When to Become a Company and When to Stay as a Sole Trader

In recent years, many farmers have incorporated their trade and began farming though a company. In reality, the purpose of most farming companies coming into existence was to take advantage of Ireland’s low corporation tax rate (currently at 12.5%). When you compare the marginal tax rates of sole traders of up to 55% (income tax at 40%, PRSI at 4% and USC at up to 11%), it is understandable why a company would be att ractive to many farmers.

The benefit of companies only really comes into effect when the farm is producing significant profits above what the farmer requires to live and support their family in a year. A benchmark commonly used is the €100,000 figure. The meaning of the €100,000 benchmark figure is only if after all farm, personal and tax expenses are paid in a year and the farmer has additional income of circa €100,000 should they begin to examine the possibility of incorporating. The rationale behind this approach is simply because a company for legal and tax purposes is a person in its own right. Once the farming trade is incorporated the income of the farm belongs to the company and not the farmer. Treating corporate funds as personal funds will easily put the farmer in breach of company law and create tax issues both of which carry significant penalties. The farmer will need to extract funds from the company to fund personal expenses. The only two options available to extract funds from the company are dividends and salary (ignoring director loan accounts which are outside the scope of this article). The farmer will incur income tax at up to the above rates on salaries and dividends received from the company. If the farmer needs all or most of the farming profits to fund personal expenses there is no benefit of a company, the farmer is merely incurring additional accountancy fees and administrative work for no benefit.

Case study

At this point I would like to reintroduce you to, John and Mary Power. We first met John and Mary a number of weeks ago when we were looking at income tax saving methods but just to recap. John and Mary are currently farming jointly as sole traders. As 2022 farm profits increased significantly and their son Sean if currently undertaking the green cert and farming with them parttime with their younger children Aisling and Oscer also interest in farming, John and Mary have increased production significantly in recent years and are seriously examining the possibility of incorporating the farming trade.

Background information

• John and Mary’s net farming profits in 2024 are expected to be circa €150,000.

• Personal, household and school fee expenses etc are expected to be €60,000.

• Medical expenses of €1,000 for the entire family paid by John.

• Tuition fees of €5,000 for Katie and Sean.

• John and Mary tax under joint assessment, with John being the assessable spouse.

• Personal tax credit for 2024 €1,875 or €3,750 combined for John and Mary.

• Earned income credit for 2024 is €1,875.

• 2024 standard rate for married individual is €51,000 with an increase of up €33,000 for the non-assessable spouse’s income. The standard rate for a single wid

• PRSI is 4%

• 2024 USC thresholds are per the table below:

1.Under this scenario we will examine John and Mary’s income tax liability:

Under this scenario John and Mary would pay tax of €44,906 and would have after tax profits of €105,094 giving an effective tax rate of 30%.

2. Under this scenario the farming trade has transferred to a company and John and Mary receive a salary of €30,000 each from the company to fund personal expenses.

Corporation Tax

John and Mary’s income tax liability on the salary

The combined tax cost for the company, John and Mary under this scenario is €19,359. Giving a combined effective rate of tax on the profits of 13%. With this level of additional income using a company significantly reduces the tax bill and provides a tax saving of circa 17% or €25,547.

3.Under the next example we will reduce the taxable profit of the farm to €80,000 while keeping John and Mary’s personal expenses at €60,000 per annum.

John and Mary income tax liability

Under this scenario John and Mary would have a tax liability of €12,909 with after tax profits of €67,091 giving and effective tax rate of circa 16%.

 4.Under this example we will keep the farm profit at €80,000 but the farming trade has been incorporated into a company, with John and Mary still requiring personal funds of €60,000 to cover personal expenses.

Corporation tax  

John and Mary’s income tax liability on the salary

Under this scenario with only additional income of €20,000 a company would not make sense, as the combined tax liability of the company plus John and Mary’s income tax liability is €10,609 giving an effective tax rate of 13%. As the John and Mary’s income tax liability was only €12,909 if they were taxed on the full €80,000 of profits the saving with the company is only €2,300. The additional costs associated with setting up companies and administrating them would likely out weight the tax saving of setting up a company.

Summary

While generally it is more tax efficient to farm through a company the personal needs of the family must be considered. It is only when the farm is generating significate income over the personal expanses of the family is incorporating beneficial.