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.

If you operate a family farm, the following arguments support transition from a C corp to an S corp:

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.

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.

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.