The earlier a farm family starts succession and transition planning, the more tax options are available to them, says John Anderson of the Canadian Farm Business Development Council.
Anderson used the analogy of eating fast food.
“If you want a fast food meal, you can expect acid burning of taxes,” he said. “If you don’t plan, you may not be able to use tax strategies that can save money.”
Begin by breaking down assets into tax consequences, the senior manager of the council’s farm succession project said while citing a plethora of federal and provincial tax laws.
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“You cannot give anything away,” he said, noting the proceeds from each asset is calculated into income in the year of disposal. “Someone has to pay the tax man.”
While farmers can’t eliminate paying taxes, a good succession plan using the right farm structure can reduce the amount of taxable income in any one year.
One example is a farm partnership. Tax laws allow inventories such as livestock, crops and supplies to be rolled into a partnership. The farming parents and their successors hold shares in the partnership. The children can slowly buy this “share capital,” subject to different tax rules, to minimize and spread out
tax implications.
Anderson recommends creating a partnership arrangement from three to 10 years before a planned retirement.
“If you do it six months before retirement, someone may come knocking at your door to look at your books,” said Anderson.
If the partnership shares increase in value 10 years later, the partners can claim a capital gains exemption. Each parent can also claim a capital gains exemption if the land is registered in both their names, said Anderson.
The $500,000 capital gains exemption is available to individuals on the sale
of qualified farm property. The exemption is claimed by the partners
in a partnership, since taxes are paid at the individual level.
Farm property qualifying for the exemption includes land and buildings, shares in a family farm corporation, an interest in a family farm partnership and quota, considered eligible capital property.
Current tax laws relate to assets acquired since Jan. 1, 1972. Anything purchased before then falls under different rules.
Depreciable property, such as machinery, equipment and buildings, is also subject to capital gains but cannot incur losses. For example, selling a machine for more than the original cost results in a capital gain. If it were sold for less, the loss on the sale is not deductible for tax purposes.
Corporations do not have any exemption.
Acquiring shares as gifts or by sales is another option for families to consider, said Anderson.
For example, Dad can ask for a demand note, an IOU from the children for their share. As long as it is not paid, it does not count as income, Anderson said.
“The demand note is security to the parents because they know if they need it they have the right to ask for it,” said Anderson. “If they don’t need it, it can be transferred through their will or estate.”
These notes should be payable on the 367th day after the demand is made, to ensure that payments fall over different tax years, he said.
Creating a five- to 10-year capital reserve is another option to allow payments to be made over many years, reduce taxable amounts coming in at one time and to avoid the alternate minimum tax (AMT).
Anderson noted there are two personal tax systems in Canada, the well known income tax and the AMT. The latter was created to collect tax from people with high yet irregular gross incomes who were paying little or no income tax.
“If calculation under the AMT is a greater tax payable than the tax under regular tax, you pay the AMT.”
Under the AMT, retirement savings plans and capital gains exemptions cannot be used as deductions. Here, the individual claims income, less expenses and the personal deduction.
The amount by which the AMT exceeds the regular tax can be carried forward over seven years, as a credit against future regular income tax. That can be incorporated into a long-range tax plan, which spreads taxable income over several years and several partners.
In a partnership agreement, taxes can be deferred, the parents can continue to get income through the partnership and the succeeding child can have income based on the labour, management or capital he contributes to the business.
Parents can also increase their Canada Pension Plan contributions in their final work years and ensure a healthier retirement income.
Citing numerous complex and changing tax rules, Anderson recommended that families doing succession planning talk to professionals with expertise in farm transfers.
“It can provide options that do not put stress on the family,” he said. It can also save money, increase confidence in their succession plan and allow them “to rest at night.”
