$10,000 ASSETS CURRENT ASSETS INTERMEDIATE ASSETS TOTAL LONG TERM ASSETS LIABILITIES CURRENT LIABILITIES TOTAL INTERMEDIATE LIABILITES LONG TERM LIABILITES
Last weekend we were out to see Jimmy Bond race his new snowmobile. Bond is the kind of farmer who lives for the moment. He is the kind of man who wears a red jacket into the bull pen and there isn’t a PTO shield in place on his farm.
We were doing annual planning for Bond but his lifestyle begs the question that many of us should ask. What if we died tomorrow? Lots of life insurance is an obvious answer but this has cost associated with it and there is a limit to what many farms can afford. We started firing questions at Jimmy like Russian interrogators and he wasn’t talking! Our first question was centred on the tax consequences if Jimmy died tomorrow.
Jimmy operates as a sole proprietorship, his wife of sixteen years Kitty, receives a wage from the farm. They have a daughter named JoJo who works professionally and is not involved in the farm. They have a son named Roderick who married a Mexican writer named Juanita. Who also both live and work on the farm.
Jimmy came to us with the balance sheet pictured at right.
When considering our question of the tax implications of Jimmy’s sudden demise, we came across a potential problem: Jimmy had never considered that, as a sole proprietor, all his inventory will potentially be deemed to be sold to whomever he leaves it to; resulting in a taxable income of $1,250,000. Ouch! This sum, taxed at the highest rate, could be a significant amount of tax (assuming a 50 per cent tax bracket). Although there are provisions that will allow the tax payable to move with the inventory to a spouse or child who inherits it, that individual is forced to continue the business or pay the tax. If they do not continue the business, the inventory is sold without any expenses to reduce net income and the tax becomes very significant. This can be easily avoided by structuring the operation slightly differently.
Jimmy could form a partnership with Kitty and upon his death it could be continued on, and inventory pre-bought or sold slowly to minimize tax. Partnerships are easily formed and often hard to get out of. Challenges that would still lie ahead would include how Jimmy and Kitty would eventually get out of this. What would be the impact if both partners die in a car crash?
Jimmy could also incorporate the operation and roll the inventory into a corporation. The corporation share could then be left to Kitty, Roderick or Jojo. The inventory would not be sold upon his death and this would avoid the excessive tax bill.
Jimmy must think this through very carefully his initial reaction was to leave 51 per cent of the farm shares to Roderick and 49 per cent of the farm shares to Kitty. The controlling interest would be in Rod’s hands. If Rod dies then his share would be left to whom? If his wife Juanita inherits them and she decides to sell the farm and write from Mexico the farm is sold. This scenario was something Jimmy did not want to happen.
What happened in the end? Well, in the end Jimmy decided to incorporate the farm primarily to avoid future tax problems from anticipated net incomes, but also because of the need to have a clear and affordable estate plan. Secondly he decided to leave 49 per cent of the shares to Roderick and 49 per cent of the shares to Kitty and two per cent of the shares to Jojo. This way he felt the farm would never be sold with out the majority of the family agreeing to it. Kitty indicated that her share would be left to Roderick upon her death.
Andrew DeRuyck and Mark Sloane manage two farming operations in southern Manitoba and are partners in Right Choice Management Consulting. With over 25 years of cumulative experience, they offer support in farm management, financial management, strategic planning and mediation services. They can be reached at [email protected]and [email protected]or 204-825-7392 and 204-825-8443