Are you thinking of going into a farm
partnership? Are you now a partner in a
farm enterprise? In either case, you should
consider carefully the business consequences
of your partnership, and should get competent legal advice on the legal aspects of the
agreement. The partnership is well suited to
some farm situations, but not to others. Incorporation can offer some of the same advantages, and should also be at least considered. This publication does not offer legal
advice, but outlines some of the more important questions you should be asking yourself, your partners, and your attorney.
THE FARM PARTNERSHIP- Is It Right for You?
is a must.
The primary source of capital for a partnership is partners' contributions and loans, similar
to the funding for a sole proprietorship. Each
partner is taxed as an individual on his or her
own pro rata share of net income generated by
the partnership. The partnership is merely the
vehicle through which income passes to each of
the partners. The partnership is required to file
information returns (IRS Form 1065 and Alabama
Department of Revenue Form 65), but the partnership itself does not pay income tax.
ABOUT ONE IN TEN Alabama farms are operated as partnerships. Simple to form and operate,
the partnership is a traditional way for family
members to do business together. Others, of
course, can also take advantage of the partnership
method. However, there are pitfalls and drawbacks to this method which should be considered
by anyone thinking of forming a partnership, or
already involved in one.
CHARACTERISTICS OF THE PARTNERSHIP
A partnership is defined as "an association of
two or more persons to carry on, as co-owners, a
business for profit." The statutory laws governing
this form of doing business are contained in Title
43 of the Alabama Code.
Partnerships are deceptively simple to form
and operate. The law requires little more than an
informal, oral agreement between the parties. In
fact, it may be possible for some businesses to become partnerships in the eyes of the law without
the partners being aware of it. The basic rule for
partnership status is whether the parties have
agreed to share net income or profits. If so, this
is evidence of a partnership.
There is no maximum limit to
the number of partners. Some
partnerships may have more than
100 partners, but only two persons
are required. It is not necessary
that property used by the business
be co-owned by the partners. Unless otherwise stated in the partnership agreement, the law assumes that all partners share equally in the ownership and control of the business.
Each partner has personal liability for partnership obligations. A partner can, either by omission or through some wrongful act, subject the
other partners to liability. Partnership creditors
have access to the personal assets of the individual
partners to satisfy partnership obligations. This
is a real drawback of the partnership; insurance
J.
LAVAUGHN JoHNsoN,
WHY A PARTNERSHIP?
There are a number of reasons why the farm
partnership could be considered the solution to
certain farm problems. These factors, however,
should be analyzed carefully to see if they present
sufficient justification for forming a partnership.
The pooling of resources (physical, financial
and managerial) is often seen as a major advantage for forming a partnership. Combining such
resources may result in a more efficient economic
unit than had the separate units acted alone. This
is particularly true if the partnership combines
complementary talents, for example:
• an outstanding livestock producer and an
outstanding crops farmer.
• a good financial manager and record keeper
and a farmer adept in mechanical and engineering skills.
• a marketing expert and a crop or livestock
production expert.
Division of labor and management demands
can be attractive to an older farmer who may
want to slow down and begin turning the reins
over to a younger person. This is a valid reason
provided the farm is large enough to generate
sufficient returns to support both families. Additional debt may have to be incurred in order for
the farm to become large enough to generate
these needed funds. This additional debt requirement may therefore make the partnership look
less attractive.
Economist-Crops Farm
Management
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The informality and flexibility of the partnership is appealing to most individuals. The fact is,
however, that about as much paperwork and legal
counsel are involved in setting up a well-run partnership as are involved in incorporation. The fact
that partnerships are relatively easy to set up does
not mean that well-kept records and properly
drafted agreements are not necessary. It is only
by following such practices that a partnership can
hope to survive and prosper.
While considering the partnership as a way
of organizing your farming operation, keep in
mind the following points:
major components to be found in most partnership agreements. A brief discussion of some major, but certainly not all, points to consider in
drafting the agreement is also included.
INTHODUCTION: The introductory portion of the
agreement contains several preliminary statements
referring to:
(a) The name and address of the partnership.
(b) The names and addresses of the partners
(including the spouses if applicable).
(c) The purpose and nature of the business,
and
CoMPATIBILITY-The personalities and temperaments of the partners and their spouses can have
a great bearing on the success of the partnership.
(d) The length of time the partnership is to
exist.
CoNTRIBUTIONS: Provisions should be made
concerning what individual property will be contributed and what partnership interest will be received in return. Each partner will usually contribute capital, labor and management. Capital
contributions may be in the form of cash and personal and/or real pmperty. Partners may make
outright contributions to the partnership or simply grant exclusive use of the property to the partnership. Since partners usually share in the profits
and losses of the business in proportion to their
interest in the business, it is important that a
proper accounting of such contributions be made.
ADEQUATE PoTENTIAL BusiNEss EARNINGS-The
pooling of resources offers advantages, but the
economic returns must be large enough to adequately compensate these additional resources.
ADEQUATE CnEDIT-In order to get bigger,
more credit may be needed. Are all partners, particularly the senior partners, willing to assume
additional debt?
MANAGERIAL CoMPETENCE - Combining resources and obtaining additional credit usually
means a larger scale operation. The ability to
properly manage a larger and perhaps more complex farming operation will have a great bearing
on the success of the operation.
Some questions to consider when looking at
partners' contributions include:
(a) What contributions in money and/ or
property is each partner to make? When is cash
money to be paid in? Where will it be deposited?
WRITTEN AGREEMENT-It is
a good business practice to
put into writing the agreements that partners decide
upon that meet both business
and estate planning purposes.
(b) What is the agreed value of property
contributions? Who makes that determination?
(The fair market value of a contribution may differ significantly from the adjusted cost basis for
that property as shown on the books.) The adjusted cost basis is used for tax purposes in preparing partnership tax returns. Does the partnership assume any existing liabilities of any partners, and if so how does this affect their contribution? What provisions will be made co •.cerning the allocation of depreciation deductions, tax
credits and gains or losses on the property contributed? What interest, if any, will be paid by
the partnership on capital contributions?
THE PARTNERSHIP AGREEMENT
The Partnership Agreement is a contract between two or more people detailing the who,
what, when, where, why and how of the business
operation. A well drafted agreement helps ensure
that the partnership accomplishes what the partners had intended and minimizes possible future
problems.
The agreement may be as simple or complex
as the partners desire and will almost certainly be
somewhat different for each partnership. Legal
counsel is a must in developing a partnership arrangement that is agreeable to all parties.
There are many things to consider when forming a partnership. Following is a listing of the
(c) Is each partner required to contribute a
pro rata share of any additional contributions?
Is each partner to leave part of his or her profits in
the business as additional contributions?
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(d) What provisions are made for withdrawal
of a contribution?
full-time work; Partner Dick may only work parttime and receive $300 per month; Partner Harry
may receive $1,000 per month for full-time work
plus another $500 for record keeping, which he in
effect sub-contracts with his wife, Sue. It should
also be determined if any partner is to be guaranteed a certain minimum return.
Finally, it
should be determined if partners will be able to
withdraw profits in advance of the annual accounting or whether they will receive a set monthly withdrawal.
(e) What arrangements are necessary for
ownership of any improvements on property remaining the separate property of a partner?
(f) Will any property be loaned or leased to
the partnership by a partner? If so, what rental
arrangements are necessary?
(g) How often will inventories be made and
capital accounts updated?
FISCAL MATTERS: Financial records are important in any business, but particularly so in a
partnership. Partners should decide who will be responsible for keeping the records and filing proper
tax forms. Will the accounting be on a cash or
accrual basis? Will all partners have free access
to the books? Other questions to ponder include
whether separate capital and current accounts
will be maintained for each partner, which bank
will be used, how often financial statements for
the partnership will be prepared, if there will be
a maximum amount that any partner is allowed to
pay out of the account, and so forth.
LABOR AND MANAGEMENT: Labor and management responsibilities of the partners should be
spelled out. Partners having special skills or abilities should be assigned responsibilities suited to
their expertise. It should also be determined
whether partners will devote full time or part time
to the business. Although all partners usually have
an equal voice in management, the business often
runs more smoothly if one person is acknowledged
as the primary decision-maker in a specified area.
Provisions should be made beforehand as to how
management decisions are to be made and whether senior partners have management control. Provisions should also be made for settling disputes
arising under the partnership agreement.
PARTNERs' PowERS AND LIMITATIONS: Along
with the partners' contributions come certain
rights and responsibilities. Limitations on partners' activities or power can be inserted in any
section of the partnership agreement. For example, there may be limitations on the amount a
partner can borrow, buy or sell. These could be
spelled out in the financial records section or the
contributions section of the agreement. What this
particular type of limitation states is that no partner can buy an item or obligate the partnership
for anything costing over a certain amount without the other partners' approval.
PROFITS, LossEs AND LIABILITIES: Each partner
usually shares in any net profits or losses in connection with the business of the partnership in
the same proportion as his or her interest in the
partnership, unless other provisions are made.
Profits are the money earned as a return to labor,
management and capital after all expenses, depreciation deductions and inventory adjustments
have been made. In determining partnership
profits it needs to be determined:
(a) What items are treated as partnership
expenses? Is depreciation on farm improvements
considered an expense?
(d) How are inventory gains and losses to be
handled?
(e) Will partners have expense accounts?
Other types of limitations which may be imposed are:
(a) Obtaining loans and assigning partnership property as collateral.
(b) Selling or leasing partnership property.
(c) Admitting additional partners.
(d) Obligating the partnership as surety or
guarantor.
(e) Hiring or firing employees.
(f) Forgiving or adjusting debts due the
partnership.
Once the procedure for computing profits has
been made, provisions must be made for the distribution of those profits. For example, Partner
Tom may receive $1,000 per month in wages for
DissoLUTION: Dissolution of the partnership
on retirement, incapacity or death of a partner
should be covered through provisions for business
continuation or termination and final settlement.
(b) Will each partner receive interest on his
or her contributions or a rental payment on any
property loaned or leased to the partnership?
(c) What items will be included in farm receipts? Off-farm employment? Custom work?
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These provlSlons should contemplate all possibilities and specify a solution to prevent serious
disputes if such eventualities should arise.
This section of the agreement can be relatively
short if there is a eparate "buy-sell" agreement.
Ba ically, th buy-sell agreement gives each
partner the option (or requirement) to buy the
ther partner's interest in the case of a desired
sale, incapacity or death of the partnex. This
agreement also specifies the price and terms of
sa le and financing. It also spells out the options.
if the r maining partners do not want to buy.
Provisions are also included for arbitration and
appraisal procedures if such a situation arises.
If there is no buy-sell agreement, there must
be provisions for dissolving the partnership equitably and distributing the assets.
Realizing the distinct possibility of dissolution,
there need to be provisions in the agreement that
answer these questions:
is the penalty for wrongfully withdrawing?
(d) What provisions a.r to b mad for continuing th busines upon the death, di ability
bm1kruptcy, ex_pulsiml or withd1·awal of a partner? (It is at this point that a s parat huy-sell
agreement could specify all of th :S proc dures.)
(e) What provisions are made to ensure that
the deceased or withdrawing partner bears his or
her equitable share of the losses?
(f) If the partnership is dissolved, are all assets to be liquidated? How will the assets be distributed? Can any partner receive specific items
that he or she contributed?
LIMITED PARTNERSHIPS
Unlike general partn rsbips, the limited partnership has one or more general partners a11d one
or more limited partners. The limited or "silent"
partner is an investor whos liability is limited to
the extent of his or her investment in the partnership. The non-partnership assets of the limited
partner are not subject to claims of partnership
creditors. The liability of the limited partner is
similar to that of a stockholder in a corporation.
The limited partner does not participate in
labor or management and does not receive income
for those items. If he or she does act in some labor
or management capacity, the limited partner may
lose limited liability status and become as liable
as a general partner.
(a) What acts other than expiration of the
term of the partnership shall result in dissolution?
Death of a partner? Bankruptcy? Incompetency?
Withdrawal? Expulsion?
(b) By wJtat means and for what acts may
a partner be expelled? I physical or mental disability grounds for expulsion, and jf so, who determines what constitutes disability?
(c) In the case of withdrawal by a partner,
how much advance notice must be given? What
CIRCULAR ANR-335
The
~1Aiabama
Ei7Coopera tive
Extension Service
------"EDUCATION IS OUR BUSINESS" - - - - - -
Issued in furtherance of Cooperative Extension work in agriculture and
home economics, Acts of May 8 and June 30, 1914, in cooperation
with the U. S. Department of Agricu lture. J. Michael Sprott, Director,
Alabama Cooperative Extension Service, Auburn Unlverslty. The Ala·
bama Cooperative Extension Service offers educational programs and
materials ro all people without regard to race, color, national origin,
sex, age, or handicap . It is also an Equal Opportun ity Employer.
(UPS) 5M 13, 9:82, ANR-335
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TYPES OF BUSINESS ORGANIZATION
CHARACTERISTIC
SOLE PROPRIETOR
PARTNERSHIP
CORPORATION
Type of Organization
Single individual
Two or more individuals,
corporations or other
entities
Separate legal "person" from
shareholders
How long does business
last?
Terminates on death
Agreed term; terminates
at death of a partner
Forever or for a fixed number
of years
Who is liable for
losses or damages?
Personally liable
Each partner liable for
all partnership obligations
Shareholders not liable for
corporate obligations
How are funds raised?
Personal investment,
loans
Partners' contributions;
loans
Contributions of shareholders
for stock; sale of stock; bonds
and other loans
Who makes decisions?
Proprietor
Agreement of partners
Shareholders elect directors who
manage business along with
officers elected by directors
What is effect of sale
of interest?
Terminates proprietorship
Dissolves partnership;
new partnerships may be
formed if all agree
Transfer of stock does not affect
continuity of business-may be
transferred to outsiders if no
restrictions
What is effect of
death?
Liquidation
Liquidation or sale to
surviving partners
No effect on corporation. Stock
passes by will or inheritance
How is business taxed?
Income taxed to individual-50% deduction
for long-term
capital gains
Partnership files an information return but pays no
tax. Each partner reports
share of income or loss,
capital gains and losses
as an individual
°Corporation files a tax return and
pays tax on income (salaries to
shareholder-employees deductible).
Capital gains offset by capital
losses; no 60% deduction for capital
gains; rate: 16% on first $25,000;
19% on next $25,000; 30% on next
$25,000; 40% on next $25,000;
46% on excess
0
Note: Subchapter S corporations file information returns like a partnership. Each shareholder then files in manner
similar to a partner filing individually.
P(ace to Go
when You Need to Know
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and youth or community resource development. Drop by or call your
local county Extension office. You'll find friendly, well-trained agents
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free publications. Your county Extension office ... the place to go
when you need to know!
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E
.t.1Aiabama
~Cooperative
Extension Service
"EDUCATION IS OUR BUSINESS"