You may have heard about the advantages of “pass-through taxation” when discussing certain types of business entities with your neighbors, other producers, your lawyer, or accountant. But what exactly does pass-through taxation mean?
To explain pass-through taxation, we have to begin at the different types of business entities. The simplest business entity is the sole proprietorship. This is when a person does not have a distinct business but rather, just combines business income with personal income. The taxes due for the business income are included on the person’s personal income tax information. This is pass-through taxation — the tax passes through to the person’s own income tax and the business itself does not pay taxes.
A slightly different idea, but the flip-side to pass-through taxation, is the “double taxation” problem. This is when a corporation, known as a C-Corp, first pays income taxes and then shareholders also pay taxes on any gain or dividend the shareholder receives.
Pass-through taxation avoids the double taxation problem. The income from the pass-through business entity “passes through” to the individual(s) who have shares/ownership/income interests in the business entity and the individual then reports the income on their own federal income tax return.
It is always worth consulting your CPA for the finer details and possible outcomes when making a choice of entity decision for your operation. However, it is worth knowing some of the terms of art with regards to business entities and pass-through taxation is one of the cornerstones. There is nothing wrong with exploring all possible options for the type of entity for your operation and exploring any possible tax advantages or consequences; you never know unless you ask about pass-through taxation!
It is no longer highly unusual for landowners to be an absentee landowner. More and more beginning farmers (and farmers in general) and renting land from absentee landlords. Are there any particular pitfalls or issues to be aware when working with an absentee landlord?
First, communication, while always important, is critical in situations with an absentee landlord. Communication is how trust is built. With an absentee landlord, communication becomes even more paramount because it is more difficult to be at the same place at the same time. Non-verbal cues, such as body language and that “gut feeling” you get, may be missing. If you communicate via the written word, tone, volume, and inflection are much harder to express. Misunderstandings may occur much quicker and escalate quickly without a commitment to communication. In the end, communicate with each other and then communicate some more.
An absentee landlord is also an ideal circumstance for a written lease and/or contract. With a written lease, each party knows the exact terms and conditions of the agreement at a glance. It also allows each party to know at a glance what they can or cannot do in regards to the lease. A written lease also provides more legal protection and certainty than a verbal lease.
In the end, a relationship with an absentee landlord does not have to be markedly different than a local landlord. It just may require a different approach. Take the time to communicate and resolve differences, just like in any landlord/tenant relationship. And if that requires conference calls, Skype, email, or other communicative aids, try to embrace the change in the method of communication.
It may be a familiar scenario: you and a family member decide to work together on the farm. You both own some land, some equipment, and find it is easier to just work together indefinitely. You soon begin to combine some accounts — it is easier and less expensive to buy all the seed and fertilizer you both need rather than make two separate orders. And you discover that your family member is better at marketing the grain while you prefer the day-to-day work with the cattle herd. Eventually, without even realizing it, the business assets are tied together with each person having decision-making authority.
What has happened here? In short, you have created a partnership. A partnership is a when two or more individuals come together and cooperate to advance their mutual interests. A partnership does not have to directly or explicitly be formed; it can happen informally like in the above example. And when informal partnerships occur, it means there is no agreed-upon mechanism by the parties to the extent of each person’s authority, the type(s) of activity the partnership can engage, and should each person wish to dissolve the partnership, how the partnership will be dissolved.
What makes many lawyers cringe about partnerships like the above is the lack of a formal agreement and the potential liability for all individuals in the partnership. Let’s talk about each issue.
Partnerships can have, and many do, formal agreements on how the partnership is to organized, managed, and operated. But that does not mean every partnership has a formal agreement and in fact, there is no requirement for such an agreement. If there is no agreement, the State will step in with “default provisions” which govern any problems the parties may have. You may not like these default provisions; it is worth a trip to your lawyer to understand the consequences of an informal partnership agreement.
The other concern is liability; specifically, individual, personal liability for actions undertaken for the purpose of advancing the interests of the partnership by other members of the partnership. For example, if the partnership can no longer pay its debts, the creditor can come after your personal assets to satisfy the debt. This is true even if it your partner who made the deal the incurred the debt. In short, you can become responsible for another person’s bad behavior by virtue of a partnership.
Tread carefully if you are considering a formal partnership or if you may have inadvertently created one. The advice of a lawyer is a good idea in these situations to learn the risks and rewards of a partnership. If you would like more information for your particular situation, you are free to contact us.
For those readers in Nebraska, Iowa, Minnesota, Montana, North Dakota, and South Dakota, there is a change in crop insurance if you wish to till native sod and plant an annual crop.
The Risk Management Agency, pursuant to the 2014 Farm Bill, is limiting crop insurance benefits to producers who till native sod and plant an annual crop for the first four years of production. Native sod is defined as acreage that has never been tilled or land which the producer cannot substantiate has ever been tilled for crop production. The reduction in crop insurance benefits is for all counties in the states listed above and for production on five acres or more per crop insurance policy.
The above policy goes into effect in Fall 2014. If you have plans to till native sod, now is a good time to touch base with your crop insurance agent and discuss this and other risk management strategies.
The USDA and Risk Management Agency (RMA) continue to move forward with implementing the crop insurance requirements for beginning farmers outlined in the 2014 Farm Bill. The RMA has filed its interim final rule which provide the following:
- New farmers are exempt from paying the $300 administrative fee for catastrophic crop insurance policies;
- Premium support rates will increase 10% for a new farmers’ first five years of farming;
- Beginning farmers receive a greater yield adjustment when yields fall below the 60% of the applicable transitional yield; and
- Allowing the use of yield history from any previous involvement in a farm or ranch operation, including decision making or physical involvement in the production of the crop or livestock.
Crop insurance is a well-honed risk management strategy and one that beginning farmers in particular should seriously consider. Given the RMA has now increased incentives for beginning farmers to include crop insurance in their risk management plan, now is a good time to seriously explore the options.