My great grandfather lost his small farm in southern Alberta after three consecutive years of bad crops due to poor weather.
It was a hard life of dawn-to-dusk, labour intensive toil, driven literally by horse power -- and a great deal of elbow grease. He eventually replaced the farm income with a new business venture that worked for him, also horse-driven.
I still have family members who are farmers, and in many ways I admire their lifestyles. Although the machinery has replaced the horses, the cattle still get hungry early in the morning and again at night. The fences still need mending, mostly by hand, and the number of hours put in has not decreased with the level of automation achieved. Instead, the farms just got bigger, and the profit margins remained about as skinny as before.
Perhaps the natural outcome of this evolution is the consideration of a corporate ownership structure for these typically larger family agribusinesses. We now dedicate a few words to that idea.
Incorporating Your Farm - Part 1
Canadian Farm Ownership Structures
The 2011 Census of Agriculture indicated that there are over 200,000 Canadian farms, comprising over 160 million acres of land. While there are several ways to structure the ownership of these farms, the most common are a sole proprietorship, a corporation or a partnership. Running a farm as a sole proprietorship is the easiest solution from an administrative and cost point of view. In fact, according to the Census of Agriculture, over 55% of farms operate as sole proprietorships. However, incorporation may provide certain benefits.
Considerations in the Incorporation Decision
Income Splitting Opportunities
Incorporating a farm may allow a farmer to take advantage of income splitting opportunities. By adding lower income-earning adult family members as shareholders, the incorporated farm can pay them dividends to take advantage of their lower marginal tax rates. However, note that dividends from private corporations paid to minor children will be taxed at the top marginal tax rates (commonly referred to as the "kiddie tax").
Additionally, the incorporated farm can pay reasonable salaries to lower income family members for the services they provide, allowing family members to take advantage of their lower marginal tax rates.
Capital Gain Exemption
The capital gain exemption allows you to shelter up to $813,600 (for 2015, indexed thereafter) of capital gain when you sell your farm property, provided certain criteria is met. This exemption is available on qualified farm property whether incorporated or not. However, certain farm assets do not meet the criteria of qualified farm property. For example, inventory is not qualified farm property and you will not be able to use the capital gain exemption when you sell your farm inventory. However, if you incorporated your farm, the sale of the shares of a family farm corporation does qualify for the capital gain exemption, even if that corporation owns inventory and other assets that do not meet the criteria of qualified farm property.
By incorporating, you may also be able to add family members as shareholders to allow your family to multiply the capital gain exemption on the future growth of the corporation.
Potential for Tax Deferral
If you earn income as an unincorporated farmer, taxable income is taxed at your individual marginal tax rate. If the farming income is earned by your farm corporation, the taxable income is considered active business income for tax purposes and is subject to the general corporate tax rate, at both federal and provincial levels. If your taxable income is below the 'small business limit', the small business deduction can significantly reduce your corporate tax rate. This lower tax rate creates a tax deferral opportunity and can allow the corporation to retain more of its earnings for reinvestment.
Flexibility in Payment of the Help
By incorporating your farm, you gain access to a number of different methods of paying hired help, in or out of the family such as salary, dividends, and bonuses. The ability to select the type and amount of remuneration allows you to maximize tax deferral while still taking advantage of non-tax related benefits such as creating Registered Retirement Savings Plan (RRSP) contribution room and participating in the Canada Pension Plan.
Retirement of Debt
As explained above, income earned inside a farm corporation is eligible for the small business deduction,
which allows a corporation to have its income taxed at a lower rate. By reducing the taxes paid, the farm
corporation will have more funds to repay its outstanding debt than it would if the farm was structured as a sole proprietorship. This can allow the debt to be paid off faster and reduce the amount of interest paid.
Incorporating a farm certainly has benefits, but may not make sense for all. This article is not meant to be legal or tax advice. It is important to consult your legal and tax advisors to determine which structure is best for your personal situation.
There are many other issues to consider, and we will weigh in to some of them next week.
Mark Ryan is an advisor in Prince George with RBC Wealth Management, Dominion Securities (member CIPF) and can be reached at [email protected].
