We recently had lunch with Hans Pullteats and Johnny Cash. Pullteats talked the whole time about how much cash he was generating, milk money bought this and milk money bought that and we could see Johnny Cash was just seething. If it went on much longer he was headed for Folsom prison. Pullteats finally left to bed those little money machines and Cash just exploded. He said,“I just finished two of the most successful years on the farm and I can’t seem to use any of it on me or the wife. My corporation Cash Crops Inc. has never felt so comfortable, but the personal tax burden of taking money out has made it next to impossible to use this money personally.”
Johnny had inadvertently answered his own question. Johnny realized that he saved hundreds of thousands of dollars when he initially incorporated and doesn’t regret incorporating. He didn’t however at the time have the patience to think about how he would get money out of this corporation. He started the company for two reasons — wildly fluctuating net income of the past and high levels of net income he expected the farm to generate in the next few years. For an individual to report that kind of net income with personal income tax rates would not have been financially responsible. Johnny’s question to us was simply how do I milk my corporate cow to get some money personally?
We told Johnny we commonly see these six ways to get money out of a corporation:
4. Redemption of preferred shares
5. Sale of common shares
6. Repayment of Shareholder loans
First, a company can pay salaries for justifiable labour or management services. Johnny has four children, three of which are in University. Cash Crops Inc could pay salaries to these children to reflect the work they provide to the farm. These salaries would then be reported as income on the child’s personal income tax return and the children would pay tax on the income. Johnny is currently taking a large salary out himself, then gifting money to his children for their education. This results in Johnny having to pay a higher income tax rate because the kids’ personal exemption is not used. By giving the kids their money in the form of salary, the income can be spread over four individuals rather than one. Also, by drawing money out of the company through salaries the individual is contributing to CPP.
Second, a company can pay dividends to its shareholders. Dividends can be used to distribute the net income of the company after tax to the shareholders. Dividends are taxed at a lower rate to the individual compared to interest income.
Third, rent or lease payments can be paid on personally owned assets that are used by the company. This might include land rent, yard sites, buildings, vehicles or any other tangible assets the company uses. This would be an expense to the company but the payment would also have to be claimed personally as income, thus increasing the taxable income of the individual. The individual does however file a rental statement or statement of farming activities in which assets can be depreciated and expenses such as property taxes can be addressed. It should be noted that the statement of farming activities allows the individual to contribute to CPP, which may be beneficial to the individual.
Fourth, redemption of preferred shares is a common way to withdraw funds out of a company. When a company is formed, the preferred shares represent equity in the company for which personal tax has not yet been paid. When preferred shares are redeemed, this is a taxable income.
Fifth, sale of common shares is equivalent to selling part of your company to the purchaser of the shares. This is significantly different than the other options as in effect this changes ownership in the company and the present ownership structure is diluted.
Last and probably the most attractive option for most landowners would be the repayment of shareholders’ loans. A shareholders’ loan is a loan to the company by a shareholder on which the tax has already been paid. This loan is made to a company by a shareholder with after tax dollars. For unique ideas on how this option can be utilized to pull money out of a company without creating a personal tax liability, give us a call.
Johnny left lunch realizing he is not going to be getting a milk cheque for the corporate cow any time soon but he does have some options. He understood that there more ways to get money out of his company than he first anticipated. Given the complexity of the business we decided to meet again to put together a strategy to get money out of his company with minimized tax implications.
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 or 204-825-8443.