Different Ways of Doing Business

By: David W. Wynne, JD

Proper business entity selection is critical to the success of your cattle operation. The prudent stock contractor should seek legal counsel who is knowledgeable in the area of business law and transaction law. In addition to the advice of legal counsel, you should consult with a certified public accountant to discuss the tax treatment of income or losses.

The determination of what entity best meets the needs of your operation depends on your goals, capital limitations, need for immunity from liability and tax concerns. The proper business entity could reduce your tax liability, eliminate or reduce liability exposure and increase your productivity.

        The most common forms of business entities used in the bucking bull business are sole proprietorships, partnerships or syndicates and corporations. Selecting the most appropriate form of business entity for your operation depends upon an evaluation of your current needs, future needs, short and long term goals, and tax implications. Factors to consider when selecting the right business entity include: Nature of your operation; Costs of organizing the entity; Need for a separate entity such as a corporation; transferability of ownership; continuation of the entity following death of an owner; need for protection from liability; Tax treatment of income or losses; and degree of participation of owners.

          Lets examine the differences of the three most common entity forms used in our industry. The simplest business entity is the sole proprietorship. It is owned by only one owner and requires no formal organizational document or government filing. The owner is responsible for taxes on any income or loss and must report the income or loss on applicable IRS forms and include the income on his personal tax return.

          The owner of a sole proprietorship is personally responsible for the debts and liabilities of the business. The sole proprietorship is not a separate entity, so the owner is not immune from liability or possible judgments from lawsuits. The owner of a sole proprietorship should rely upon release and hold harmless agreements and should purchase sufficient liability insurance coverage. The sole proprietorship may operate under an assumed name and may be subject to local and state licensing requirements for their business activities.

         A partnership, syndicate or joint venture consist of two or more people or corporations owning interest in the business. Each partner contributes capital, time, talent, assets or services to the partnership and each partner shares in the profits or losses of the partnership. The partners are not immune from liability and debts of the partnership. Taxable income is reported to the IRS and each partner is responsible for reporting their portion of the taxable income on their individual returns.

          The internal affairs of a partnership is governed by its partnership agreement or in the absence of a signed written partnership agreement then the statutory partnership agreement found in most states business code would apply.

          A corporation is an entity empowered to act as an individual, possessing powers allowed to it in its articles of incorporation or certificate of formation. The individuals involved in forming the corporation transfer money or property in exchange for stock of the corporation. The formation of a corporation is costly and should involve the services of an attorney and a certified public accountant.   

          The corporation's internal affairs, is governed by the laws of its state of incorporation. To form a corporate entity, the incorporator must prepare and file articles of incorporation with the relevant state official, usually the secretary of state. The article must state the purpose for which the corporation is formed. Usually the purpose clause is broadly drafted such as "for any and all lawful purposes".

          Corporations provide immunity from liability for the shareholders and managers as long as the manager was acting within the scope of their authority. Corporate formalities such as shareholder's meetings, minute books and bank accounts must be maintained to prevent a creditor or judgment creditor from piercing the "corporate veil". This can occur if corporate formalities are not maintained, when the corporation is under-capitalized or when the corporation is a mere shell and being used as the "alter ego" of an individual shareholder.

          A sub chapter "S" corporation provides the advantages of limited liability without double taxation. The same procedures for forming a s corporation must be followed as prescribed in the formation of a corporation. Additionally, the S corporation may have no more than thirty-five shareholders and must file the S corporation election with the internal revenue service within 75 days of incorporation.      

         The main advantage in forming an S corporation is to gain the advantages of a corporation such as personal shareholder and manager immunity from liability, but to also have the tax advantages of a partnership. An S corporation avoids double taxation of income. If the S corporation incurs losses, then the losses are passed on the individual shareholders to be deducted against their income. Likewise, profits are passed on to the individual shareholder thus avoiding being taxed both to the business and the individual shareholder.  

          S corporations are often formed for the sole purpose of promoting one bull. If the bull becomes injured and incurs substantial medical expenses, then each shareholder could have potential liability exposure even with the S corporation in place.

          I am of the opinion that the S corporation is preferable over a partnership or joint venture agreement for cattle ownership in our industry. With the inherent danger involved in maintaining and promoting bulls, it is imperative to protect owners from personal liability without problems of double taxation. The income and loss allocation structures can be unequal so smaller investors can purchase less shares of stock while still being able to participate in the management and promotion of the Bull.

          Proper entity selection is imperative to the success of your operation. Operating your business in the wrong entity formation could expose you to unnecessary liability exposure and lead to devastating legal or tax consequences. There are pros and cons attached to each of the entities described above. Professional counsel should be sought before selecting the right business entity for your cattle operation.