Attorney John Sexton attended the Iowa State University Center for Agricultural Law and Taxation Summer Seminar on Agricultural Tax, Business & Transition Planning. Multiple attorneys spoke on the economic issues surrounding the agriculture community today. They also discussed how to best pass on family farm estates to future generations.
C Corporations for Family Farms
During the 1970s, Professor Neil Harl from Iowa State University advocated the creation of C corporations as the proper entity for farm operations. A great deal of experts now believe many of the advantages associated with incorporating in the 1970s are no longer prevalent today. Additionally, the double taxation feature of corporations results in an inefficient way to run the farm operations. Many clients now ask the question of whether it is possible to get out of the C corporation structure without incurring severe income tax consequences. The good news is that it is possible, but the bad news is that somebody must die.
Liquidating a C Corporation
What is the proper method of liquidating a C corporation farm? First: the farmer needs to convert the C corporation to an S corporation. Second: wait 5 years to avoid the built-in gains tax of IRC Section 1374. Third: wait for the death of a shareholder.
Ideally, all of the stock should be gifted to the parent with the shorter life expectancy. When that parent passes, the stock basis will get the stepped-up basis on the value of the farmland. The owner should now sell all assets of the corporation and liquidate the corporation in the same year as the parent’s death.
The estate (now the sole shareholder) recognizes capital gain of the amount of the value of the farmland at the time of death over the original basis amount. This gain also increases the basis of the stock which corresponds to the initial step up in basis for the value of the farmland. The corporation would then redeem the stock in liquidation. This would allow the estate to recognize a capital loss in the same amount as the initial capital gain. The beneficiaries would then receive the corporation’s land at the full stepped up basis.
Continuing the Family Farm
In the simplest form, the beneficiaries can divide the land equally and distribute it. Another option to consider is the parents can create a limited liability company. They would then distribute the membership interests to the children. The parents must take care in drafting the agreement if they wish to have certain family members continue to farm the land without the intervention of others. The on-farm heir should be elected as the manager of the limited liability company. Removal of the manager would then require unanimous consent. The off-farm heirs would receive their portion as rental income.
I commonly see a lack of exit plans for the beneficiaries of a family farm corporation or limited liability company. The operating agreement needs to be detailed in describing triggering events and purchase price.
Farms have constantly continued to increase in size. This leaves the running of large farms under the purview of a C corporation or limited liability company to the children. Fiduciary duties arise out of these business entity structures. We have successfully brought derivative suits when minority shareholders are victims of breaches of fiduciary duties by directors and officers. Beneficiaries should be mindful they are still running a business even if it is just with family.
A recent Wall Street Journal article discussed the economic difficulties facing the typical family farmer today. The article said that farmers currently file for Chapter 12 bankruptcy protection at the highest levels in 10 years. If you are a family farmer facing difficult financial situations, contact Attorney Ron Martin to discuss debt restructuring and Chapter 12 bankruptcy options. Additionally, contact Attorney John Sexton if you would like to discuss efficiently passing on your agriculture business to the next generation or if you are a beneficiary of an estate plan gone wrong.