Katie: Hello and thank you for joining us for this rural entrepreneurship video series. In this video, several UW Madison Division of Extension colleagues will be talking about entity structures for your food and farm business.

Hello, I’m Katie Wantoch, Farm Management Outreach Specialist with the UW Madison Division of Extension. In this first section of the video, I’m going to be providing an overview of potential business entity structures that you may consider as you start your new food or farm business. In particular, this section will focus on the entities if you’re planning to generate profits from your new business. Let’s get started.

Have you asked yourself this question? “I’m not sure which business structure is the right one for my farm or ranch. Where do I start?”

You are not alone if you have. An important part of beginning your food and farm business is considering which business entity structure is right for you. While it may seem an overwhelming choice, this video will provide an overview of business entity structures and the options to consider if you are focused on operating for a profit, looking to form a cooperative, or operating as a nonprofit. 

Please note this video is intended to provide general information about legal issues in business entity structures and should not be construed as providing legal advice. It should not be cited or relied upon as legal authority for advice about how the issues discussed here might apply to your individual situation, you should consult an attorney and an accountant or tax professional.

Some of the information in this video is from Farm Commons, a 501(c)(3) charitable organization. They empower agricultural communities to resolve their own legal vulnerabilities within an ecosystem of support. For more information, please visit their website at Farm Commons.org.  Farm Commons provides legal workshops, timely resources and a community for farmers, ranchers and ag service providers. Farm Commons also has a written book entitled Farmers’ Guide to Business Structures. And you can find this publication in their Farm Law library, along with other resources to answer questions related to business entity structures.

A business entity is a legal structure or form that outlines the legal parameters of a business operation. Traditionally, a business entity’s choice involved selecting from a sole proprietorship, partnership or corporation as a C or B corporation. Beginning in the 1960s, however, the S Corporation election became available to allow the pass through of income and loss to the shareholders.

In the late 1970s, the limited liability company or LLC concept emerged. When the IRS later blessed partnership tax treatment of an LLC, every other state passed legislation that allowed for the creation of LLCs. 

Every business entity carries legal implications which help define how the business is taxed and who has the authority to make decisions, draw on profits, and is liable for decisions and actions. For more on cooperatives, stay tuned. 

Let’s review each of these business entities. As a sole proprietor, no action needs to be taken to set up a business. You will be the sole owner of your business and operate under your personal name. Key characteristics to this business entity include being your own boss, receiving all profits generated from the business, and the ability to be flexible. Please note you as a sole owner will take on the risk of personal liability for any debt, taxes and claims made against your business.

When there are multiple operators, the form of a business structure selected is other than sole proprietorship. A partnership is an association of two or more persons contributing their assets to the business and sharing with each other the management responsibility and the profits and losses of the partnership.

Partners each report and pay taxes on their share of the business’s earnings while filing their individual tax returns. Each partner pledges faith in the other partners and stands liable for the actions of all partners within the scope of partnership business activities. Examples of partnership structures include a general partnership, limited partnership, and a limited liability partnership or LLP.

A corporation differs from a sole proprietorship and partnership in that it is a separate legal entity with its own rights and duties. It has power to make contracts and hold property in its own name. A corporation has most of the rights and privileges of natural persons, although it acts through its human agents and employees.

The existence of a corporation as an entity is important. Separation of ownership and management is a characteristic of the corporation structure. In a corporation, the shareholders are the owners, but not necessarily the managers. Shareholders own the corporation, but the corporation owns and operates the farm. The shareholders elect a board of directors who set policy and make broad management decisions for the corporation. The directors select the officers who are responsible for the day to day operation of the corporate business.

An important characteristic of the corporation is the limited liability of the shareholders for acts or obligations of the corporation. A corporation is a separate taxpayer for income tax purposes. However, a tax option corporation or S corporation pays no income tax. Corporate income, deductions, capital gains and losses, operating losses, and credits are reported by the shareholders of an S corporation on their individual tax returns.

Establishing a corporation requires more documentation to be completed than other business structures. An article of incorporation must be approved by the state and becomes the formal charter under which the corporation exists. The shareholders or directors must enact corporate bylaws to regulate the everyday affairs of the corporation. They also must establish routine procedures of operation. 

In carrying on the farm business, somewhat greater formality is required of a corporation. The state requires annual reports and annual meetings of the shareholders, and periodic meetings of the directors are common corporate formalities. Examples of corporate structures include a C for the traditional corporation, the B for the benefit corporation and S corporation with federal tax status, where S stands for small.

The more recent business structure allowed by state law is referred to as a limited liability company or LLC. Limited liability companies consist of one or more members in an unincorporated association organized under state rules and regulations. The LLC is a form of business organization that combines a limited liability of a corporation with the structural flexibility and tax benefits of a partnership or corporation. LLCs should be formed with a certificate of organization and managed according to an operating agreement. 

Though these documents are not required, the table on your screen provides a summary of the business entity structures that you might consider if you are planning to operate your business for a profit. These include Sole Proprietor, Partnership, Corporation, or Limited Liability Company or LLC. If only one person will be involved with the business, their choices might include sole proprietorship, corporation or LLC.

Organizing documents will be required as a corporation, though documentation is recommended if your business operates as a partnership or LLC. A corporation or LLC may provide you with personal liability protection when operating your food or farm business. All these business entity structures will provide an opportunity for the owners to make a profit. Also, these entities, except for an S corporation, will not have to pay income taxes as those taxes will be passed on to the owners. 

Next, my colleagues from UW Center for Cooperatives will be discussing the business entity Structure of Cooperatives.

Courtney: Hi, my name is Courtney Berner, and I’m the Executive Director of the University of Wisconsin Center for Cooperatives. In this video, my colleague Kelly Maynard and I will share a brief overview of the cooperative model and how it differs from other forms of enterprise.

Alright, a cooperative or a co-op is an enterprise that is owned and democratically controlled by the members who use its services. Cooperatives are found across the U.S. in nearly every sector of the economy. Members who use the cooperative own their co-op because they finance it in a variety of ways. They share in both the business risks and the business profits.

Each cooperative determines the level of financial participation that is required to establish membership status in the co-op. Members democratically control their cooperatives by exercising the voting rights that come with membership. In Wisconsin, each member is typically entitled to one vote. Members benefit from the cooperative based on their use of the co-op, all or part of the cooperative’s profits may be distributed proportionately based on each member’s use or patronage of the co-op. 

So let’s talk about what this all means in the context of organizational ownership, purpose, profit, taxes, and liability. 

First, who are the owners? The members. Depending on the type of cooperative, the members could be consumers of a product or service, producers of a product or service, employees, or businesses, nonprofits, governments, or even other cooperatives.

Cooperatives exist to meet the social or economic needs of these members. Often, a cooperative is organized in response to some adversity. Individual farmers face falling dairy prices, for example, or a community loses its grocery store. Instead of operating to maximize profits or returns,a cooperative operates to maximize member benefit by meeting member needs in a financially sustainable manner.

In a cooperative, the Board of Directors ultimately has control, which I will unpack a bit more on the next slide. If the co-op generates a profit or a surplus, it can be distributed to members in proportion to their use of the co-op and then tax on that profit is either paid at the member level or the co-op level, but not by both. Most cooperatives are corporations with limited liability for owners, so liability is limited to the members’ investment in the cooperative. 

So this graphic illustrates how responsibility and authority are distributed within a cooperative. The members are responsible for electing the board, amending the bylaws, and addressing other major issues as outlined in the bylaws, such as mergers or major financial expenditures. But the members entrust the board with the power to handle policy and governance matters that are not handled by the members. 

Specifically, they select a manager and monitor that manager, they approve the budget, and guide the co-op’s strategic direction. The management is responsible for carrying out the regular business of the cooperative. Then employees carry out the tasks that are needed to operate the co-op. In a worker owned cooperative, all or some of the employees are also the members of the cooperative. And now, I’ll hand it over to Kelly to talk about where and how the co-op model shows up in the food system.

Kelly: This graphic shows examples of the spectrum of cooperatives that exist across the food supply chain and who typically comprises the membership. Starting with farm inputs and supplies, agronomy services, financing, and insurance, these cooperatives are usually owned by farmers directly or by farmer owned cooperatives.

Next, value added food production cooperatives can include both farms and food processing facilities that produce and sell products like local vegetables and fruits, coffee, or pickles. These cooperatives tend to be owned by their employees. There are also a few examples of cooperative land ownership, where individual farms purchase and own a piece of land jointly.

Many brands that we see on our grocery shelves are farmer owned aggregation, processing, and distribution cooperatives. In Wisconsin, we are particularly known for our dairy and cranberry cooperatives. In some cases, cooperatives in this part of the supply chain are owned by other businesses or cooperatives with a common need. 

Finally, consumers of all this great food can join together to create grocery cooperatives that are typically consumer owned.

All of these cooperatives have bylaws that define who the members are and that outline membership eligibility. Their boards of directors are elected from their membership, so are producers or farmers themselves, employees, or food consumers, depending on the ownership type. As Courtney mentioned, profits from these cooperatives are returned to their members based on their patronage or use of the co-op.

In farmer owned cooperatives, this is usually tracked by the amount of goods or services purchased from the cooperative or the amount of product sold to the cooperative. In an employee or worker owned cooperative, patronage can be a combination of hours worked and wage level. Grocery cooperatives track the amount of goods purchased by their consumer owners.

In summary, cooperatives are owned by a group of people or entities, not just one person. In Wisconsin, you typically need a minimum of five people to incorporate a cooperative. You must file articles of incorporation with the Wisconsin Department of Financial Institutions and pay a small incorporation and filing fee. Personal liability is protected, similar to an LLC, and the cooperative business can earn a profit which is distributed to its member owners.

Lastly, cooperatives are not subject to double taxation the way that some corporations are. The member owners are responsible for paying taxes on profit that is allocated to them, and the co-op is responsible for paying any taxes on profit that is retained within the cooperative and not allocated to members.

If you have any questions about cooperatives or about starting a cooperative in Wisconsin, please reach out. Our UW CC website has a wealth of free resources and we have a team of cooperative development specialists ready to support you.

Patrick: Hello, I’m Patrick Nehring, the Community Development Educator for UW Madison Extension in Brown and Kewaunee Counties. In this section of the video, I’ll be covering nonprofit organizations.

A nonprofit is an organization that is required to pay income taxes on its profits, which is revenue minus expenses, rather than profits being dispersed to– to the owners. They’re used to further the mission of the organization, its purpose.

Although there are a few specific exceptions for nonprofit organizations, they still need to pay or collect sales tax, which will be covered in a separate video in this series, and payroll taxes, for example, Social Security. The organization may be involved in activities that are unrelated to the purpose identified in their organizational documents, but they will need to pay income taxes on that aspect of their operation.

A nonprofit organization is controlled by its board of directors and members. It cannot be controlled by a single individual. There need to be at least three people involved. State law provides some default rules on how a nonprofit organization may operate, but in general, the nonprofit, through its bylaws and articles of an organization, defines how it will operate.

In Wisconsin, a nonprofit will typically organize as a nonstock corporation, but it may also organize under the other structures discussed in this video, including as a corporation, LLC, or a cooperative. What makes an organization a nonprofit is the profits do not benefit the individuals. Instead, they are used to further the mission of the organization, its purpose for forming. For the organization to be truly a nonprofit, an organization that is not required to pay income tax, it needs to be recognized as a nonprofit by the IRS.

If the organization is incorporated, liability is limited to the organization. If not incorporated, liability is similar to that of a partnership. In addition to liability insurance, many nonprofit organizations will carry errors and omissions insurance to protect its board for decisions that they made or failed to make.

There are more than 20 types of nonprofit organizations recognized by the IRS. The three that are closely related to food and agriculture ventures are 501(c)(3), 501(c)(5), and 501(c)(6). The number refers to the section of the Internal Revenue Code. 

A 501(c)(3) organization is the most well known type of nonprofit organization. The IRS describes them as charitable organizations. The purpose or mission of a 501(c)(3) organization that may be related to food or a farm venture are educational, scientific, religious, and charity. Donations to a 501(c)(3) organization may be tax deductible to a donor. Some grant providers use the 501(c)(3) designation as a shortcut to determine that the grant will be used for a public benefit, because if the IRS says they are a charity, that’s good enough for the funder. 501(c)(3) organizations have limited lobbying ability.

A 501(c)(5) organization is created for the purpose of promoting the interests of raising livestock, harvesting crops or aquatic resources, cultivating useful ornamental plants. Generally, donations to a 501(c)(5) organization are not tax deductible to the donor unless they are for a purpose related to a 501(c)(3) activity. While 501(c)(3) organizations are focused on enhancing the community and assisting others, 501(c)(5) organizations are focusing  on strengthening aspects of agriculture and horticulture.

A 501(c)(6) organization is formed to promote the common interests of a line of business or trade community, which may be a particular geography. Like a 501(c)(5) nonprofit organization, a 501(c)(6) organization may lobby for its interests as long as it’s not the primary activity.

A 501(c)(5) nonprofit is focused on enhancing aspects of agriculture and horticulture in general, while a 501(c)(6) nonprofit is focused on the common interests of the group that makes up– that makes up its membership.

Nonprofit organizations must have at least three people involved to be recognized as a nonprofit organization and to protect personal liability. A nonprofit must have an organization document. In Wisconsin, these are articles of incorporation. Other states may call these documents charters or constitutions. Nonprofit is an organization without owners that does not need to pay income taxes because the profits go towards the purpose, which is the mission of the organization.

Steps in the formation process. The steps for creating a business or organization in Wisconsin. The process is similar in other states, although they may use different names such as a charter instead of articles of incorporation. As with the filing of your personal income tax forms, you can hire a professional like an accountant or an attorney to assist you. But hiring a professional is not a requirement. You can do it all yourself.

A sole proprietor or partnership may file with the Wisconsin Department of Financial Institutions to protect their name, and they may need to obtain an employee identification number from the IRS or EIN. Cooperatives may be a corporation, LLC, or a nonprofit. Nonprofits typically are organized as a Non-Stock corporation. 

A corporation, LLC, or nonprofit needs to file formation documents with the Department of Financial Institutions. Changes can be made to these documents as needed through various processes provided by the Department. In addition, they need to create bylaws, policies and operating agreements. Although you may be required to provide a copy of those documents under different circumstances. These documents are created and then amended internally. Once formed, the Department of Financial Institutions, by the Department of Financial Situations, applies for an EIN number from the IRS.

For nonprofit organizations, there’s an extra step to gain recognition as a nonprofit by filing a 1023 or 1024 form with the IRS or requesting the ability to file a 990N, which is the annual report that needs to be re-filed with the IRS. 

Some resources to help you on your journey are available from the Wisconsin Department of Revenue, the Small Business Development Center, UW Center for Cooperatives, and the IRS nonprofit site. And of course, UW Madison Extension is a resource for you, including the farm management website, where you will find this Food and Farm Entrepreneur video series and the Community Development Institute website, which includes the Center for Cooperatives, Community Food Systems, Community Economic Development, and Organization and Leadership Development Programs.

Feel free to reach out to us. Our contact information is provided on the screen. You can talk to Katie.Wantoch@wisc.edu, Kelly.Maynard@wisc.edu, or myself Patrick.Nehring@wisc.edu. Thank you for watching.