A farm’s business structure plays a major role in determining the taxes paid on federal and state returns. While it may have been advantageous to operate a family farm as a C corporation, changes in tax law and personal circumstances may argue for a course correction. This post takes a look at the potential trigger points for a change and provides a few considerations when developing a transition plan.
Key Factors in Favor of an S Corp
If you operate a family farm, the following arguments support transition from a C corp to an S corp:
Income from a C corporation gets taxed twice before landing in your bank account. Corporate tax rates apply to the farm’s net income, and individual tax rates apply to the corporate dividends you receive. Income from an S corporation gets taxed once on your individual tax return.
Cash vs. Accrual Accounting
If revenue totals from your C corp family farm teeter on the edge of mandatory conversion to accrual accounting, it’s time to look at conversion to an S corp. An S corporation allows you to maintain the favorable tax treatment associated with cash method accounting even if your revenues cross the C corp threshold.
Although treatment of gains in an S corporation can be handled differently, sales of appreciated assets can create a significant tax implication when the gain is locked inside a C corporation.
If you plan to fund your retirement using rental income from your farmland, an S corporation can offer far more attractive tax treatment than a C corporation.
Oregon Minimum Tax
If you operate within the State of Oregon, your farm will be subject to a minimum state tax payment even if you earn little to no income from it. The minimum tax for a C corporation is based on gross revenue; an S corporation pays $150.
While the aforementioned considerations favor a transition to an S corporation, a C corporation structure may still be the best option based on your specific circumstances. Your tax accountant can evaluate your options and provide guidance on the most tax-efficient solution.
Considerations When Making the Transition
On the date of conversion, the assets of the C corporation are valued at fair market value including any blue sky to calculate “built-in gain.” If assets are sold, the taxpayer might pay corporate taxes at the S corporation level on the recognition of the built-in gains. This calculation is crucial to farming entities due to the cash basis method of accounting. For example, inventory and accounts receivable have to tax basis; therefore, the built-in gain on those assets on the date of conversion can create significant current year tax, if not planned correctly.
Thanks to the Protecting Americans from Tax Hikes (PATH) Act of 2015, you can avoid a tax liability on built-in gains associated with long-term assets IF you wait 5 or more years before selling them. The PATH Act made permanent a temporary provision that reduced the holding period from 10 to 5 years. This treatment can be applied retroactively to those who’ve already converted to an S corp and prospectively for those who find it beneficial to do so now. Long-term assets sold within 5 years of conversion to an S corporation will be taxed at the C corporation rates.
If you are planning to retire and earn passive income from land rental, then you need to be attentive to the level of retained C corporation earnings and profits. If substantial, you could be subject to excess passive investment income tax and risk a mandatory termination of S corporation status. While there are several strategies to address this circumstance, it’s helpful to have some lead time before the S corporation conversion to put them in place and reap the maximum financial benefit.
Finally, your tax professional can offer invaluable advice when and if you choose to lease your land, buildings, and/or equipment to third party farmers. If you are able to structure an arrangement in which you provide substantial services for your tenants or incur material rental costs, you could avoid the pitfalls associated with passive income generation and provide the means to pay yourself a reasonable salary.
Leverage Expert Advice
Your tax professional has the knowledge to help you determine the best business structure for your farm whether you continue to manage the business actively or anticipate a speedy retirement. He or she can also help you determine the optimal timing to effect the transition and define the action plan leading up to a conversion. With an appropriate lead time, you have the best chance of minimizing your tax liability and retaining your hard-earned cash.
This post was originally published on August 8, 2016. It was updated on December 8, 2017 to provide you the most current information.
Meet the Author
Curtis Sawyer, CPA
Aldrich CPAs + Advisors LLP
Curtis Sawyer provides farm accounting, tax compliance, planning, and agribusiness consulting services to his clients in the agriculture industry. He works closely with businesses across several industries with an emphasis in agriculture, farming, cooperatives and food-processing, as well as closely-held businesses and their owners. Curtis also presents on topics including regulatory reform and tax savings…
- Agribusiness consulting
- Farm accounting
- Closely-held businesses
- Certified Public Accountant
- Strategic tax planning and compliance