Getting your farm entity right: A practical checklist

Setting up your farm entity can feel overwhelming. How do you navigate it all and make sure nothing falls through the cracks?

In this episode of Straight Talk with NDFB, the Harvesting Legal Knowledge series continues with NDFB Executive Vice President and CEO Jeffrey Missling and attorneys from Ohnstad Twichell Law Firm.

The conversation focuses on what it takes to properly set up and structure a farm or ranch entity — and why getting it right from the beginning matters. From tax liability and paperwork to meeting minutes and written agreements, the discussion highlights the key details that are often overlooked but essential to protecting the operation.

Ohnstad Twichell attorneys Casey Drege and Marshall McCullough walk through a practical checklist and planning considerations for farmers and ranchers forming or updating their business structures, emphasizing the importance of clear documentation and intentional planning.

Links 

Harvesting Legal Knowledge

Contact us at emmery@ndfb.org

The statements made and information provided in this podcast are for educational and informational purposes only. The statements do not constitute legal advice, nor are they intended to create an attorney-client relationship. Every situation is unique, so you should not rely on any statements in this podcast as a substitute for personalized legal counsel. Before taking action or making any decisions which may affect your legal rights and obligations, you should consult with an attorney licensed in your jurisdiction.

Transcript

[Straight Talk theme]

[00:11] Emmery Mehlhoff: Setting up your farm entity can feel overwhelming. Tax liability, paperwork, meeting minutes, it's a lot. So how do you navigate it all and make sure nothing falls through the cracks? 

Welcome to Straight Talk with NDFB. I am your host, Emmery Mehlhoff. Farming and ranching are tough businesses, and legal issues can just complicate things. That's why this season features Harvesting Legal Knowledge, a conversation between NDFB and the Ohnstad Twichell law firm. NDFB CEO Jeff Missling and the attorneys at Ohnstad Twichell break down key legal topics impacting farmers, ranchers, and ag businesses every day. Today, our attorneys walk through a practical checklist and planning tips to help you get your farming or ranching entity right from the start. As always, if you have a specific, specific legal question, be sure to consult an attorney who can address your situation. Let's get into this episode.

[01:06 Straight Talk stinger]


[01:11] Jeffrey Missling: Welcome to a series that we're calling Harvesting Legal Knowledge. I'm your host, Jeff Missling, Executive Vice President and CEO from North Dakota Farm Bureau. And this is kind of a collaboration between NDFB and Ohnstad Twichell Law Firm. So with us today, we have Casey Drege and Marshall McCullough. So welcome, gentlemen. 

[01:28] Marshall: Thank you.

[01:29] Casey: Thanks.

[01:30] Jeff: So once again, once an entity is created and has filed, what are some things that folks need to look out for as far as actual farm and ranch operations?

[01:42] Marshall: I think one of the biggest is, oral contracts are not good for anyone. Everything should be written down. If you're having a lease, whether it's with your parents or the neighbors or your cousins or a third party, you need a written contract. That way, if any issues come up, there's at least a document that shows what the original agreement was. So the kind essence is write it down. 

So in farming and ranching, what do we see? Cattle agreements, lease agreements, those type of issues. But it's best to have it written down. A lot of times we'll see where a parent wants to sell their assets to their son, daughter, whoever's farming it will create a significant tax consequence of depreciation recapture when you sell the machinery and equipment. So they just want to lease it to the farming heir, saying they can lease it for 10 years, and at the end of 10 years, it's theirs. They've in essence, paid for it. 

Well, the IRS is very careful to look at what's called an operating lease or versus what's called a capital lease. So capital leases, if the equipment's worth $100,000 and you pay me $10,000 a year for 10 years and it's your lease, you really bought it, you didn't lease it, and you're going to have depreciation, recapture and some tax consequences, as opposed to an operating lease where you just pay a fair market value rent, but then at the end of the lease, you're going to have to buy it out at fair market value. If you do the operating lease and the intent is the farming heir receive the assets, then once again, you have to coordinate with your will in case something happens during the lease. So that the one that's kind of leasing the property knows what's going to happen if you pass away unexpectedly. 

So there's an operating lease issue, a capital lease issue. And again, you have to coordinate the type of assets or the type of documents that you have. 

Um, we've seen where simple 50-50 ownership, maybe two brothers, maybe father, farming heir, own property, 50-50. If there's a fight and they can no longer farm together, what's going to happen to that equipment? So there are agreements that you can write ahead of time as to who would get which pool of assets. 

I have some farmers that they farm together, two brothers as a partnership. They own their land individually, 50-50 in each of their names. If one of them passes away, we have an agreement that basically they'll flip a coin. The estate will get pool A assets, the survivor will get the pool B assets, and they set new values each year, depending on land values, and maybe readjust the pools. But it's a way to address it so their spouses and their children don't have to fight about those issues down the road. So again, it's what type of agreement, what's going to happen down the road kind of operationally that we look at.

[04:46] Casey: Yeah, I think with any business we talk a lot about, down the road, like Marshall is talking about. Marshall also just kind of brought up oral contracts. They may technically be legally binding, but if we don't have evidence of that, it's, it's going to cause a fight. 

And the unfortunate reality of it is families do fight. And when we start hitting these large sums of money, these, you know, a lot of land, families, families fight over this stuff. So the best thing we can do up front is have written contracts and have governing documents that lay out how we handle this issue versus that issue. Um, so that is something we, we work through with a lot of clients as far as, you know, death, disability, divorce, those are definitely the big three. But there's a lot of other things that come into play.

[05:40] Jeff: Anything else on the operation, specific side of things, gentlemen. Or if not, we'll move on to documentation, I guess, and talk about a little bit about what do families need and how often are they reviewing or updating, like your governance documents?

[05:56] Casey: Yeah, governance documents. They're kind of boring to look at. There are a lot of, a lot of things you read in them, kind of, you think, we're not going to use this. Why are we even including this? But again, we're thinking 10 years in the future, 20 years in the future, we want to be updating those. 

I mean, we like to say annually. The reality is a lot of people aren't doing that, but we'll probably try to, you know, bug you and get you to update those or at least review them a lot of times, wha we tell clients as well, especially when we have some of these farming entities that are, that are carrying on for decades. If the operating agreement or the governing documents don't work for you right now, well, let's get together and we can amend them, we can change them so they do work for, you know, what your operations look like today. So. And you don't want to be stuck with something that was written 15 years ago that no longer applies. So any type of change, families growing, the land is growing, anything like that, we want to, we want to sit down and say, you know, do these documents still work for us today?

[06:59] Marshall: Yeah, I think I'd just add on the documentation. A lot of the clients, if they're a single member or a one shareholder corporation, don't want to do the annual corporate minutes, the annual shareholder minutes, board of director minutes. They say it's just me. But it's even, it's important even if you're a sole shareholder, to do the documents. If you don't dot your I's and cross your T's, the IRS could ignore the entity and say, you're not following the corporate rules. We're going to treat you as though you're not a corporation. 

People ask me on the corporate minutes, I think it's number three on the checklist when I was a CPA that they want to see your last three year corporate minutes. So when you come in for an IRS audit, they're going to look at the returns, your articles of incorporation, they're going to want to see your bylaws and they want to make sure you're dotting your I's and crossing your T's. And part of that is doing those corporate minutes. And I know you can say, I'm the president, I'm the vice president I'm the secretary, I'm the treasurer. It doesn't matter. But it does when you come under audit with the IRS. So it's important to have those done and done timely. 

I think Casey mentioned things becoming outdated. A lot of buy-sell agreements provide that the shareholders will set a price for the stock annually, maybe semiannually, depending on changes. But if you don't set a price for five or 10 years and that's outdated, what's going to happen? A lot of buy-sells have a formula price that will come into play if you don't set one. But that formula also needs to be reviewed. Like say you look at the value of machinery, look at value of equipment, you look at the value of land. There are a lot of issues that the those numbers, once they're outdated, will not have the effect that you want with the buy-sell. 

I've had some clients that just use a trade name with no supporting documents between them. Maybe their siblings, maybe their cousins. Is that a partnership? The rules for the IRS is an association of two or more individuals that carry on a business as co-owners for profit. Can we argue you really are a partnership? Or if you're a partnership, why aren't you filing a partnership tax return? So there are different rules there. If it comes to leasing of equipment and you're going to split up if the lease is only in one person's name, not the other, but it's showing 50-50 on your depreciation list, who owns that, how is that going to be treated? 

So having documentation, just the leases with an entity, again, what are the values, what's being leased, what's happening? So we want to be very careful and I think the last one, we had a question earlier about the common Paymaster rules. If you have two related corporations and you're sharing employees, maybe they're doing trucking for the LLC, but they're also working on the farm driving machinery and equipment. One of the entities can pay them and be responsible for all the payroll taxes, the withholding taxes. But withholding taxes are a personal liability. Even if you're incorporated, the individual shareholders or anyone that can sign on the checkbook is personally responsible for those. 

So if the other entity does not withhold and you're under common Paymaster, you're personally responsible for those unpaid taxes. So again, related entities shouldn't be an issue. But if you have different people in the two entities that could come up, you need to document the that agreement so you aren't paying someone else's tax liability.

[10:41] Emmery: So how do you navigate tax liability?

[10:45] Jeff: Speaking of tax liability, we kind of want to close with a segment here in regard to taxation and maybe talk through with us a little bit, Marshall, the issues to consider when forming an entity. And then what are some of the either the tax benefits or maybe the consequences in having formed it.

[11:03] Marshall: Well, I think first, whenever you discuss the taxation, it's nice to get together in kind of a group, both with the attorney and with the CPA and then with the family members that are involved. 

The CPAs will know the business from the tax standpoint. The attorneys know more from the legal responsibility standpoint. 

But you know, when you're setting up a corporation, they're easy to create. They're at a lower tax rate when in operations than an individual. But there are some real issues with the corporation that you have to look at. One, whenever you take assets out of the corporation, it's treated as though the corporation sold it. So you're going to have depreciation, recapture and ordinary income. 

So if you put a piece of equipment into a corporation, now you want to take it out, even though you own 100% of the corporation and you're putting it in your personal name, you will have a tax consequence when you take that out. 

If you liquidate the corporation, you'd have a tax consequence both in the corporation and to you individually. So one of the negatives about a corporation is often known as double taxation. So once in the corporate level and then again at the individual level. So unless you're going to pass a corporation on to future generations, there's a lot of tax planning that has to go into how are you going to liquidate that entity in the most tax advantageous manner. 

Other than corporations, there are the pass through entities, a partnership, an LLC taxed as a partnership, or what's called a Subchapter S Corporation. Those entities do not pay any income tax, but the income flows through to the individual owners and that can create issues, what we call phantom income. 

So if your entity had gross income of, let's say $100,000, you have tax deductible expenses of $70,000. So you have a taxable income of $30,000. If there are three owners that are equal, that comes out $10,000 to each owner. And they have to pay the income tax on that money even though they didn't receive the cash. The cash could have remained in the entity. It could be used for buying more equipment, maybe saving up for a rainy day fund. A lot of reasons that could be in there. 

But this phantom income can cause problems when you're getting what's called a Schedule K1 out of the entity saying you need to pay tax and the entity has not distributed the fund. So it's kind of taxation without the cash is what we look at. So again, you have to be aware of that. 

Some documents put in that the entity will distribute at least 20% of the net income figure to at least help take some of the bite out of the tax rate that you are in. Also in a corporation there are no capital gains rates. When you think as an individual and you have investments, you have a lower capital gain rate but a higher rate on ordinary income. In a corporation, if you're holding liquid investments, maybe you've sold some assets and you're on cash and you think you're going to get a capital gains rate, you're not. Everything's taxed at the corporate rate. 

So there's some issues there. We have to look at again what the plans are for the entity down the road. For a few years now, there's no like kind exchange for equipment. So when you trade in some equipment, get new equipment, technically you have a gain on what you traded in. It's probably been fully depreciated. So you're going to have some gain if you're not replacing it. You could be stuck with that gain. If you replace it, I think the new big Beautiful bill extended the Section 179 expensing and the bonus depreciation expensing. So hopefully with the depreciation you can use that to offset the new purchase. 

But again, if you're getting out, you're not going to replace that machinery and equipment, then you're going to have some tax issues. 

I think the last one there were some issues I've seen with kind of using a limited partnership or a limited liability partnership as we've done, where distributions to a limited partner or a limited liability partner are not subject to self-employment tax. So if you're just a general partnership, but you have some people that really aren't involved in the operations and they're willing just to be a limited partner, we can save some self-employment tax by converting that entity as well. 

So again, there are a lot of different tax components that go into each specific entity. We don't have time to go through the entire tax code today. thankfully.

[15:54] Jeff: Thankfully! (everyone laughs) Thank you for your time, gentlemen. Anything we missed at all? I guess any of the subject matter that we covered here?

[16:00] Casey: No, but parting words. Document everything. I think.

[16:03] Marshall: Yeah, I would say document everything. And we were speaking a little earlier. I think the artificial intelligence and what you can do on your own will be greatly enhanced going forward. But you don't know what you don't know, and that can cause some issues down the road. So it's still very much worthwhile at this point to have some experts involved from the beginning to get you set up correctly.

[16:31] Jeff: Yeah, great, great comments. Casey Marshall, thank you so much for your time.

[16:37] Straight Talk stinger

[16:38] Emmery: You've been listening to Straight Talk with NDFB, our Harvesting Legal Knowledge Season. To watch the entire interview with Jeff and Ohnstad Twichell, please click the link below. If you have any questions, contact us at emmery@ndfb.org.

[Straight Talk theme]