By John Lavelle
In my prior three articles, we discussed estate tax implications of large land ownership, business succession issues in farming operations, and the tax benefits of conservation easements. Now let’s discuss something completely different: the day-to-day issues all business owners must cope with, but that are particularly challenging for farmers.
One of the fastest ways to go out of business is to ignore the basic rules of compliance with all the various governmental entities. This article is not going to cover special issues that are peculiar to farms: environmental and land use, grant compliance, crop programs and insurance are often covered in detail by your local farm bureau, cooperative extension and county. Rather, we are going to review some compliance obligations that can impact any business and even cause business failures.
My day job as a lawyer and my other job as “CFO” of my wife’s farm business have exclusively been in New York jurisdictions. While rules and regulations can vary even within a state, it is especially true from state to state. For non-New York farmers, these pointers need to be adjusted for your state and local experience.
If you hire employees outside of the family (there are exemptions from some payroll obligations for your spouse and minor children), payroll compliance has to be a top priority. A very strong recommendation is to use a payroll service. Do not be tempted to save money processing payroll through your own accounting software. Making one payroll mistake will often cost you interest and penalties that could have paid for a service for a year.
Carefully interview the service to determine their capabilities and what is covered and not covered by them. A really good payroll company will advise you on wage reporting, withholding and prepare forms. They should also help with overtime rules, hiring and firing practices and so forth. Bottom line for a service: if their services cause you penalties, the penalties are on them, not you. That should be part of your contract.
One of the major causes of business failures is neglecting to remit wage withholding. Since this money belongs to the employees and not the employer, the farm owners are personally liable for unremitted taxes. Certain supervisory managers or general executives of the farm business, if any, may also be liable. This is true even if your farm operation is a corporation or limited liability company.
These payroll problems happen all too often. The net payroll deduction generally comes out of the operating or payroll account automatically each pay period. The taxes are often billed by the payroll service on a different schedule when due. Once a payroll period happens, however, those withholdings are owed to the government. Unlike other farm expenses, they must be paid when due. There are interest and penalties for late deposits, but worse yet, the government has little patience for unremitted taxes.
Garnishments are another problem. The state or federal government and sometimes a local court may contact you about an employee’s unpaid personal taxes, spousal or child support. These notices to withhold from an employee’s paycheck are mandatory, binding obligations. Failure to comply can cause huge penalties to the farm employer.
Unemployment Insurance (UI)
Once the big step is taken to go with non-family labor, UI becomes an issue. In most states, it is part of the payroll function and is mandatory. Usually based on gross payroll, UI can only be controlled by the employer through good hiring practices. The more employees who are terminated who claim unemployment benefits, the higher the employer’s rate gets. In every case, you must timely respond to the agency involved, and have your facts on record to control your exposure. Respond promptly – deadlines are often very short. Best of all, implement vigorous hiring practices to avoid employing short term problem employees and know which terminations trigger UI payments.
State unemployment payments affect your federal liability. Review your payroll filings regularly to confirm they are accurate. Problems with UI withholding or claims can trigger a general department of labor audit. Yikes.
Worker’s Compensation (WC)
This can be a disaster for many farms. In our farm operation in NY, with no claims since inception (ten years), our WC cost is as high as our business liability insurance premiums. There is a state fund and several commercial alternatives. In our experience, the state fund is most difficult and expensive. Annual audits raised the cost every year, despite no claims filed. When we switched to a farm insurance provider, classification issues were easy to manage, but costs were not much cheaper.
In any event, your farm’s classification and payroll drive the cost. Make sure it is accurate, and ask around for a good provider if that option is available. If there is a self-insurance option, only the largest and most profitable farms should consider it, and be cautious about it. In other industries in NY, these self-insurance pools have imploded with long term consequences.
Farm operations are blessed with many special tax rules that make income taxes less of a concern for all but the largest, most profitable farms. Beyond the scope of this article, tax planning should be managed by the owners and reviewed on at least an annual basis. Farm profits can generally be reinvested in a deductible fashion to minimize current taxes.
Farm compensation to owners, on the other hand, can be expensive. In addition to income taxes, farm owners are generally self-employed and have self-employment (or, if paid by a family entity, FICA) taxes to consider. This latter tax directly affects the farm owners’ Social Security benefits. Taking measures to minimize payroll taxes of owners can also wipe out a substantial retirement benefit. Owner retirement planning must be reviewed at the earliest stages of a farmer’s career. Income tax planning should never run contrary to good retirement planning.
Sales tax is another concern. In NY, exemptions exist for most farm purchases, although “zero” sales tax returns are recommended. However, if the farm also operates retail stores, gift shops, or other direct to consumer sales, exemptions should be checked. Often sales tax may be due on some or all of these items. Once sales tax is collected from the consumer, it works like withheld payroll taxes discussed above. Liability for failure to remit sales tax collected is a personal liability of the people involved, including farm owners.
In addition to the above tax and benefit issues in connection with having employees, farm management must be familiar with both federal and state labor laws. Wage and hour laws are in constant flux. Plus, special rules frequently apply to farms. There can be different rules for overtime, paid time off, minimum wage and the like. The higher the number of employees, the more rules generally apply. Also, discriminatory hiring and firing practices must be carefully avoided to nullify potential claims by disgruntled applicants or terminated employees.
Since housing is often a component of farm labor compensation, make sure you know the tax rules. Housing furnished for the farm employer’s convenience is a tax-free benefit to the employee. This makes it a very valuable benefit for the employee and should be factored into his or her cash compensation. However, housing provided by the employer for the employee’s convenience is fully taxable. Documentation showing why you need a particular employee in your housing should be maintained to support the tax exclusion.
Managing many of these issues can often be outsourced to a good payroll service or HR consultant to some extent. Any payroll service under consideration should be familiar with the myriad of agricultural special rules. In addition, for non-payroll labor issues, the various farm resource organizations often have an HR advisory service. Finally, even your farm lender or insurance company may offer help in some of these areas.
This is a very select group of the compliance issues that drive us all crazy and these areas in particular can destroy a farm business. Farm managers must be alert to these issues and farm owners must acquire resources through outside contractors, like payroll services and farm lenders or insurers. Eventually, hired administrative staff can help to protect their farm investment. Whether you’re managing these critical functions solo or as a team, navigating these potential business killers is no place to “wing” it.