Forms of Farm Business Organization Chapter 14

1
Forms of Farm Business Organization(Chapter 14)
2
Objectives

• Discuss the organization and characteristics of
  each form of business.
• Show how income taxes are affected by the form of
  the business.
• Discuss the factors to be considered when
  selecting a form of business organization.
• Transferring the income, ownership, and
  management of a farm business from one generation
  to the next.

3
3 Most Common Forms of Farm Business

• 1997 U.S. Census of Agriculture
• Sole proprietorship 86
• Partnership 9
• Corporation (family held) 4
• Other 1
• Cooperatives, institutional or non-family
  corporations, limited liability companies

4
Farm Business Organization

• Depends On
• Size.
• Number of people involved.
• Career stage age of operators.
• Owners desires for passing it on to the next
  generation.
• Life cycle.

5
Life Cycle

• Four Stages
• Entry
• Growth
• Consolidation
• Exit

6
Life Cycle

• Entry Stage
• Choosing farming as a career.
• Selecting enterprises.
• Acquiring and organizing resources.
• Establishing a financial base.

7
Life Cycle

• Growth Stage
• Expansion by internal growth
• Purchasing and leasing additional land.
• Increasing the scale of the livestock enterprise.
• Merging is another means of growth.

8
Life Cycle

• Consolidation Stage
• Debt reduction.
• Increased efficiency is preferred to increased
  size (when possible).
• Planning and including the next generation.

9
Life Cycle

• Exit Stage
• Reducing risk.
• Liquidating the business.
• Transferring property to the next generation.
• Size may decline by selling long term assets.
• Income taxes and retirement income must be
  considered.
• Equitable treatment to all the heirs.

10
Sole Proprietorships

• Most common.
• Easy to form.
• Relatively easy to operate.

11
Sole Proprietorships

• Organization and Characteristics
• Owner Business
• Owns and manages the business.
• Assumes all the risks.
• Receives all profits and losses.
• Responsible for success or failure.
• No legal procedures, permits, or licenses.
• No limit to size or number of employees.

12
Sole Proprietorships

• Advantages
• Simple
• Freedom
• All profits belong to owner.
• Flexible

• Disadvantages
• All responsibilities
• Personally liable
• Limited capital
• Smaller size
• Difficult to compete
• Insufficient time and management skills.
• Poor continuity

13
Sole Proprietorships

• Income Taxes
• Owner pays income taxes on any profits.
• Business profits and capital gains are added to
  any other taxable income.
• Income is subject to self-employment taxes
  (Social Security and Medicare).

14
Joint Ventures

• Two or more operators combine their abilities
• Operating agreements
• Partnerships
• Corporations
• Limited liability companies
• Cooperatives

15
Operating Agreements

• Typically informal for a short duration
• Two or more sole proprietors work together on
  some farming activity.
• Generally pay their own ownership costs.
• Operating expenses may be shared
• Usually in the same proportion as fixed costs.
• Share income in the same proportion as total
  resources are contributed.

16
Partnerships

• A formal association of two or more persons who
  share the ownership of a business
• General partnership
• Limited partnership

17
General Partnerships

• Three Basic Characteristics
• Shared business profits and losses.
• Shared control of property, with possible shared
  ownership of some property.
• Shared management of the business.
• Sharing arrangements should be outlined
• in the partnership agreement.

18
General Partnerships

• Oral partnership agreements are legal in most
  states, but are not recommended
• Overlook important points.
• People forget.
• Income tax problems.

19
General Partnerships

• Unless there is a written agreement most courts
  assume an equal partnership in everything.
• Written agreements should include
• Management
• Property Ownership and Contribution
• Sharing of Profits and Losses
• Records
• Taxation
• Termination
• Dissolution

20
General Partnerships

• Factors that indicate a particular business
• arrangement is legally a partnership
• Joint ownership of assets.
• Operation under a firm name.
• A joint bank account.
• A single set of business records.
• Management participation by all parties.
• Sharing of profits and losses.
• A business arrangement may be a legal
• partnership, even though a partnership was not
• intended.

21
General Partnerships

• Advantages
• Easier and cheaper than a corporation.
• Less records than a corporation.
• Freedom.
• Flexibility.

• Disadvantages
• Unlimited liability.
• Any partner can act for the partnership in legal
  and financial transactions.
• Poor continuity.

22
General Partnerships

• Income Taxes
• File an information income tax return reporting
  income and expenses.
• Income from the partnership is reported by the
  individual partners on their personal tax
  returns.
• Partnership Operations (see handout)

23
Limited Partnerships

• At least one general partner
• Can have many limited partners.
• Limited partners
• Cant participate in management.
• Financial liability is limited to their
  investment.
• Liability of general partners can extend to
  personal assets.
• Common limited partnerships
• Real estate development.
• Cattle feeding.

24
Corporations

• A separate legal entity.
• A legal person, separate and apart from its
  owners, managers, and employees.
• A corporation can
• Own property.
• Borrow money.
• Enter into contracts.
• Sue and be sued.
• Family farm corporations are growing!

25
Corporations

• Basic steps to create (seek professional help)
• File a preliminary application with the
  appropriate state official.
• Draft a pre-incorporation agreement outlining the
  major rights and duties of the parties.
• Prepare the articles of incorporation and file
  with the proper state office.
• Turn property and/or cash over to the corporation
  in exchange for shares of stock.
• Shareholders meet to organize the business and
  elect directors.
• Directors meet to elect officers, adopt bylaws,
  and begin business in the name of the corporation.

26
Corporations

• Organization and Characteristics
• Shareholders
• Directors
• Officers
• Can be the same individuals.

27
Corporations

• Shareholders
• Own the corporation.
• Direct affairs through elected directors.
• Each shareholder has one vote per share of voting
  stock owned.

28
Corporations

• Directors
• Elected by shareholders.
• Manage the business.
• Set broad management policy.
• Have a fiduciary responsibility.

29
Corporations

• Officers
• Elected by the board of directors.
• Responsible for day-to-day operations.

30
Corporations

• Two Types of Corporations
• C Corporation
• -Regular corporation.
• S Corporation (Family Farm?)
• -Tax-option corporation.

31
Corporations

• Restrictions on S Corporations
• Limited to 75 shareholders.
• Shareholders can be individuals, estates, certain
  types of trusts. Other corporations cannot hold
  stock.
• Only one class of stock. Voting rights may be
  different for some shareholders.
• All shareholders must initially consent to
  operating as an S corporation.
• Certain of earned income.

32
Corporations

• Advantages
• Limited liability
• Pool resources
• Specialized management
• Obtaining credit
• Continuity
• Transferring ownership
• Fringe benefits
• Vehicles
• Insurance

• Disadvantages
• Costly to form and maintain
• Legal advice
• Meetings
• Double taxation
• S corporations are taxed like a partnership

33
Corporations

• Corporation Operation
• Basically operated similar to a partnership.
• Number of shares to be issued is decided by the
  stockholders.
• Value of each share is the beginning equity
  divided by the number of shares to be issued.
• Net income is distributed in the form of
  dividends.

34
Limited Liability Companies(LLC)

• Resembles a partnership, but offers its members
  the advantage of limited liability
• Creditors or others can pursue the assets of the
  LLC, but cannot pursue personal or business
  assets owned individually by members of the LLC.
• Any number of members.
• Ownership is distributed according to the fair
  market value of assets contributed.
• Net farm income is passed on to members in
  proportion to their shares of ownership.

35
Limited Liability Companies(LLC)

• Advantages
• Limited liability for investors.
• Less time to form than a corporation.
• Simple
• Flexible

• Disadvantages
• Cant deduct cost of fringe benefits.
• Poor continuity.
• New
• Limited legal precedence.

36
Cooperatives

• A special type of corporation formed to
• Obtain inputs or services.
• Market products jointly.
• Engage in farm production.
• The key is a true desire to cooperate!

37
Cooperatives

• Traditional Characteristics
• Limited liability.
• Net income is passed on to members before
  taxation.
• Provide tax deductible benefits to owner/members.
• Maximum return payable is 8.
• Remaining net income is distributed to members as
  patronage refunds, based on amount of business.
• All members have one vote.

38
Transferring the Farm Business

• Important Questions for Family 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?

39
Key Areas to Transfer

• Income
• Ownership
• Management

40
Key Areas to Transfer

• Income
• Pay the new operator a wage and/or return to
  asset contribution.
• Bonus
• Profit sharing

41
Key Areas to Transfer

• Ownership
• Saving breeding stock.
• Investing in machinery.
• Selling assets.
• Gifting assets.
• Careful estate planning.

42
Key Areas to Transfer

• Management
• Often the most difficult to transfer.
• Give responsibility one enterprise at a time.
• Allow younger operators to rent land to gain
  experience and learn management skills.

43
Stages in Transferring the Business

• Testing stage of 2-5 years is often a good idea
  then
• Spin-off.
• Takeover.
• Joint operation.

44
Stages in Transferring the Business

• Spin-off
• Operators separate into their own individual
  operations.
• Can still trade labor or use of equipment.

45
Stages in Transferring the Business

• Takeover
• Older generation phases out of active labor and
  management.
• Renting or selling to the younger generation.

46
Stages in Transferring the Business

• Joint operation
• Both generations wish to continue farming
  together.
• Often involves expansion.
• Crucial to have effective personal working and
  management relationships.

47
Alternatives for Farm Business Transfer
48
Summary

• A farm or ranch business can be organized as a
  sole proprietorship, partnership, corporation,
  LLC, or cooperative.
• The form of business organization depends on the
  size of the business, stage of its life-cycle,
  and the desires of the owners.
• The right form of business can make transferring
  farm income, ownership, and management to the
  next generation easier.