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If you’ve been following my family farming blog series to date, you’ll already have picked up some valuable tips on
matrimonial breakdowns and
goal congruence. This blog will take a closer look at selecting and refining the best business structure for your farm operation based on more than just the tax benefits. Tax should not be the
primary motivation behind a business structure. The tax structure can be determined
after the business arrangement is determined. In developing the appropriate structure, the goals of all involved parties should be stated, land ownership should be discussed and the allocation of accrual profits should be negotiated.
Typically, the goals of the parents are:
Typically, the goal of the children is:
One of the first issues in the discussion should be whether land should be viewed as an integral part of the business or as an asset than can be owned outside of the business and rented to the business.
To provide perspective, please consider the following non-farming scenarios:
Scenario 1: Son just returned from a three-year contract with a large engineering firm and would like to come back and work with Dad in his small engineering firm. Dad owns a medium sized office building, 60% of which is used by the engineering firm and 40% of which is rented out to various unrelated tenants.
In this scenario, Dad would probably agree to Son joining the engineering firm because Son’s value lies in improving the business but would likely keep the real estate separate for three main reasons:
Scenario 2: Dad wants to bring Son into the family construction company. Though concurrently attending post-secondary education, Son has worked in the business for the last 8 years (from the time he was 15 years old). The construction company owns two properties; the main site that houses the majority of the buildings including the specialty equipment and another site directly beside a key client’s operation presently producing about 25 percent of their annual revenue. In this scenario, the property is not easily replaced by the business nor would it be easy to rent out to a third party. In that case, the property would likely be included in the entity (or entities) in which the Son would acquire ownership.
Consider, now, the following farming scenarios:Scenario 1: Dad operates a 7,000 acre grain farm that he wishes to transition to Son. Dad owns 1,000 acres and the remaining 6,000 acres are rented from long term 3rd parties. In this situation, generally all but the base of operations (usually the home quarter) would remain outside the operating entity in which Son will acquire ownership.
Please note that, though from a legal protection perspective, it is generally recommended that the home quarter would remain held personally by Dad, from the perspective of protecting the business, the home quarter would always be included in the operational entity because often the base of operations contains significant infrastructure used by the business (bins, shop, etc).
The decision regarding the home quarter is affected by the value of farm infrastructure compared with the value of the house. If there are bins worth $50,000 and a $700,000 house, the home quarter would be left out of the operating entity. If there is infrastructure worth $850,000 and a 1940’s bungalow, the home quarter would be owned by the operating entity. If there was a $700,000 house and infrastructure worth $850,000, typically the two would be subdivided so that the land with the infrastructure would be owned by the operating entity and the home would remain personally owned.
Scenario 2: Son is joining Dad in a 700 cow/calf pair ranch with 1,300 acres of deeded grass, 600 acres for silage/grain feed next to the home operation, and 5,000 acres of crown lease land that are all connected.
In this case, the importance of that specific parcel of land is vital to the success of the operation and would, therefore, be included in the operating entity.
Once the decision regarding land ownership is settled, the last significant issue is determining the appropriate allocation of profit. This allocation should be based on three components:
This process is foreign to most farm owners who, though they need guidance through the process, fundamentally need to determine the arrangement themselves.
Once the business arrangement is finalized, operation of the farm moves forward with all parties involved trying to maximize the farm’s profit so that all may benefit. This is not the end of planning. The parties must still figure out how to communicate, determine each individual’s roles and responsibilities, develop an effective decision-making process and address operational and corporate governance. Even so, it is a good start!
To learn more about business and tax structures for your agriculture operation, contact Dean Klippenstine, CPA, CA, Director, Primary Producers, at 877.790.7990 or
[email protected], or your local MNP Advisor.
Related Topics:Family; Farmers; Business Structures
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