A couple we’ll call Mark and Susan, both 59, have been farming in south-central Manitoba for three decades. They have had off-farm work too, both in a machine shop Mark owns where Susan does administrative work as an employee. The farm, 1,440 acres valued at $3.45 million, and the off-farm business, organized as a corporation, are both profitable. The value of the land plus the $200,000 estimated value of the machine shop, suggests that the couple can have a prosperous retirement.
Mark and Susan have no children, and have come to a point in their lives at which they want to turn the substantial equity in their farm and business into retirement income. They would like to continue farming, but spend winters in Arizona.
Mark and Susan approached Don and Erik Forbes, of Forbes Wealth Management Ltd. in Carberry, Manitoba, for a tax-efficient plan to turn their businesses into retirement income. He suggests a process in stages.
First, wind up the machine shop. The business can pay Mark $60,000 a year in dividends. The farm can pay out $20,000 a year and then defer additional income, Don Forbes estimates.
Second, Mark can purchase the plant and equipment of the machine shop company for $200,000. He might need a short-term loan to finance the transaction, but he will get the money back when he liquidates the business.
Third, create a farming partnership with Susan for long-term income splitting.
Fourth, sell one or two quarters of land for cash to help with liquidating the company and to make hefty RRSP contributions to defer taxable income, to build up Tax-Free Savings Accounts, and to make taxable investments when they have hit RRSP and TFSA limits.
The goal of the plan is to hold annual taxable income in a band from 26 to 35 per cent, to avoid having the maximum amount of income deferred until death where the tax rate could be 50 per cent or higher. As well, making the sale in stages is flexible and can be halted or adjusted at any time.
The machine shop can generate as much as $80,000 a year of pre-tax income. The company can issue taxable dividends, or reduce retained earnings or increase the salaries that Mark and Susan draw.
The machine shop can sell its assets at market price to Mark and Susan. The business would report its sale and pay taxes due. What is left over could be distributed to Mark and Susan.
Alternatively, Mark and Susan could form a new farm corporation and then transfer in at market value the equipment and other assets of the machine shop. The farming corporation would take a promissory note as a shareholder loan and/or fixed value preferred shares. The machine shop would be wound up, but Mark and Susan would need enough cash in the business to pay any taxes owing. Creating companies, paying incorporation costs, and doing the books for a couple of more holding companies would add to total costs but would not avoid the final tab of eventual taxation of distributed money at what could be peak rates.
There is another way: create a partnership for the farm with Susan. Each partner would then be eligible for the Qualified Farmland Capital Grains Exemption Credit. That would save about $200,000 in tax. The new partnership would purchase the machine shop’s assets. Income paid out would keep each partner’s income at about $80,000 per year, Erik Forbes suggests.
The exemptions would be two times $1 million plus the allowable exemption of the primary residence and one acre, a $200,000 further exemption. There are other tax postponements and tax eliminations to use for income saved.
“They should consider a provision in their wills for donation of remaining land and/or financial assets to good causes,” Don Forbes says. “That donation would eliminate any final tax burden.”