Ted (00:00.152)

Hello everyone. Our guest today is Bill Scott, who is a CPA who focuses in on the agricultural market, what I call the ag market, advising family farms about tax issues and other related issues. Welcome to the show, Bill. Hey, just as a preliminary matter, when I bring on another professional, I want everybody to understand that we’re not intending here to provide

specific tax advice or legal advice, just general advice on the topic. Did I say that right, Yep. Yeah, it’s just important to understand that, you know, this is just a high level conversation. No tax advice is given through this conversation. Obviously, if any of these topics that we discussed today are, you know, of relevance to you, I’ll make sure you consult your tax advisor before making any decisions based on what’s discussed today. Bill, give us your background.

Sure. So I’m a tax principal with Clifton Larson Allen. CLA is where more commonly known. We’re a national firm. We have offices really all across the country. I sit in our Northwest Ohio office in Maumee, Ohio, which is suburb of Toledo. So I’ve been leading our agribusiness practice here in Ohio for about 10 years now. Been with CLA for about 15 and spend the majority of my time, probably 80 percent, maybe even more, working with agribusiness clients.

Specifically, drill down for me on some of the things that you advise family farms about. Sure. So one of the biggest things we’re advising on these days, really an issue across all industries, but specifically an ag is succession planning is a huge issue out there. Huge of a lot of interest, big topic of conversation. There’s a lot of, you know, farmers from the boomer generation that are starting to get that retirement age or they’ve already reached retirement age and

It’s time to start looking at how they’re going to transition this thing either to the next generation. One thing we see a lot of, which has not been common in previous generations, is sometimes there isn’t a next generation. So you’ve got to look outside the farm. Are we going to sell the farm? Are we going to sell to a third party? Maybe there’s an employee on the farm that wants to take over and they would carry on the legacy of the owner.

Ted (02:17.675)

So we’re having a lot of those conversations right now with our clients on what that succession plan looks like. And as you’re well aware, the sooner you have those conversations, the more seamless that transition tends to be. You want to make sure you’re having those conversations well in advance of when it’s time to actually start making that transition. Are you seeing more and more family farms transition during the current owner’s lifetime or is still the bulk of it what you’re seeing is transitioning when they pass away?

It really depends on the size and complexity of the operation. Your traditional, you know, if it’s just operation, I don’t want to minimize these operations because this is a bedrock of really what local agriculture is here in Ohio. Operations that are farming a thousand acres, 1500 acres, maybe even a little more, a little less. A lot of those, you know, we do see, you know, at least from a land holding standpoint, you hold that land until pass away and…

transition it on to the next generation, you get that step up in basis, which is a huge tax planning tool, huge transition tool to use for succession planning. And then at some point, the operation transfers over to the next generation. But generally, that older generation sticks around for as long as they possibly can, as you’re well aware. In the more larger complex operations, maybe you have a few different legal entities. The assets have grown to the point where you’re beyond that estate.

planning or that estate tax threshold and some more complex planning needs to be done. Sometimes you have to get some trusts involved. There’s transition kind of along the way. Maybe there’s some gifting to use up annual exclusions and then make sure you’re using up that lifetime exclusion. So it really just depends on the situation. But yeah, I would say the more simple operations, you know, we still see that traditional model of just, you know, transitioning it on, you know, after death. But again,

The bigger and more complex you get, the more planning that needs to go in. generally speaking, there’s some transition that needs to happen sooner. Well, as you know, our paths cross because we’re working in the same arena, the same area, helping our family farms successfully transition while protecting it during their lifetime. What I have found is that a sub-specialty that we do regularly is to help

Ted (04:34.309)

with respect to asset protection, whether that is protecting the family farm from a potential creditor claim or a lawsuit claim or from a nursing home. And generally speaking, in order to do that, we have to create these entities. So in my career, what I see out here is that some of the older entities are corporations and some of the newer entities are limited liability companies or LLCs.

But I still to this day see a whole lot of general partnerships. I still see today a whole lot of farm ground owned individually. And in today’s world, frankly, that doesn’t make any sense. What I would like to do though is spend a little time talking about farm business structures with you to get an idea if you’re seeing the same thing I’m seeing and to see, you know, what direction current

planning should go in. Have you ever seen a farm organized like I have as a corporation and taxed as a C Corp? We’ve definitely seen that. Like you mentioned a minute ago, generally the farm operations that we see that are sitting in a C Corp were set up several years ago, back these nineties and maybe beyond that before LLCs were the more common structure to organize under. So the majority of our C Corp farming operations are older entities.

In rare occasions, we might see a newer operation set up under a C-corp, but generally speaking, what we’re seeing is typically an LLC or an S-corporation. do still see sold So when we deal with a corporation, from a legal standpoint, when you’re going to form a corporation, you form that under state law. So here we’re in the state of Ohio. We would register the corporation with the Ohio Secretary of State.

And then we would file a form with the Internal Revenue Service saying whether we wanted that corporation to be taxed as a C Corp under the C Corp rules or an S Corp under the S Corp rules for those who have chosen to be taxed as a C Corp. Why would somebody have done that, say in the 60s or 70s, and even go to the point where that C Corp

Ted (06:58.625)

owns land that will not get a step up in basis. Why would a family go that path? What benefits do they get? Yeah, I think back then there was less flexibility in structure. That was just the common structure that most entities were set up under. There are benefits to being a C Corp from a liability standpoint. And you know, this is this is your world. So feel free to speak on that. But generally speaking, you’re protected from liability better in a C Corp than any other structure. Well, and I will

I will pause you on that. The reality is that a C Corp, was intended to protect the farmer’s personal assets from any farm liabilities and therefore most of the time the assets are not, at least the land, is not owned by the C Corp, but occasionally I see out here where even the C Corp owns the land, which is a bit unusual, but it does happen.

The purpose, as I understand it, was primarily from a tax standpoint, in addition, as you say, to protect personal assets from the farm liabilities. But let’s talk about the tax aspects of a C-Corp. How does that help us? So the benefit from a tax perspective of being in a C-Corp is your tax at that flat rate, which is now 21%. So when the Tax Cuts and Jobs Act was passed back in 2017, the corporate tax rate

was decreased. So there was some, I would say, some increased interest in, you know, looking at C-Corps again. Prior to that, there was kind of a graduated tax rate. So depending on your income, you may have been, you know, higher or lower tax rate. Now it’s a flat 21 % rate, which, you know, at 21%, you know, if you look across the globe, it’s a pretty low corporate tax rate. You know, there’s definitely tax benefits there. The downside

from a tax perspective is you’re subject to potentially double taxation. Anytime you distribute any income out of the corporation to the shareholders, you’re going to pay tax both at the entity level and then the shareholders are going to pay tax on those dividends. So let’s stop there. So the double taxation rule applies to C-Corps, but it only applies if we have profits that we distribute out to the shareholders.

Ted (09:21.468)

And so if we’re able to manage the C Corp, shareholders can be employees, they can be paid wages, they can be given bonuses. They do have to pay payroll taxes though, don’t they? Correct. Yep. And actually it’s kind of, it’s a requirement by the IRS that they should be drawing a wage. If you’re, if you’re structured as a corporation, you should be drawing a wage. And there’s a concept that the IRS scrutinizes pretty, pretty closely in corporations. And that’s to make sure that

you know, your employees are being reasonably compensated and you kind of have two different issues, whether it’s an S-corp or a C-corp and a C-corp, they’re looking to make sure you’re not overcompensating your employees to take that deduction and avoid, you know, you’re pushing out income and avoiding that double taxation. You know, they can have what, you know, they deem to be, well, that’s actually a dividend payment because, you know, that person is receiving, you know, excess compensation for what their role is in the business or what.

you know, what typically you would see somebody in that position being paid. Whereas in an S-Corp, you have the opposite issue where people are underpaying those wages because you’re trying to push out those tax-free distributions out of the S-Corp. So depending on, you know, what corporate structure you’re under from a tax standpoint, you still run into that reasonable compensation issue. It’s just kind of the opposite issue whether you’re talking about a C-Corp or an S-Corp. But yes, you’re correct. As long as you’re not pushing out

profits from the corporation to the shareholders, you’re not going to be subject to that double taxation. So if we can find a way to eliminate the double taxation, the other thing you can do within a C Corp, am I right? can retain some earnings with inside the corporation and not distribute them out, not issue them as payroll. And are there limits on how much I’m allowed to retain within the entity?

So there isn’t a hard and fast rule on that. The IRS just says you can’t have excess retained earnings. Essentially, you can’t be hoarding the retain, you can’t be hoarding the earnings at the corporation level and not distributing it out if there’s no reason to hold it back. But I think all of us who are in business understand, you know, the common rule out here that I’ve heard is that it is prudent.

Ted (11:30.494)

to retain at least six months of your monthly expenses. you either got to get a line of credit or you got to retain some earnings or do a little bit of both. you know, if you have a small business and you become disabled and you want that business to continue, you better have some money saved up. It seems to me that the C Corp, more so than any other entity, allows you to do that.

Yeah, I wouldn’t disagree with that. And I would say, you know, in the farming world, you know, you can make the argument that you need more than that six months because as you’re well aware, the farm economy ebbs and flows and you got to have a rainy day fund in those strong years because those lean years can be, they can be really tough to, you know, can be tough sledding there for a couple of years. So if you only have six months of retained earnings built up, that might not be enough. So I think making that case for building up a reserve and a C-corp for a farming operation would be

It’d be a pretty easy argument to make in most cases if the IRS were to ever ask questions. Let’s also talk about employee benefits. Understanding is that we have much greater latitude because we have employees who are being paid a W-2 wage and when we have that, the law says we can have benefits for those employees that are paid for by the C-Corp.

that are fully deductible against our profits to again lower the amount that is subject to that quote double taxation. Yep, that’s correct. Yeah, it would be treated just like any other corporation where the employee benefits are deductible expenses, whereas you have different rules when you get into the LLC and S Corp world. But yeah, the S or the C Corp. So let’s talk a little bit about what are the range of benefits that a corporation can provide to the owners.

You’d have health insurance benefits, you your 401Ks or whatever the retirement plan, typically you’d be looking at a 401K. Life insurance benefits, now key man life insurance is generally going to be not deductible for tax. So if you have a key man life insurance policy in there, that might be something that’s not deductible. But really any of the, you know, your typical fringe benefits that you’d see at any other company, you have that flexibility inside of a C Corp. Talk to me about though, within the egg sector.

Ted (13:46.819)

What is unique about the ag sector in terms of employee benefits that you’re seeing? You mentioned, of course, what all businesses deal with is providing health insurance for the employees, fully deductible. As I understand it, a corporation can provide long-term care insurance at a very favorable rate if they have a C corporation. I even have seen some C corps

providing other types of benefits, whether it be paying for rent or employee meals or things like that. Talk to me a little bit about uniforms or employee meals or things like that. What else are you seeing? What’s the range? Yeah, I mean, you you could have some of the stuff, you you mentioned uniforms and meals and that sort of thing. So as long as it falls under, you know, the de minimis fringe benefit rules with the IRS, you’re generally going to have, you know, deductible benefits you can provide to your employees again, like any other.

corporation. But I would say the big one is the retirement benefits you can see under C-Corp. You a lot of times you see that can be pretty lacking in a lot of our the farm operations I see that are structured under, you know, sole proprietor LLC limited partnership. A lot of times they don’t even have a retirement plan set up or an opportunity for their employees to put money away for retirement. So they’re, you know.

stuck with, you know, the best they have is an individual IRA or Roth IRA that they set up on their own. So in C-Corp, you have a kind of a broader range of retirement options, generally speaking, and you typically see that structure. Does it allow for both a K as well as a profit sharing component? It can, yeah, certainly can. So for some entities that I see, the basic deduction can go all the way up to

$65,000 when we combine a 401k plan with a profit sharing plan. Correct. And that profit sharing component part from what I understand can be discretionary. You can do it one year and not do it another year depending upon the profitability of the company. Correct. Yeah. Subject to discrimination laws and all that sort of thing. But yeah, absolutely. Now I have

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A particular client of mine who has four family members involved in the farm and the farm land that it owns also has their houses on it. And there in particular those who live in a house where the main operation is, they’ve concluded that they need to have a manager on site for a whole lot of reasons. I won’t get into the details.

But in those cases, I think the entity is paying for the home and the home expenses because the manager has to be on site. Any reaction? I guess so. I would say that’s not uncommon. The one thing to watch out for is to make sure that, you know, any personal use is being accounted for and either grossed up an income or excluded from deductible expenses from the business. That is one thing that the IRS, if they were ever, you know, come in and take a look.

They will scrutinize personal use versus business use of assets. So you have kind of the same issue. You generally see farmers putting their trucks in the business, which makes perfect sense. They’re using those trucks probably 95 % of the time for business. But if there’s personal use, you just have to be careful to not abuse that and put yourself at risk to having mingled personal and business use assets. Sure.

And I understand that. You know, it’s interesting. I really haven’t seen in my 40 years of doing this any audits on those issues. I think it’s pretty widespread. we’re able to, to a large part, put our vehicles, our pickup trucks, all of our farm equipment, and even pay for some of the housing expenses, maybe meal expenses, maybe uniforms, as you said, retirement accounts. We can

put money in and we can accumulate funds within the company for our ongoing expenses and if we’re in a profitable business we can reduce our tax rate down to the 21 % rate. So from that standpoint that’s all fairly attractive. So what’s the downside to this C Corp? What’s the downside particularly, let’s start off with

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kind of the old fashioned, the C Corp that owns land. What is the downside to a farm family if they put a thousand acres in a C Corp? Yep, so that’s really the big one. So if you have land or really any kind of appreciating property sitting in a C Corp, to get that out of the business is going to be a taxable transaction. Unlike in an LLC or some other structures, you cannot distribute that land out without creating a taxable transaction. And you also aren’t going to get the step up.

So under, you know, an LLC, if you have an LLC or general partnership, you can do 754 elections if your tax is a partnership to step up the basis in that land when there’s an event, an ownership event. There’s in a C Corp, that basis is what it is. If you bought land back in the 60s and that’s in the C Corp and it continues to carry on 50, 60, 70 years in the future, your basis is pretty close to zero. So when that transaction happens, there’s huge capital gains that

could potentially be building up in that land. And then I guess to kind of expand on that, if there’s any kind of exit event from the C Corp, let’s say you sell the business, generally speaking, you’re gonna see most times in agriculture, we see an asset sale. So when that happens, you have an asset sale, you sell all the equipment, land, everything, you the operations, you’re gonna really get, that’s where that double taxation can really hurt, because you’re gonna pay tax on all the gain inside of the…

The C-Corp, again, at that flat 21 % rate, but then we distribute everything out to the shareholders, they’re going to get hit with that dividend as well. on the back end in an exit event, unless there’s very careful planning done and structuring, it can be pretty painful on the back end if the proper planning wasn’t done ahead of time, especially from a double taxation standpoint.

So there are a few families that really are wanting to do multi-generational planning and so they’re not looking for anybody to ever exit the entity. In other words, they want to take the stock. Let’s say you got four brothers and they each own 25 % of the stock. When each of them passes, they’re not looking to get cashed out. They’re looking to transition it.

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to those involved in the farm, those family members involved in the farm, and they’re not looking for those family members long term to ever exit. So if you’re trying to, I suppose, develop a strategy that says we want our family farm to continue for as long as possible, the lack of getting a step up in basis becomes somewhat irrelevant.

because the plan is that it’s never going to get sold and nobody’s ever going to cash out. Is that a fair statement? Yeah, generally speaking, I would say, yeah, that’s a fair statement. And if the plan is to continue to reinvest profits in the business into the business to expand, whether that’s to purchase new ground or new equipment, that sort of thing, you’re continuously reinvesting in the business. In those profitable years, you pay out a bonus or profit sharing, whatever, to get that income out to the

shareholders without passing it out as a dividend. So again, you’re staying within those constraints of, you know, reasonable compensation and making sure that you’re not, you know, creating any unnecessary exposure. I could see that being a viable strategy. Now would say I would still recommend not putting things like land in the C Corp. Generally, we would want to see a separate land holding LLC and you’d have kind of a lease back agreement between the business and the land. So you’re going to get a rent deduction at the Corp and you’re going to pick up

rental income at the land holding up. Again, keep those separate and keep that land. You know as well as I do that, you can plan as much as possible, but you never know what’s gonna happen 10, 20, 40 years down the road. There could be a falling out. There could be any sort of, several things could happen that could result in some sort of transaction that you didn’t anticipate. Having that land outside of the corp is still

preferred if you’re going to have the operations inside of corporation. Yeah, and I think the only pushback on that is, for instance, I was talking to one of your partners and his family has got a C Corp set up and they own land within it. And from his perspective, there’s no need to change that. He’s happy with that. In fact, I had actually had a client of mine when I explained this no step up in basis rule for all the real estate that was owned by his entity, by a C Corp. He said, you know what?

Ted (22:59.543)

That’ll make sure that my boys never sell that land because they’re never gonna want to pay taxes on it. That’s fair, yeah. On the other hand, he had another 350 acres. He wasn’t about to put it in, so. Sure, yep. We did put that in a separate entity. Well, I think we’ve pretty well covered the C corporation. Let’s transition. Do you see any S corporations being formed within the ag community or is it mostly? I would say S Corp.

LLC is probably the most common one that we see, but we do see quite a few S-Corps. A lot of times when S-Corps… And let me, let me, let me, the difference between how CPAs talk and how lawyers talk. let me introduce it this way. Just remember, from a legal standpoint, again, when we form a limited liability company, we form that under state law. And then we have to decide how it’s going to be taxed. It can be taxed as a sole proprietor. It can be taxed.

as an S corporation. It can be taxed as a C corporation and believe it or not, can be taxed as a partnership. So after I form the entity in Ohio, I then have to notify the IRS how it’s going to be taxed. So we can have an LLC taxed as an S corp, but we can also have a corporation taxed as an S corp. The default on the LLC is if we don’t make the election, it’s going to be a partnership.

So let’s talk about either a corporation taxed as an S-Corp or an LLC taxed as an S-Corp as one in the same. Why would somebody who is involved in farming want to have an entity taxed as an S-Corp? So generally, the big tax benefit you can get from an S-Corp is assuming there’s enough profits in the business, there can be some significant self-employment tax savings in the S-Corp structure. So…

Again, going back to the reasonable compensation issue that we discussed earlier with the C Corp, you have the same issue in an S Corp. And I had mentioned that people are kind of doing the opposite where they’re trying to get that wage as low as possible. And the reason for that is, you know, as a shareholder in an S Corp, you have to draw a salary, just like if you’re in a C Corp. But then whatever your ordinary income allocation from the S Corp, after, you know, salaries and all other expenses are deducted, that comes through to you on a Schedule K1, just like a partnership, as ordinary income.

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but it’s not subject to self-employment tax. like. So let’s talk about this thing, this concept called self-employment tax. What does that mean? What kind of tax is it and who is it paid to? So that’s your FICA, your Medicare. So if you’re an employee at a business, when you look at your W-2, when you look at your social security tax, your Medicare, that’s essentially your payroll tax. So when you’re a business owner, you have both the employer and the employee portion that gets paid.

So let’s say I have $50,000. What percentage of that do I have to pay in self-employment tax? So you’d pay, and I can’t recall the exact percentages off the of my head, payroll tax expert.

but you would pay both the employee and the employer portion as self-employment tax, but then you turn around and you get a deduction for the employer portion on your personal tax return. And the reason for that is, you know, as a business owner or as a business, they would deduct the payroll taxes that they’re remitting on behalf of their employees as the employer portion. So when you’re self-employed, you still get a deduction for that employer portion, but you still have to pay tax on it. So you’re paying the tax, but then you get a deduction.

at whatever your tax rate is. seem to recall the rate somewhere being around 15.3 percent but don’t hold me to that. That’s about what I was going to say but I can never remember exactly what it is so I didn’t want to put a number out there. So to make sure I understand what you’re saying is this. If I have a farm entity, a corporation or an LLC taxed as an S-corp, I have to pay myself a reasonable salary. But it may turn out

that the entity makes more money than my reasonable salary. Let’s say that my, and we pay payroll tax up to how much profit these days. Isn’t it somewhere around 170,000 or so is where we’re at? Yeah, the social security portion, which is the majority of it, does get capped and then you just pay the Medicare after that. Yeah.

Ted (27:26.791)

So the Medicare I think is 2.9 % of that. portion. So we’re capping the social security somewhere around 170. So if I have an entity and let’s say a reasonable salary is $70,000 for a farmer and I have $170,000 worth of income profit. Prior to that salary. If I elect

to an S-Corp, I’m only going to pay the 15.3 % self-employment tax on the 70,000. I’m not going to pay it on the excess of 100,000. So I will be saving roughly $15,000 per year, roughly speaking, just by taking my sole proprietorship and electing S-Corporation treatment. Did I say that right?

Correct, yeah, in a nutshell, that’s essentially what happens. Savings can be, generally we wanna see at least over 100, 150,000 or so of profits for this to really start making sense because there is some additional compliance involved with being an S-Corp, especially if you’re going from that sole proprietor, a single member LLC where you’re just filing on a schedule F. You now have a business tax return that has to be filed. You have to put yourself on payroll. So there’s some additional administrative costs and

headaches associated with being an S-Corp. So you kind of have to make sure you do a cost benefit analysis there. But generally speaking, if you have a highly profitable entity that is showing taxable income year after year, the S-Corp can be a powerful tax saving. Yeah, because let’s face it, while $15,000 isn’t all the money in the world, it’s still real money. Yeah. And if you’re doing that every year and you do that for 20 years, you’ve saved $300,000 for yourself. Correct.

So at least it’s something to think about. Now what’s the downside? What’s the downside for an operation to be an S-Corp? So I mentioned the addition. Clearly got to do an extra tax return. Clearly got to do payroll. And typically these days payroll is complicated. So we’re going to have a third party do that, a CPA firm or some payroll company do that. Correct. And you also have, lose some flexibility in an S-Corp, especially if you’re going from an LLC, again, a tax, you know,

Ted (29:51.855)

And your taxes and LLC have a little more flexibility as far as distributions and income allocations and that sort of thing under an ESS. So just to be clear on that, there are times when, let’s say, I had a client in here, son owned 85%, dad owned 15, dad’s 80 years old. Dad really doesn’t need money, but he doesn’t want to give up ownership. In theory, all of the income can be allocated to the son and he can pay all the tax. Dad doesn’t have to be allocated any income.

We cannot do that with an S corporation. It has to be pro rata according to the percentage of ownership. Whereas if we’re a partnership, we can do it differently, right? That’s exactly right. So lot more flexibility under that LLC structure. So you lose some of that as an S corp. So, you know, if you want to be flexible with your income allocations, you kind of, lose that ability under an S corp. And you also run into the same issues we talked about with the C corp. If you own land in an S corp or appreciating assets.

Whereas under a partnership or an LLC, as long as you have appropriate basis, you can get those assets out in a tax-free distribution. Whereas in an S-Corp, you’re going to have a taxable event. So you run into the same issues under an S-Corp as you would with a C-Corp when you’re trying to get those. You don’t have the double taxation issues of a C-Corp. But if you’re trying to distribute out an appreciated asset like land, there’s tax implications. Whereas under an LLC or a partnership structure, you typically can get that done in a tax-free manner.

You know, lot of times I’ll see an entity that is taxed as an S-Corp and it will own assets, whether it be land or primarily I see a lot of equipment. Let’s say I’ve got an operation that’s got two million dollars worth of equipment in an S-Corp and when I explain to the client, you understand that if you are sued, if the entity is sued because there’s a farm accident, they’re going to be able to seize your equipment as well as all the grain on hand.

So clients of mine are asking me, there anything you can do? I will tell you this, 10 years ago or so I read an article about something called a Q-sub, creating a subsidiary for the corp as a way to try to get some asset protection. But I don’t think I’ve ever seen anybody do that. Have you ever seen that? We have, and generally it’s, you know, if you have a couple, generally we do that if we have a couple of existing.

Ted (32:11.426)

S corporations that we kind of want to merge into one. You can structure that in a way where you form a Q sub. I would defer to you on the liability protection piece. There’s always the issue of piercing the corporate veil and I’m not qualified to speak in a legal capacity, especially in agriculture, you see a lot of, yeah, everything is under separate legal entities, but generally speaking, everything is from a optic standpoint.

A lot of times you’re running everything through the operation. So I know you run into issues where, you know, just because you have it separated legally, unless you’re checking all the boxes to make sure everything is separate, you’re not co-mingling assets or no resources. I think you can, you can ruin that, that legal protection pretty easily. Well, yeah, I think the key, I think you hit the nail on the head. I mean, the reality is dividing and conquering is real and legitimate under the law, but

You can’t ignore it. If you’re going to ignore the legal entities that you set up, then so will the court. Having said that, if you have proper lease agreements, you make lease payments, you operate them separately, you don’t co-mingle, the law will uphold the separation. I don’t think there’s any doubt about that. Well, maybe on another podcast we’ll talk about Q subs, but let’s move on a little bit. As you indicated,

To summarize with the S-Corp, we have to pay ourselves a salary. It generally has to be a reasonable salary. We’re going to pay payroll taxes on that reasonable salary, but if we’re successful, if we’re profitable, we won’t pay the payroll tax, particularly the Social Security tax, up to 170,000, so we can achieve some real savings. And then number two, of course, it’s a pass-through entity, so anything we’re going to distribute out of the entity is not subject to that double taxation like a C-Corp is.

Instead we issue a K1 that goes directly on our personal tax return. Correct. All right, so let’s move over to say an LLC taxed as a partnership or let’s talk about a general partnership. And I’ll make some comments here. I will tell you this, we’ve had LLC law here in Ohio for almost 50 years now. As I mentioned, you know, in my practice,

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I’m going to form a limited liability company instead of a corporation unless I’m doing something in the non-profit world. I can honestly tell you that I’ve never formed a general partnership and the reason I’ve never formed a general partnership is because my law school professor told me there’s never a good reason to ever create a general partnership. And the reason is that let’s say my son and I are general partners.

I become totally responsible for his business activities and he becomes totally responsible for mine. And if we’re on business and I hit a school bus and kill six people, not only are my personal assets at stake, not only are my business assets at stake, so are my sons. So as a general rule, hear me, ag community, as a general rule, we don’t want to be a sole proprietor and we don’t want to be a general partnership.

Having said that, I still see a lot of it. Let’s talk about though, what benefits does a partnership structure, a limited liability, taxed as a partnership, what is different about that partnership compared to that C corporation we talked about and that S corporation we talked about? Yep.

So similar to an S-Corp, it’s gonna be a flow through tax structure where income flows through to the partners and tax at their individual tax level. Really the big benefit of being an LLC or a partnership or LLC tax as a partnership or a general partnership from a tax standpoint is the flexibility you get. We talked about income allocations, the ability to distribute assets out tax free. And it’s also, I mentioned earlier, if you have an event where somebody is buying or exiting.

So entering or exiting the partnership, you can make what’s called the 754 election to step up the assets inside the partnership. There’s some very complex tax rules in LLC partnership structures, but they can be very powerful in the sense that it’s really the only way you can step up those assets inside the business. Other entity types, you don’t have the ability to do that. So I think the flexibility is key here though, being able to have

Ted (36:43.198)

You you could have it as simple as pro rata, just like an S corp. You could get as creative as you want with your income allocations. can have. let’s talk, let’s talk a little bit about the income allocations again. Let’s say my son and I have a limited liability company in LLC. let’s say, because I contributed all the money, let’s say I got an 85 % ownership interest. He has a 15 % ownership and let’s say we make $200,000. Let’s say.

because I have other outside activities. I’m at the highest tax rate of 37%. And he is, let’s say, got a 21 % tax rate because he has lower income or he has more deductions than I have. Well, if we’re a partnership or an S-Corp, 85 % of that profit is going to be given to me whether I like it or not. But with a partnership, assuming there’s economic substance to it,

we can allocate that $200,000 of income, maybe 75 % to my son or 50 % to my son, even though he only owns 15 % of the company. And the IRS is going to allow it to be taxed at his lower rate than my high rate. Did I explain that right? Correct. You hit on the most important piece and it’s that it has to have economic substance. And what does that mean? It means there has to be some

basis in the actual economic operations of the business and it has to be written in the operating agreement that you’re allocating it for a specific reason and there has to be an economic reason other than evading taxes. You can’t just allocate incomes for the sole purpose of evading taxes. So in your situation, you have the one partner who’s in the top tax bracket, you have the son who’s in the low tax bracket. You can’t just allocate.

the sun, the majority of the income to have a tax benefit without any other business reason for that allocation. if the reality is, is that what I’ve done is contributed money, but he works 40 hours a week in the business that might provide some support. So when we have a partnership, we don’t, we don’t because the partners can’t be employees. Now, having said that, if it can’t be employees,

Ted (38:59.201)

All of those employee benefits that we were talking about deducting at the corporate level are no longer deductible within the partnership. Is that the fair statement? Yep, that is correct. You could have, so if you generally are going be paying your own self-employment, or I’m sorry, your health insurance, so you’d have self-employed health insurance deduction at the individual level that is contingent on you having self-employed income.

So if you have a loss year, you still paid your insurance, but you’re not gonna get a deduction for that, because you can only reduce self-employed income using that. Same with, you if you make a self-employed retirement contribution, it’s contingent on your self-employed income. So definitely more restrictions on that. And it’s at the individual level as opposed to a deduction at the entity level. So the partnership files a…

A return though, still has to file the entity at the entity level. We have to file the 1065 return, right? Yep. So with the corporation, we file an 1120 with the S Corp. We file 1120 S and now this is something different called a 1065. And in like the S Corp, the partnership issues a K1 of either profits or losses to the individuals.

but we’re really limited on our deductions. But ordinary normal business expenses, we still get a take. Absolutely. And we still get a take depreciation. Correct. And we’re still qualifying for the QBI, the qualified business deduction. Yep. Yeah. And the one thing you have to be careful on with LLCs or partnerships, or again, LLCs, taxes, partnerships, is if you have a guaranteed payment in there, which is

kind of a, it was very common several years back, I would say pre-tax cuts and jobs act. You could have something in the operating agreement that says you’re guaranteed X amount of dollars for the year and it comes through as a guaranteed payment. So you’d mention you can’t have wages in a partnership so it’s kind of a way to structure it to where you’re getting at least a set amount. The problem with that from a tax standpoint is those guaranteed payments are not eligible for the QBI deduction. So we’ve done some.

Ted (41:11.58)

some consulting with clients that historically had those guaranteed payments built into their operating agreements to kind of move that to the ordinary income bucket to take advantage of that 199A 20 % deduction. Am I right that the current legislation that was just adopted continued that qualified business deduction for a period of time? Correct. It actually made it permanent, which was a great, great thing to see in the tax bill. So that’s a big deal.

Other than those limitations, why wouldn’t we want to do a LLC tax as a partnership? What other downside is there? So you, we mentioned self-employment tax earlier. anything that flows through as ordinary income on your K-1 from a partnership is going to be subject. Assuming you’re active in the business, going to be subject to self-employment tax. I would say from a compliance standpoint, partnerships, they can be very simple, but they can also be extremely complex and come with

pretty significant compliance costs, especially if you have partners coming in and going out. We mentioned the 754 election for stepping up basis. There’s a lot of tracking that goes into that, a lot of potential compliance. Partnership tax law is probably the most complex out of any of the entity structures. S-corps, C-corps are generally pretty straightforward. You don’t have those income allocations and things like that, where with the LLC, you have a lot of flexibility, which is a pro.

but it also adds potential complexity from a compliance standpoint, which can be a negative. A lot of times when I get involved and take a look at some of the partnership returns that are done by some of the smaller tax firms, they are lacking in any kind of balance sheet at all. Is that a red flag? Is that a concern? So there is, if the entity is small enough, you can actually be exempt from including a balance sheet on your partnership return.

That said, I still encourage keeping a balance sheet internally so you know where you stand. And if you reach that point where you have to report a balance sheet, know, trying to make one up on the fly can be very difficult if you’re not tracking that. But if the entity is required because of its size, the amount of gross receipts or assets that it has, then yeah, that would certainly be a red flag. And I’ve seen some, you mentioned, you know, smaller operations. Occasionally I’ll see one where the balance sheet’s not even in balance. And, you know, if you see something like that, then that’s definitely, that’s something that’s going to easily be picked up by, you know, an IRS.

Ted (43:32.869)

you know, computer scanning software as a red flag. And that I seem to recall a $250,000 number. Is that is that gross income? Yes, I believe so. OK, income and total assets, I believe a million. Don’t quote me on that. I always have to look those were most of mine fall above that. So I always have to look up those rules if I have a smaller operation. But I believe that’s those are the numbers.

So, yeah, I would just encourage a lot of folks to have a conversation with their tax advisor with respect to if they’re doing a 1065 partnership return. Just ask who’s maintaining the balance sheet. Somebody’s got to track assets because you’re going to need that information sooner than later. And I’ll say just one final note on that. Another reason I don’t know those numbers off the top of my head is

Generally speaking, even if we have a smaller operation that is eligible for that, we still typically report a balance sheet on their tax return. That makes sense to me. Unfortunately, I see a lot of the smaller tax firms not doing that as a way to reduce the costs associated with the tax return. But I always worry when I meet a farmer and I ask him how much they’re paying for their tax return and they tell me a few hundred bucks, I said, boy, we’re going to have some issues here. I can always tell.

You know one of the things that I would encourage everybody to do is make sure that their tax returns are done properly the last The last organization you ever want to get in a fight with whether you’re a farmer or other small business owners You’d never want to get a fight with the IRS. You’re rarely gonna win that fight. I’m very painful What’s that? Even if you do win that fight, it’s still a painful process. Yeah and an expensive process, correct. Okay, so

I think we’ve covered the gamut of corporations, both C-Corp, S-Corp. We’ve talked a little bit about partnerships and we’ve talked about there being really no good reason to be a general partnership. Do you see situations where a farm family might have multiple entities taxed differently? Yes, we actually see that all the time. Tell me what would be the common arrangement that you would see?

Ted (45:47.886)

So I can tell you common arrangement that kind of hits hits all the buckets we’ve discussed is we’ll see an operation that maybe the operation itself is in an S corp to take advantage of those self-employment benefits, self-employment tax benefits. You have a separate land holding LLC that actually holds all the real property, the land. You should just farming and then we have a lot of operations that run a say, you know, they have their own trucking operation and a lot of times we’ll see that sitting in a C quarter.

So you could have, you know, one enterprise operating with all three of those structures. And that’s, that’s pretty common arrangement that we see. Now, why do you particularly see the trucking arrangement pulled into a C-Corp? So I would defer to you on that, but generally speaking, there’s liability reasons for that to keep it all contained within the corp. Keep every, keep the trucks.

As you’re aware, there’s a lot of liability associated with trucks. So the more we can keep that separate from everything else and not have any commingling, the better. So generally speaking, that’s what we What about the tax issue? Whether that be taxed a partnership, a C-Corp or an S-Corp, is there anything particular that suggests that a trucking operation should be owned by a C-Corp?

Not that I’m aware of and full disclosure, typically in our operations we have a separate team handling the trucking side of things. We have a trucking group and an agriculture group. So generally I would be managing the agricultural side, the farm operation and the land and we have a separate team that would handle the trucking. there may be a tax reason for that, but I’m definitely not a trucking expert. But as far as I know, liability tends to be the biggest reason you want to have that separate. And C-Corp is a common structure that’s chosen for those trucking entities.

Hey, one thing that I forgot to ask you in terms of the employee benefits that are payable from a C Corp to an S Corp. I think an S Corp is probably a little more limited. What can’t you not pay out of an S Corp that you could out of a C Corp? Anything you can think of? me there. Off the top of my head, can’t really think of any. There probably is something, but I can’t really think of anything off the top of my head. Okay, very good. If you do me a favor, if you come up with something in that regard, shoot me an email, would you? Sure. Yep. Well, boy, Bill, we’ve…

Ted (47:52.075)

covered the gamut here. We’ve covered a lot of information. I would love to go for another hour to talk about succession planning and lifetime gifting and all those, maybe on another podcast, we can drill down on that. But, uh, I probably have overextended my time here, but I think this has been very valuable and very useful. really enjoyed the conversation. Great. Well, thanks for having me on. was a pleasure. Thanks Bill. Thank you.