Family farms, more than ever before, have been transitioning from generation to generation. In cases where the farm’s main goal is to continue operating for the foreseeable future, the structure of the farm business is vital.
Many farm disputes happen between different family members (siblings, parent and child) owning shares in the same corporation.
There are many business structures from which to choose. We believe family members having separate corporations sets both families and farm businesses up for success.
Disadvantages of family members owning shares in the same corporation include:
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- Difficulty in separating income and assets when an event occurs that requires the separation. Farm separations include events such as death, disability, divorce and disagreement. Separation of income or assets after one of these events is difficult. It is much better to do this when relationships are in good standing, with the original shareholders agreeing on a split.
Some concerns and issues that need to be resolved when death, disability, divorce or disagreements occur are:
- When a death occurs, family members are left to decide the fate of their ownership in the corporation. For example, if two siblings own shares in the same farm corporation, and one sibling passes away, does the deceased sibling have a documented plan for their family impacted by their death? What obligations does the corporation have to the estate of the deceased sibling for the value of the shares? Can the corporation afford to complete the obligation it has to the estate?
- When a family member becomes disabled, does the disabled family member have a power of attorney for financial or medical matters? Does the family of the disabled shareholder have the financial means to cover health-care costs and living expenses? Will the disabled shareholder’s family need to sell their share in the corporation? Will the corporation be able to fund a buyout of the disabled shareholder? Does the income split change if the non-disabled shareholder is suddenly doing all the work with no additional shares of the corporation?
- When a divorce or separation occurs, is there a prenuptial agreement in place? How will the shares be valued upon divorce? What impact will the divorce settlement have on the future of the shares in the corporation? How will the changes in finances impact the cash needs of the corporation? Will other family members have to fund a buyout just to keep the family farm from liquidating?
- Disagreements occur between shareholders. Sometimes, it escalates to the point of a split between shareholders. The split of the corporation can be costly and messy. Will the timeline of the corporation’s asset split process interfere with operations? Will legal counsel be required? Will a corporation’s split of assets impact the future viability of the farm’s operation?
- In cases of limited separation of decision making and compensation, no family is the same. They differ in areas such as living expenses, children, spouses and off-farm income. Disputes arise when some family members may want to pull money out of the corporation for personal purchases (new house, vehicles, etc.) while other family members want to reinvest the money in the corporation for growth or efficiency of the operation.
Advantages of family members having separate farm corporations include:
- Each corporation has its own small business deduction. Depending on the business structure, each corporation could use the low small business tax rate on the first $500,000 of taxable income. This can result in more after-tax funds to re-invest in the corporation, allowing for additional purchases or provide additional funds to compensate shareholders.
- Separation of decision making and compensation between family units. Each shareholder’s family has the ability to make decisions that are in their best interest without consulting siblings or parents. This includes decisions on compensation for their family, investments (in the corporation or personal), or equipment and land purchases within their respective corporations. Having to ask family members for permission to make decisions can easily result in disputes.
- Following an event (death, disability, divorce, disagreement), separation of a joint venture typically is easier than separating the assets of one corporation. With land, equipment and other assets already split between multiple corporations, if a split were to occur, each corporation is a separate entity with their own assets.
- Tax rules have recently loosened to allow certain qualified farm corporations to split assets into multiple corporations of family members without significant tax consequences. Performing the split of assets into multiple corporations while family members’ relationships are amicable is the best time to complete this process, since it has the best opportunity for success.
