There are three forms of legal entities that farmers typically choose for their business: sole proprietorship, partnership, or limited liability company. In addition to the for-profit entities, a farm may choose to be a nonprofit corporation. There are a number of excellent resources available online, in your public library, and via your networks and associations. The purpose of this post is to introduce you to the possible legal entities for your business, to help you begin to think about which one is right for you, and to provide you with a few resources to get you started. Please note that each state has its own filing requirements. This article is based primarily on the requirements for filing in Massachusetts.
Before you continue reading, please note that the information contained in this presentation does not constitute legal advice and is not a substitute for the professional judgment of an attorney as applied to your particular situation. You should consult an attorney and/or accountant for individual assistance.
Basic Summary of For-Profit Legal Entities
This is the most common and easiest form of ownership structure, if only one person is involved. As a sole proprietor, you do not need to register with the state or file any special papers to set up a sole proprietorship. If you do business under a name other than your own name, you will need to file a doing business as “d/b/a” certificate with your town. The cost varies by town. It is wise to speak with your town hall before doing business, as there may be additional local registration requirements. The business and owner of a sole proprietorship are the same. You are personally liable for any business-related obligations and you report business income and losses on your own personal tax return. The self-employment tax (contributions to social security and Medicare) rate for 2012 is 15.3%. A sole proprietorship is generally not advisable for businesses that are at high risk of liability, even if insurance is purchased. This is particularly relevant to farms that sell their goods to the public, have employees, and are open to the public.
A general partnership consists of two or more people. You do not need to file paperwork with the state to become a partnership. It is suggested that the partners enter into an agreement detailing the partnership arrangement. See this link for suggestions as to what to include in the partnership agreement: http://www.nolo.com/legal-encyclopedia/creating-partnership-agreement-29906.html. Each partner pays his or her shares of the business income on his or her personal tax returns and each partner is personally liable for the entire amount of any business-obligations. As with a sole proprietorship, a general partnership is generally not advisable because it does not limit liability.
Limited Liability Partnerships (LLP)
An LLP protects the owners’ personal liability from claims against the business. Professionals, such as lawyers and accountants prefer LLPs so that each partner is not personally liable for another partner’s malpractice or other claims. Forming an LLP requires filing with the state and a fee.
An LLC protects the owners’ personal liability from claims against the business. Unlike a corporation, profits and losses pass through the business to the owners, who report them on their personal tax returns (similar to a partnership or sole proprietor). However, the LLC must file an informational tax return with the IRS each year. Also, it is important for owners of an LLC to treat it as a separate business entity to avoid personal liability. Forming an LLC requires filing with the state and a fee.
A corporation protects the owners’ personal assets from creditors of the corporation. It is important for the owners to treat the corporation as a separate business entity to avoid personal liability. Observing corporate formalities typically includes holding annual or other regular meetings, providing written notice thereof, preparing minutes, and more. The corporation pays taxes on profits after paying out salaries and expenses. The owner and other employees report and pay taxes on their income through their personal tax returns. Alternatively, if an S Corporation is elected, the corporation will be treated like a partnership or LLC, such that business profit and losses pass through the corporation and are reported on the owners’ individual tax returns. The IRS allows the corporation to leave profits in the corporation up to a limit (i.e. to fund future expansion) without taxing those profits, thus the corporation receives a tax advantage as compared to sole proprietors, partnerships, and LLCs -- all of whom must pay taxes on all business profits, whether they retain the profits in the business or not. Forming a corporation requires filing with the state and a fee, and annual filings once incorporated.
Basic Summary of the Nonprofit Legal Entity
A nonprofit entity may be formed under state law and federal law. If formed as a corporation under state law, the entity assumes the following characteristics: no stock is issued; no income is distributed to members, directors, or officers; organized and operated exclusively for a charitable purpose (applies to 501(c)(3)); and upon dissolution, assets must be distributed to another charitable organization or governmental entity for a public purpose. A nonprofit, however, may conduct business to further its charitable purpose and generate revenue. But, that revenue may not be distributed to as profits to its members, directors, and/or officers (such as would be the case with a for-profit corporation). To incorporate in Massachusetts, an organization must file with the state and pay a fee of $35. Annual filings with the state are also required. Additional filings with the Massachusetts Attorney General’s office may be required if the organization plans to solicit funds from the public. Nonprofits intending to operate as an organization exempt from taxation by the federal government and serve a charitable purpose will likely be defined by the Internal Revenue Code section 501(c)(3). A nonprofit organization may apply, by filing a Form 1023, to the Internal Revenue Service to receive federal tax exemption status. State tax exemptions may also be available.
Steps to Start a Business in Massachusetts: This guide provides the requirements for starting a business in the Commonwealth, including:
- Choosing a legal entity
- Choosing a Name
- Filing with the Commonwealth
- Filing a Business Certificate
- Obtaining an Tax ID or EIN
- Registering with the Department of Revenue
Registering as a Massachusetts Nonprofit Corporation:
National Agricultural Law Center (see “An Overview of Organizational and Ownership Options Available to Agricultural Enterprises” by Carol R. Goforth). This two-part article provides a comprehensive analysis of the different organizational choices available to agricultural business owners, including sole proprietorships, general partnerships, limited liability partnerships, limited partnerships, limited liability partnerships, limited liability companies, corporations, and cooperatives. The article also includes practical formation tips, such as a list of suggested substantive provisions that might be included in a partnership agreement (see part I, page 30).
Beginning Farmers Online. Not only does this resource summarize a few of the legal entities, including S-Corps and C-Corps, it also offers links to a number of other resources and articles.
Agricultural Marketing Resource Center. This article links to a number of resources, including NOLO Law for All, which is a great resource for free legal information.
After you take a look at these resources, be sure to check for the specific requirements in your state and local community. Becoming familiar with the federal, state, and local laws governing your farm business will help you stay out of trouble in the future.
Heidi Alexander, Esq. is a solo practitioner who counsels new and existing for-profit and nonprofit businesses, and practices Internet law. She also owns a web consulting practice. Heidi may be contacted at Heidi@heidialexanderlaw.com or 617-299-0459. You can find her at www.heidialexanderlaw.com and www.alexanderwebconsulting.com.