Producers who operate a personal farm have probably thought about whether it is a good idea to incorporate.
There are several important considerations because every individual’s situation is different.
Here are some things to think about when considering incorporation.
Tax rates :The government has es-tablished personal and corporate tax rates in such a way that income earned in a corporation that is paid in its entirety to an individual results in relatively the same combined tax as if the income has been earned entirely by the individual operating as a sole proprietor.
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Incorporation will likely provide producers with little tax relief if they use all of their farming income to support personal finances.
However, a corporation can provide tax benefits if they do not need all of the net income for personal expenses and wish to reinvest some of it back into operations.
Corporations are taxed at lower rates than businesses that are operated personally. Leaving some of the earnings behind in the company would give it more after-tax dollars to reinvest and pay down farm debt more quickly. This means big ticket purchases such as equipment and land wouldn’t be as big of a strain.
Asset protection: The act of incorporating creates a new legal entity, which has the same rights and obligations under Canadian law as an individual. This means the company can acquire assets, enter into contracts, go into debt and be sued, which limit personal liability by keeping personal and corporate assets separate.
Fiscal year flexibility: An incorporated business can choose a non-calendar fiscal year that may work better for a producer’s business cycle.
They might choose a slow month for year end to ease administration. Alternatively, they may time their year end to cut off when cattle or grain prices are normally softer.
As well, a corporate year end that staggers the calendar year can allow for effective tax planning when funds are taken out personally, which allows producers to defer personal taxes to a future year.
Income splitting: If spouses and adult children are shareholders in the corporation, any dividends they receive will be taxed in their hands.
A corporation can employ family members as long as the amount paid is considered to be reasonable for the work performed. Reasonability is based on what would normally be paid to a non-family member to do the same work.
Producers who operate a sole proprietorship need to pay wages to split income. They need to be cautious to ensure wages appear appropriate.Dividends can be paid to the corporation’s shareholders without a concern if the amounts are reasonable or fair for the work done. This can be an effective way to split income among a family. A shareholder does not have to be actively involved in the corporation’s business to get dividends.
Spouses and adult children could be shareholders, giving the opportunity to redistribute income from family members in higher tax brackets to those with lower incomes that are taxed at a lower rate.
Capital gains exemption: A $750,000 capital gains exemption is available if the corporation is considered a qualifying farm corporation or small business corporation. This will shelter the gain that will arise when the shares are sold or on death.
Shares in a family farm corporation can also be given or transferred to the next generation without any tax consequence to the original shareholder.
This is similar to the rules farmers benefit from when owning farmland personally. These rules are specific, so be sure to talk with a tax adviser to ensure the operation would qualify.
Drawbacks: Against these potential advantages, producers will need to weigh the legal and administrative costs of setting up and maintaining the corporation as well as keeping separate books and filing corporate federal and provincial tax returns.
