According to the last Census of Agriculture, about 87% of farms in Ohio are sole proprietorships. This means that the vast majority of farms have no formal business structure. However, we often hear of the need to have a business entity for liability protection, taxes or for a variety of other reasons. So, how do you know if you need a business entity.
Like most legal answers, it depends. LLCs and corporations can help with liability protection. These entities prevent the owners from having personal liability for the acts of the entity or anyone acting on behalf of the entity. For example, if an employee of an LLC causes an accident driving equipment on a roadway, the owners of the LLC will not usually be personally liable. The assets in the LLC are at risk but not the other assets outside of the LLC.
While LLCs do provide liability protection, they are no substitute for liability insurance. The most important liability risk management strategy should always be a good liability insurance policy. LLCs and corporations are good backup plans if the insurance policy does not cover the liability in some way. Therefore, business entities can help with liability protection, but they are not a necessity like insurance. Generally, the more owners and employees a business has, the more liability protection benefit an LLC or corporation will provide.
Business entities are often more valuable as a succession planning tool than they are for liability protection. For example, land that is or will be owned by multiple family members is subject to the risks of partition. Partition is the process where a co-owner of land forces the land to be sold as a way of “cashing out” their ownership in the land. Land held in business entities is not subject to partition. Those who own land with other people should strongly consider an LLC or other entity to protect against partition.
Business entities can be tax management tools as well. For example, a sole proprietorship can only file taxes as a sole proprietor on a Schedule F or Schedule C. That same sole proprietorship can convert to an S-Corp which often reduces self-employment tax liability. Farm and business owners who seek the best fringe benefits such as health insurance and retirement benefits may want to be taxed as a C-Corp. As these examples illustrate, business entities can provide tax management options that sole proprietorships do not.
Business entities do have several disadvantages. One is the cost of establishing the entity. The cost depends on the number of owners, the assets that will be put into the LLC and the terms of the governing document. Establishing an entity can cost several thousand dollars or more in legal fees. Another disadvantage is managing the entity. Each entity will need its own bank account, accounting, and tax return. If an entity is not properly managed, it may not provide the expected liability protection or tax structure.
Liability management, succession planning and tax management are just a few of the many factors that should be considered when deciding if a business entity is worthwhile. The best course of action is to meet with your attorney and accountant to assess the benefit that a business entity may have for your farm or business. If the benefits outweigh the disadvantages, then you should strongly consider establishing a business entity. If benefits do not outweigh the disadvantages, you may not need an entity and that is OK. Many successful businesses are sole proprietorships and yours can be as well.