My mother-in-law grew up on a family farm in Wales. Uncharacteristic, as far as farm life goes, she described her early years as pampered and storybook. Her loving father doted on her and her sister while he carried most of the load on the farm himself. One of her earliest memories is biting her sister in the leg while they were playing in the house.
Not as retribution, but because she was bored.
A few years later, as a beautiful young 18 year-old, she moved away to train as a nurse during the Second World War. What anxiety her parents must have felt knowing that Nazi bombs were dropping over the United Kingdom's darkened cities, damaging, but not destroying the very building their daughter was housed in. On one such bombing raid, the young lass and her companions had been huddling in the basement with their patients, and became anxious to see what was going on. Against the rules, they mischievously snuck out of the bomb shelter to peak out the upstairs window and see what was happening. There they saw the nearby devastation, with fires and rubble nearby. Fortunately, she and her friend lived to tell the tale.
Back on the farm, eventually her father helped her nephews secure the neighbouring property to keep up the family dream. The boys have since made it in to a significant enterprise today, one of the U.K.'s largest egg producers.
There are a few key risk points in the life cycle of any business. The first is during the early years, when cash flow is typically very tight.
Another is an inter-generational transfer. As often as not, the second or third generation is not equipped to manage the day-to-day trials of making ends meet.
Another crucial conversion point is the eventual transition from family managers to professional, where hired executives oversee other staff, finances, marketing and so on. The incorporation decision is somewhere along this journey, and probably as much a factor of size as anything.
Transitioning family values in to a corporate culture is tricky, and not always successful, but the enterprise seems to be working so far back in Wales for my wife's extended family.
Incorporating the Family Farm - Part 4
In this segment on incorporating the family farm, we look at a summary of key issues which may help you make this decision.
Should You Incorporate?
When deciding whether to incorporate your farm, consider the following:
Is your farm producing more income than you need for personal expenses? If so, incorporating may allow you to benefit from the income splitting strategies discussed above.
Do you have significant sources of non-farm income which can provide you with sufficient cash flow? If so, it may make sense to incorporate your farm. If incorporated, the farm income will be subject to the lower corporate tax rates, as opposed to your high personal marginal tax rate. You can achieve tax deferral by keeping the profits inside the corporation and pay yourself a salary or dividends in a later year when your marginal tax rate is lower.
Do you need all or a substantial portion of your total farm and nonfarm income for your annual living expenses and financial goals? If so, incorporating your farm is likely not a solution. You may not be able to benefit from the tax-deferral a corporation can offer if you need to receive a significant amount of the corporation's income as salary or dividends to cover your living expenses.
If your farm does not have a history of profits, it may not make sense to incorporate. As mentioned above, if your farming business is your chief source of income, farm losses incurred personally can be used to offset other sources of income, which will reduce your overall tax burden. However, as losses incurred in a corporation cannot be used to offset personal income, it may not make sense to incorporate your farm if you are generating farm losses.
If you are just starting your farm business, this may not be the right time to incorporate. Farm businesses may generate losses in the first few years of operation. As mentioned above, these losses can be used to offset other sources of personal income if they are generated personally. If incorporated, the farming losses can only be used to offset income from the farming corporation in a future period.
Are the potential tax savings from incorporating greater than the fees associated with establishing a corporation and the on-going costs of maintaining the corporation? As mentioned above, establishing a corporation can be expensive and complex and these costs should be considered in the context of the tax savings that can be achieved by incorporating.
Incorporating a farm certainly has benefits, but may not make sense for all. It is important to consult your legal and tax advisors to determine which structure is best for your personal situation.
Mark Ryan is an advisor in Prince George with RBC Wealth Management, Dominion Securities (member CIPF) and can be reached at [email protected].
