
Discuss the organization and characteristics of each form
Compare their advantages and disadvantages
Show the effect on income taxes
Summarize the factors to consider when selecting a form of organization
Compare the different forms for estate planning
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Life Cycle
Each farm business has a life cycle
with four stages:
entry
growth
consolidation
exit
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5. 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
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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9. Table 14-1 Example Budget for a Cow/Calf Joint Enterprise (One Head)
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10. 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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12. General Partnerships: Organization and Characteristics
Sharing of business profits and losses
Shared control of property, with possible shared ownership of some property
Shared management of the business
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13. Written Partnership Agreements
Management: who is responsible for which decisions and how they shall be made
Property: list the property each partner will contribute and how it will be owned
Share of profits and losses: carefully describe how these will be divided
Records: designate who will keep the records
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14. Written Partnership Agreements (continued)
Taxation: include a detailed account of tax basis of property and copies of the partnership information tax return
Termination: state the date of termination if one is known
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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16. 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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17. 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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20. Forming a Farm Corporation
File a preliminary application, reserving a name for the corporation
Draft a pre-incorporation agreement outlining major rights and duties of the parties
Prepare and file the articles of incorporation
Turn property or cash over to corporation in exchange for shares of stock
Shareholders meet to organize and elect directors
The directors elect officers, adopt bylaws, and begin business
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21. Two Types of Corporations
C corporation: a “regular” corporation
S corporation: a “tax-option” corporation
No more than 75 shareholders
Shareholders must be U.S. citizens,
estates, or certain types of trusts
One class of stock
All shareholders must agree to form
an S corporation
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22. 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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23. Disadvantages of Corporations
Costly to form and maintain
Legal advice needed
Shareholder and director meetings must be held
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24. 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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25. 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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26. Table 14-2 Personal and Corporate Income Tax Rates (2006)
Check current tax rates for changes
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27. 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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28. 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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30. Table 14-3 Comparison of Forms of Farm Business Organization
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31. Transferring the Farm Business
Is the business large enough to productively employ another person or family?
Is the business profitable enough to support another operator?
Can management responsibilities be shared?
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Stages of Transfer
Spin-off: separation of operators into individual operations
Takeover: older generation retires and rents or sells farm to younger generation
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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33. 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.
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