Levi, Donald R.

Mallett, James I.

Prater, Tom E.

Texas A&M University

l- 1341
BUSINESS PLANNING FAMILY PLANNING
ESTATE PLANNING - EMPHASIS ON CORPORATIONS
Donald R. levi, James I. Mallett and Tom E. Prater*
Two of the more important aspects of estate
planning for farmers and ranchers are business
planning and family planning.
The business management facets of estate planning
include such items as (1) continuity of management,
(2) high-quality management, (3) continuous finan-
cial flow and (4) continuity of life of the business.
The form of business organization utilized - sole
proprietorship, partnership or corporation - may
decidedly affect the degree of success achieved in
both business and family planning. While these
three forms of bu iness organization are compared
in the brief chart at the end of this publication,
only corporations are presented in detail in the text
discussion.
OVERVIEW OF A CORPORATION
Of the forms of business organization available to
farmers, the corporation is probably one of the types
least understood. First of all, a corporation is a
creature of statute and cannot exist apart from the
law that gave it authority to exist. A corporation is
also a legal entity. It can acquire, hold and transfer
property in its own name. It can sue and be sued.
It can make contracts with its own owners as well
as with others. But it is not affected by the death,
withdrawal or disagreements of its members. And,
unlike a partnership, it does pay taxes. As will be
discussed later, it may be taxed in either of two
ways, depending on whether it is subject to either
subchapter C or S of the Internal Revenue Code.
Although a corporation is a legal entity, it does
not, however, have all of the rights, privileges and
obligations of an individual. For example, it cannot
vote except in some elections such as an irrigation
district where it votes as a member of the district
rather than as an individual. Even though a corpo-
ration cannot be imprisoned, this does not protect
its owners and officers from such treatment. A limit-
ing feature of a corporation, particularly as a
°Respectively, associate professor of agricultural law; Exten-
sion economist-community resource development project
leader; and Extension economist-management, The Texas
A&M University System.
farming venture, is that it cannot go freely from
state to state doing business in each state on the
same terms as the businesses in that state. A corpo-
ration must be registered in each state in which it
does business, and it must operate within the laws
of each state regulating such business.
The ownership interest in a corporation is repre-
sented by stock. This ownership may be transferred
by endorsing and delivering the stock certificate to
another entity. This is particularly helpful, for
example, where land is owned by the corporation.
The corporation holds title to the land. The indi-
viduals hold title to the corporate stock, and the
stock can thus be exchanged without reference to
any change in the ownership of the land.
If the ownership is widespread, the management
of a corporation can be concentrated in a relatively
few persons (such as an elected board of directors).
This may be advantageous in family situations
where certain members do not wish to participate
in the operation of the business but would still like
to retain some ownership, leaving the actual man-
agement to other members.
CORPORATE CHARACTERISTICS
It is hard to discuss corporations in terms of
advantages or disadvantages. What is a plus to one
family could well be a disadvantage to another.
Families face different circumstances. Though the
specific circumstances might differ, some of the more
common reasons for forming corporations are sum-
marized below:
1. Estate Planning. For an individual or group faced
with substantial federal estate taxes, incorporation may
be attractive. It is possible to lower the size of one's
estate for estate tax purposes by making lifetime trans-
fers of stock (shares) in the corporation. However, so
long as 51% of the voting stock is retained, the indi-
vidual or group has the power to control the manage-
ment of all corporate assets. Since the opportunity to
decrease estate taxes while retaining control is more
difficult to achieve with other fom1s of business organi-
zation, this is a major reason that many farms and
ranches are now incorporating.
2. Limited liability. That stockholders are not personally
liable for corporate debts and obligations is well known.
Only limited partners in a limited partnership share this
Texas Agricultural extension service • The Texas A&M University System • Daniel C. Pfannstlel, Director • College Station, Texas
Filing fees are determined by the state legislature.
Current rates are as follows:
(Note: A foreign corporation) as cited above, is any
corporation doing business in Texas that is fran-
chised in another state.)
The Articles of Incorporation must include (but
not be limited to), the following:
1. Name of the corporation.
2. Life of the corporation (may be perpetual).
3. Purpose or type of business to be conducted by the
corporation.
4. Total shares, class and par value of stock authorized.
5. Rights or privileges of incorporators or others to each
class of stock.
6. Statement as to date of starting business as a corpora-
tion.
7. Limit or pre-emptive right of incorporators or others
to treasury shares of stock.
8. Specific regulations of internal affairs of the corpora-
tion.
9. Name and address of the agent and office of the
corporation.
10. The number and name of initial directors.
11. Name and address of each incorporator.
OPERATIONAL PROCEDURES
The services of an attorney should always be
secured in creating and operating a corporation.
The following information describes the general
requirements and procedures for incorporating, fil-
ing fees and the franchise tax.
The general requirements include:
1. A minimum of three people over 18 years of age, at
least two of whom are Texas citizens, are required to
incorporate a Texas corporation, but one person may
own all corporate stock.
2. Articles of incorporation must be prepared and filed
with the Secretary of State, and the required filing fees
must be paid.
3. Thereafter, the Secretary of State will issue a certificate
of incorporation, indicating the creation of a valid
corporation.
4. After paying in the required capital minimum, the
corporation can commence business.
5. An organizational meeting must be called with at least
3 days' notice to the incorporators. The organizational
meeting must satisfy the following requirements:
• Be called by a majority of the incorporators.
• Adopt by-laws.
• Elect officers.
• Conduct other business as may be appropriate.
$100
$100
$200
$500
$100
$200
$ 10
$ 10
$ 10
$ 10
AmountFee
• Initial articles and certificate
• Amend articles
• Articles of merger or consolidation
• Foreign corporation certificate
• Amend foreign corporation certificate
• Restated articles
• Reserve corporation name
• Change of registered office or agent
• Cancellation or withdrawal of shares
• Reduction of capital or dissolution
distinction. However, the aspect of limited liability is
not very important to many farmers and ranchers be-
cause they have the vast majority of their assets in-
vested in their businesses. Limited liability is of pri-
mary importance when someone has extensive assets
in other areas (that is, outside of the business) which
they want to protect. Additionally, lenders may require
major farm and ranch stockholders to co-sign corporate
obligations. This practice effectively eliminates the pos-
sibility of limited liability.
3. Continuity of business life. A corporation may have
perpetual life. The death of a stockholder has no effect
on the life of the corporation, nor on its day-to-day
operation except as membership on the corporate board
of directors is changed. This situation is not true for
the sole proprietorship, and it is also more difficult to
achieve with a partnership.
4. Credit availability. If they are willing to pay the price
(interest rate), corporations may have more ready ac-
cess to capital than the other forms of business organi-
zation because they are not subject to state usury laws.
In addition, off-farm and off-ranch family members
may, in some cases, be encouraged to invest in the
farm business. These investments can be made either
by stock purchases or by loans.
But some lenders place limitations on loans to cor-
porate borrowers and, particularly in smaller farm and
ranch corporations, may require principal shareholders
to co-sign corporate obligations personally. Thus, before
incorporating, each individual should analyze and in-
vestigate how incorporation would affect his or her
ability to obtain both operating and real estate credit.
5. Retirement planning. A corporation can be used to
set up an attractive retirement for older family mem-
bers. This may be done through coordinating social
security, annuity and or "Keogh" plans, "baby group"
insurance purchases etc.
6. Minority-shareholder problems. Minority sharehold-
ers in a small family corporation may be "locked-in"
the business because outside investors may not be
interested in purchasing shares in a corporation in
which they will have no effective voice in manage-
ment. Thus, these minority stockholders may be unable
to get their money out of the farm or ranch business
to make desired investments elsewhere. This problc:m
may be somewhat alleviated by creating binding "buy-
sell" agreements designed to treat both majority and
minority shareholders equitably.
7. Red tape. Corporations must keep some records not
generally required of sole proprietorships and partner-
ships. These include recording the minutes of meetings
of shareholders and the board of directors. Of course,
to the extent that such records give additional informa-
tion to improve decision-making, they are a help rather
than a disadvantage.
Compliance with the corporate charter and the some-
what rigid state laws is necessary for a corporation.
Mergers, consolidations, reorganizations, issuance of
stock, etc. must follow legal rules and regulations.
8. Income taxes. Since most Texas farm and ranch cor-
porations have 10 or fewer shareholders, they have the
option of being taxed under either subchapter S or C
of the Internal Revenue Code, Incorporation not only
need not appreciably increase the firm's income tax bill,
but it can even decrease it in some cases. Income taxes
are discussed in more detail later.
9. Additional costs. Some costs are or may be higher with
the corporate firm - such as attorney's fees, annual
filing fees, franchise taxes, social security taxes and
fees for accounting services. These must be evaluated
in conjunction with the benefits of incorporating under
the individual's particular circumstances.
Every corporation doing business in Texas is
required to file annual reports and pay a franchise
tax to the State Comptroller for the period of May
1 each year through April 30 of the following year.
The franchise tax can be computed either on the
basis of taxable capital or by an optional method
based on total assets. The initial franchise tax must
be paid 90 days after the end of a year following
the date of filing its charter or of granting its cer-
tificate of authority, at which time the second year's
tax is paid in advance. Both the first and second
year's tax is based on the first year's business.
Since the francise tax may be substantial, it may
be high enough to lead some to decide against
incorporating the farm or ranch business. Space
prevents a full discussion of it here. However, for
a fuller discussion of this tax, refer to MP-l158,
Incorporating the Texas Family Farm or Ranch
Business, available at your local county Extension
office.
CORPORATION TAX CONSIDERATIONS
Most corporations are subject to the income tax
rules of subchapter C of the Internal Revenue
Code. Under these rules the corporate income tax
rates are 22% on the first $25,000 of ordinary (non-
long-term capital gain) corporate profits and 48%
on any additional ordinary income.! Deductions
are given to the corporations for salaries paid share-
holder-employees so long as they are reasonable
and are for work actually done. Such salary is, of
course, taxable for those who receive it. On the
other hand, dividends paid to shareholders are not
deductible to the corporation but are taxable to
receiving shareholders. Subchapter C corporate in-
come tax rules are also discussed in more detail in
MP-1158, Incorporating the Texas Family Farm or
Ranch Business, available at your local county
Extension office.
"Tax Option" Corporation
Incorporation under "tax option" or "subchap-
ter S" results in a corporate creation of federal in-
come tax law that allows small corporations to elect
lIn 1975 Congress amended this portion of the Internal Reve-
nue Code. It says the first $25,000 of corporate profit will
be taxed at 20 percent, the next $25,000 at 22 percent and
the rest at 48 percent. This has also been extended into 1976.
Another change was raising accumulated earnings credit
from $100,000 to $150,000. This may be changed by future
legislation.
to be taxed in a manner similar to partnerships,
provided the corporation meets all of the following
conditions:
Has only one class of stock outstanding
Has no more than 10 shareholders, all of whom
must be individuals or estates (that is, another
corporation or trust cannot be a shareholder)
Has had all shareholders consent to the election
to be taxed as a partnership
Does not have more than 20 percent of the
corporate income derived from rents, royalties,
interests, dividends or other "passive" investment
income sources
Does not have more than 80 percent of the cor-
poration's income from sources outside the
United States
When shareholders have elected to be taxed as
a partnership, they must include their pro rata
share of the corporation's ordinary taxable income
for their taxable year, whether distributed or not.
The excess of net long-term capital gain over net
short-term capital gain of the corporation is treated
as long-term capital gain and is generally passed
through to shareholders. (Other subchapter S corpo-
ration rules are discussed in a more comprehensive
Texas Agricultural Extension Service publication,
Incorporating the Texas Family Farm or Ranch
Business, which js also available at your local
Extension office.)
CONCLUDING COMMENTS
Before creating either a partnership or a corpo-
ration, make sure that the form chosen can help
meet the desired financial, business and estate plan-
ning objectives. Discussion with others already in
partnerships or corporations will help to bring out
the major problems they experienced, a!i well as the
major benefits they enjoyed. While this publication
set out some items to consider, each individual
should be cautious and as well-informed as possible.
(For a more detailed discussion of corporations, ob-
tain MP-1158, Incorporating the Texas Family Farm
or Ranch Business, from your county Extension
office.) Sole proprietorships, partnerships and cor-
porations are briefly compared in the following sum-
mary chart on the back of the present publication.
COMPARISONS OF FARM AND RANCH
BUSINESS ORGANIZATIONS
Category
Ownership
Life of the organization
Liability
Capital
Management decisions
and limits on business
Taxes
Taxes (estate)
Sole Proprietor
Single individual
Death temlinates and
there is liquidation;
there may be transfer
of intent during life
Proprietor liable
Personal investments;
loans
Proprietor fully
responsible
Tax on income of
individual and related
tax laws
Based on value of
proprietor's estate, both
separate and his or her
community part of
property and assets
Partnership
Two or more individuals
Business terminates with
death of partner or at agreed
time; sale to surviving
partner or partners;
liquidation
Partners are liable for all of
partnership obligations
Partner contributions; loans
Ability and agreement of
partners
Each partner pays his or her
own income tax based on his
or her income and related
tax laws at tax time;
partnership does file IRS
Information Report
Based on each partner's
estate value, considering not
only all separate property,
but also his or her share of
community property; his or
her part in the partnership
must be included in the
above
Corporation
A legal separate entity
separate from shareholders
(but made up of individual
stockholders)
Forever, or for fixed number
of years; in case of death,
stock passes by will or
inheritance
Corporation is liable for
obligations; (in some cases,
individual stockholders may
be asked to sign separate
payment notes)
Shareholders' stock, sale of
stock and loans
Directors' decisions, Articles
of Incorporation and Texas
Law
Regular Corporation:
Corporations file a tax return
and pay tax on income;
salaries to shareholders and
employees deductible;
Rate: 22% on first $25,000
and 48% on excess capital
gains offset by capital losses,
and no 50% deduction on
capital gains; shareholders
taxed on dividends received
Tax-Option Corporation:
Each shareholder reports
shared income, operating
loss and long-term capital
gain; IRS Information Report
filed by corporation
Based on value on shares
of stock and other assets,
including other separate and
shares of community
property
Educational programs conducted by the Texas Agricultural Extension Service serve people of all ages regardless of socio-economic
levels, race, color, sex, religion or national origin.
Cooperative Extension Work in Agriculture and Home Economics, The Texas A&M University System and the United States
Department of Agriculture cooperating. Distributed in furtherance of the Acts of Congress of May 8, 1914, as amended, and
June 30, 1914.
15M-4-76, Revision AECO 6


Estate Planning--Emphasis on Corporations.

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Estate Planning--Emphasis on Corporations.

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