If you have been following the blog you have likely seen our business entities series or perhaps even my and Paul’s publication on business organizations. After forming a business entity with your farm operation, you may want to consider developing an operating agreement, if there is more than one member in that organization. For example, if Ma and Pa and Son and Daughter are all owners of the farm limited liability company (LLC), an operating agreement would help protect all ownership interests and lay out details not addressed in the paperwork filled out for the state. Today’s post will briefly go over what an LLC operating agreement is and why it may be something to consider for your own agriculture operation.
What Is An Operating Agreement and What Does It Do?
When you form a limited liability company in Maryland, you are not required to have an operating agreement. Such agreements are highly advisable, however, and many other states actually require that LLCs have them. With that said, let’s get to the real beef of our discussion today. An operating agreement is an agreement among all members of the LLC governing the financial, managerial, and dissolution rights and duties of each member. The main purpose of this document is to structure the internal operations of the business in a way that suits the specific needs of the business owners. Once the document is signed by all LLC members, it acts as an official contract binding them to its terms.
For example, if Susie and Paul, brother and sister, both own the farm under an LLC but Susie lives in downtown Chicago and works as a nurse while Paul lives on the farm in Oklahoma, their operating agreement may state that Paul makes all business decisions while Susie has no decision-making power. Another important part of the operating agreement is the ability to avoid state default rules governing LLCs when they do not have an official operating agreement or for the purpose of farm transitions. For example, operating agreements can help transfer interest in the event of a member choosing to leave or in the event of a death. The operating agreement may state who, how, and why a buyout or buy-sell options are necessary or required. This can save a lot of pain and heartache when unfortunate situations occur under a farm LLC.
Other items which may be included in an operating agreement are, but are not limited to:
· Percentage of members’ ownership
· Voting rights and responsibilities
· Powers and duties of members and managers
· Distribution of profits and losses
· Statement of when and how to hold meetings
· Dissolution options
Today’s post is not to be considered legal advice but simply a piece of education to use in the forming of your business organization. If you have further questions about business entities or operating agreements, feel free to email me at mailto:firstname.lastname@example.org
Utilizing a variety of financial tools and estate planning techniques, a family may significantly mitigate the estate tax and minimize transfer costs.
Q: Should we establish an LLC for our family farming business? We’ve spent our entire adult lives building a diversified farming and ranching operation. Now in our mid-70s, it’s time to make a plan for passing it to the next generation. Though none of our children are active in the farming business, we’d still like them to share in it equally and maintain the home place without the burden of an estate tax or other costly transfer obligations. In other words, is an LLC is the best way to pass our property to the next generation without losing it due to the death tax?
A: A limited liability company (LLC) is an excellent tool for holding and managing properties. An LLC allows for shared ownership, clearly defined management structure and, as the name implies, liability limited to the assets of the company. An LLC also allows for shared, yet disproportionate ownership percentages among an owner group, i.e.: so, though you mention equal, your children do not necessarily have to receive or maintain equal shares.
For your situation and based on your brief description, an LLC may be an excellent entity choice for managing the family farm.
• You may leave membership shares (ownership interests in an LLC) to your children in your trust/will.
• The LLC agreement should specify how to manage the entity, make decisions, add members, or allow for withdrawal.
• Allow your children to co-manage the property, lease the land, acquire additional property, etc., according to a written operating agreement.
An LLC alone will not help you avoid the estate tax. However, you may decrease the value of the properties and thereby reduce the estate tax through valuation discounts using an LLC.
Two discounts are commonly used in estate planning. One is for a lack of control and the other is for a lack of marketability. Assuming you establish some form of divided ownership in which no single person has a majority or controlling interest, each owner’s separate interest may be appropriately discounted.
So, an LLC may allow you to better manage the property and at the same time mitigate the estate tax by discounting the property value. But these advantages are accompanied by some disadvantages, including record-keeping and income tax planning. Your children will have to keep both financial and property management records. They’ll have to account for the entity separately and include their share of expenses/income in their personal tax return.
Before committing to an LLC, and in an effort to fully achieve your goals, I recommend a comprehensive succession plan. There are four steps to completing a plan, attaining financial security, and creating a lasting legacy:
Financial Security – Securing the owner’s financial future and determining the best course of action for passing the family business to the next generation. The plan will include retirement planning, debt satisfaction, diversified investing, and contingency planning.
Ownership Transition – Combining financial, tax, and estate planning strategies to design the most effective transfer of family business ownership to the next generation, including researching the best financing methods, gifting strategies, buy-sell provisions, and business entity review (which is where the LLC discussion may take place).
Leadership Development – Structuring business management and preparing family business leaders to govern as business ownership and management transition to the next generation. Leadership will explore the best structure to manage the entity, define roles/responsibilities, spell out compensation/benefits, and may use assessments for leader selection.
Estate Tax Strategies – Planning to mitigate the estate tax and efficiently transfer ownership, while providing for dependents due to the death of a family business owner. This is another point in the process where the entity structure will be reviewed and altered if necessary. Estate tax strategies are designed to mitigate tax burden, define distributions to heirs, satisfy any outstanding obligations, and provide for your dependent’s lifestyle.
Success in the planning process is predicated on good communication and common goals. The entire design is to help the owners pass the family farm, ranch, or agribusiness, as a going concern, to a well-prepared next generation.
Kevin Spafford and his firm Legacy by Design (Legacy-by-Design.com) serve the succession planning needs of farmers, ranchers, and agribusiness owners. Reach Kevin by email ([email protected]) or phone (877) 523-7411.