Should Machinery Be in an LLC?
A common question related to farm business planning is: should I put my machinery in a separate LLC for liability protection? Like most answers to legal questions, the answer is “it depends”. Let’s discuss this issue further.
First, let’s look at the strategy behind using a machinery LLC. Machinery is put into an LLC and then the farming operation leases the machinery from the LLC. The idea is that if the machinery is involved in a liability incident, such as an accident on the road, the liability is trapped in the machinery LLC and does extend to the farming operation or other assets.
Unfortunately, strategy and reality are not always the same. Machinery LLCs do provide some liability protection but do have definite limitations. The problem is that the source of the liability may be the operator of the machinery, not the machine itself. If the liability is due to operator error, the liability will likely come back to the operator. If the operator is working on behalf of the farming operation, the liability can and likely will come back to the farming operation. Let’s look at an example:
Farmer operates a grain farm and often has large equipment traversing narrow roads. Understandably, Farmer is concerned about the potential liability of the machinery. He places his machinery in Machinery LLC. Farmer leases the machinery from Machinery LLC.
After the LLC is established, Farmer’s employee is moving the corn planter from one field to another and is involved in a traffic accident. It is determined that employee was at fault for the accident.
Machinery LLC, in this situation, will probably not provide much liability protection. The source of the liability for the accident is not the machine but the operator. So, liability follows the operator which brings the liability back to the farming operation. Farmer’s farming operation is at risk to the liability caused by the accident.
If the accident referred to above was caused solely by a failure of the machine and not operator error, then the LLC would provide liability protection to the farm operation. However, most accidents involving farm machinery are due to operator error rather than machinery malfunction.
LLCs can provide liability protection, even if operator error causes the liability, but they must be operated in a very specific manner that will require considerably more management. To maximize liability protection, the LLC must be the employer of the machine operator. The farm operation then contracts with the machinery LLC to essentially provide custom operations. This strategy requires separate payrolls for both the farming operation and the machinery LLC and tracking which employee is working for which business. Frankly, this strategy is not feasible for most farm operations.
Where this strategy does sometimes work is with grain trucks. An LLC can be established for holding the grain trucks. The truck LLC has a payroll separate and apart from the farming operation. When an employee is hauling grain, they are paid by the trucking LLC rather than the farming operation. The farming operation pays the truck LLC a custom hauling rate. If an accident occurs while hauling grain, the farming operation has considerable protection from the resulting liability. Let’s look at an example:
Farmer sets up Truck LLC and transfers his grain trucks to the LLC. The new LLC establishes a payroll and instructs all employees to keep separate hours depending on whether they are doing farm work or trucking work. Farmer’s farm operation pays Truck LLC a custom hauling rate for all grain hauled.
Employee is hauling grain to the elevator when they cause a traffic accident. The employee and Truck LLC (as the employer) is likely to be liable for the accident. However, the farm operation is likely insulated from liability because it neither employed the driver nor owned the truck.
The above example illustrates how LLCs can be set up to maximize liability protection for farming operations. However, this maximized liability protection requires considerably more management including leases, tax returns, and separate payrolls. This situation usually works best when the farming operation has already been doing some custom hauling and is familiar with managing custom hauling contracts.
So, what do we do to overcome the limitations of LLCs? The answer is liability insurance. The most important and effective liability protection is liability insurance. Using business entities for liability protection should only ever be as backup to the liability insurance. Before spending time on machinery LLCs, farmers should take the time to review their insurance policy with their insurance agent to make sure all activities and assets are covered. There is no substitute for good liability insurance.
While machinery LLCs have limitations for liability protection, there are still many reasons they may be beneficial to a farm operation. The following are a few benefits of machinery LLCs:
- Consolidation of ownership. It is common for different family members to own different pieces of equipment or to share ownership in equipment. Over time this can become complicated and cumbersome. For convenience and easier management, it can be beneficial to put all machinery in one LLC and then each family member receives an ownership interest in the LLC.
- Transition planning. It is very easy to transfer ownership in an LLC –essentially just signing a piece of paper. In situations where we may want to transfer the ownership of machinery over time, LLCs are a great method to do this.
- Avoiding probate. Machinery is untitled so cannot be made transfer on death to avoid probate. However, the ownership interests of a machinery LLC can be transfer on death avoiding probate. By transferring machinery to an LLC then making the LLC ownership transfer on death, probate can be avoided on machinery.
- Tax planning. LLCs can be taxed as partnerships, C-Corporations, S-Corporations or sole proprietorships. The flexibility of the LLC tax structure can allow for creative tax planning.
Machinery LLCs do provide at least some liability protection for farming operations but in many situations the protection may be limited. However, there are many other good reasons to consider establishing a machinery LLC. Discuss the strategies and their advantages and disadvantages with your legal and tax advisors to determine if a machinery LLC may be the best strategy for you.
This article has been reposted from the Ag Law Blog, to view the original article, click HERE.
