Tax advantages of LLCs in farm operations.

AuthorShrader, Dwight
PositionLimited liability companies

The use of limited liability companies (LLCs) to own real estate used by farm operations provides self-employed farmers with significant opportunities to save taxes. Specifically, the use of passthrough entities in tax planning for self-employed individuals provides opportunities for (but not limited to) lowering self-employment (SE) tax; limiting personal liability; estate planning; and preserving Social Security benefits.

Example: A farmer, F, is currently filing Schedule F and reporting a $50,000 net farm profit. The farm consists of land and fully depreciated outbuildings, and has incurred a reasonable debt load that could be attributable to operating capital. F forms an LLC with (at least) two members and transfers the real estate to it, which begins to charge F rent for use of the real estate. Further, the lease is a triple net lease; the farm operation will continue to bear the real estate tax, insurance and cost of minor repairs. The fair market value (FMV) of the real estate approximates $500,000, with a reasonable annual rent of $40,000.

F has effectively transferred $40,000 of SE income from Schedule F to passive income reported on Schedule E, and reduced his SE tax by $5,652. The decrease in SE tax will decrease the deduction from adjusted gross income of 50% of the SE tax, thereby increasing income tax by approximately $600 (depending on F's specific incremental tax rate). If F uses some of the tax savings to purchase an individual retirement account (IRA) or a simplified employee pension-IRA; the increase in income tax is mitigated and he has secured a source of future retirement benefits to replace those lost from the reduction in future Social Security benefits.

Another benefit of this plan is that, if F is between ages 63 and 70 and receiving Social Security benefits, the lower farm income may not exceed the earnings limit (SE earnings test) that can trigger repayment of Social Security benefits. The potential savings of Social Security benefits could exceed the savings from the SE tax. Together, they provide the older farmer with an excellent tax savings opportunity.

This course of action, however, may have adverse consequences. For example, if a farmer transfers relatively new buildings (with depreciation expense) and significant acquisition debt (with related interest expense) to an LLC, a net rental loss may be created, while simultaneously increasing farm profit. In addition, young farmers with families will want to...

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