Many farmers have already made the decision to incorporate. If you’re still on the fence, here are six potential benefits to consider
Farming has been in the family for generations. The farm you’re operating started out with only a few acres, but over the years it’s expanded. When your grandfather owned the farm, it was organized as a sole proprietorship. Now, you’re grappling with the decision to incorporate — to create a new legal entity for the farm.
Not many years ago my husband and I encountered the same decision in our farming operation.
The process is not without complications. Incorporating, like most things, has pros and cons, and it’s not for everyone. How do you know if it’s for you?
“To incorporate or not,” says Al Kimber, financial consultant at Weyburn Security at Weyburn, Sask., “comes down to income.” Kimber has 24 years experience as a financial planner, and specializes in agricultural and retirement planning.
Kimber says incorporating gives you better control over your farm’s income and taxation.
1. Lower tax rates
There are four personal tax brackets. The first begins at about $11,000 and is taxed at a rate of 25 per cent. The second begins at $42,000 and is taxed at a rate of 35 per cent. The third bracket begins at about $82,000 and is taxed at a rate of 40 per cent. The final tax bracket begins at $129,000 and is taxed at 44 per cent.
While personal incomes can be taxed at up to 44 per cent, corporations earning up to $500,000 in income are taxed at only 13 per cent.
2. No need for income deferral
Incorporating removes the need to continuously defer farm income to keep from jumping up into the next personal tax bracket.
Corporations are taxed at 13 per cent regardless of the level of income. This keeps the “tax tail” from wagging the dog, making way for sound business and marketing decisions.
3. Enhanced estate planning
Some farmers fear that they will not have enough flexibility for estate planning with a corporate structure.
“When that comment is made, people are failing to recognize what the alternative is,” says Kimber. “Corporate structure would never hinder estate planning, and would likely only enhance it.”
There is room for flexibility when using a corporate structure to transfer the farm to the next generation. For example, a share structure could be created where control sits with some shareholders and the opportunity for growth goes to others. Mum and dad could retain control of the corporation, while a daughter just beginning to farm receives a different class of shares, so she can receive financial benefits to grow her farming operation.
Kimber admits that transferring specific quarters of land to certain family members can be administratively more challenging through a corporate structure, but a discussion with your accountant can make this possible.
4. Lower taxes at wind-up
There are advantages to being incorporated when business operations cease, but before the farm is sold, or passed on. Personal tax rates are typically higher than the corporate rate. Kimber says, “In a planned wind-up, typically an active business corporation would turn into a holding company. This can still be a very efficient, and administratively simple, tax structure.”
Nobody likes to think about it, but death of the farm operator does occur, and when it does, taxes must be paid. Tax on death is riskier with a proprietorship than a corporation. A corporate structure allows a bigger window to handle a lump sum sale, for example, inventory, or machinery recapture. Profits from a lump sum sale for a proprietorship will be taxed at personal tax rates.
5. Lower liabilities
Incorporation may reduce liabilities. If you were to be sued personally, the corporation may remain exempt; if the corporation is sued, you may remain personally exempt. Still on a legal note, when the corporation borrows money, you will likely need to guarantee the loan personally.
6. Control personal income
After incorporation, you will need income from the farm for personal expenses. This can be done through wages, dividends, shareholder’s loans or a combination of these. Incorporation makes it easier to split income, such as dividends, between spouses using different share classes. This has been an advantage for my husband and me.
Personal income can be divided between spouses to meet personal and household needs whiel keeping each spouse’s income in a lower personal tax bracket, taxed at a lower rate.
Wages: Wages paid by a farm corporation are subject to the same deductions as non-farm corporation wages, such as the Canada Pension Plan.
Dividends: You can pay a percentage of profits to shareholders to avoid government deductions. However, if you are primarily taking dividends, you may still want to consider paying enough wages to equal 10 per cent of the maximum annual pensionable earnings ($50,100). This would be $5,010 (10 per cent of $50,100) paid as wages, and allow you to qualify for disability insurance under the Canada Pension Plan.
Shareholders loans: Shareholder’s loans are often used in conjunction with wages or dividends, and are a good way to add personal cash flow. Potential shareholder’s loan may be created when assets, such as land, are rolled into the corporation via use of the Capital Gains Exemption. For example, if one quarter of land worth $60,000 has an original purchase value (Adjusted Cost Base) of $15,000, then the $45,000 difference may be exempt from taxation (via the Capital Gains Exemption) upon transfer to the corporation. The corporation now owes you $60,000 — the shareholder’s loan. Your accountant can guide you through it.
Having basic control over your personal income can allow you to take advantage of government programs. Families who keep their family net income below $42,707 (in 2012) are eligible for the Child Tax Benefit. Old Age Security is reduced 15 per cent for any income greater than $69,562 (2012). The GST credit is also affected by income level, and begins to phase out when family net income exceeds $33,884 (2012).
Cons of incorporating
Al Kimber sees only two main drawbacks.
First: the initial cost of creating the corporation. This can run in the thousands of dollars.
Second: the increased annual costs of preparing necessary financial statements, such as corporate tax returns and annual minutes.
“Weigh those to other options,” says Kimber, “and they don’t compare. Assuming that you have consistently reached mid to high income, incorporating will never make your tax situation worse. It can only make it better.”
If you are still pondering the question of whether to incorporate or not to incorporate, talk to qualified tax accountants and legal experts who will guide you through the process. †