Incorporation questions often come to this column. Recently Saskatoon lawyer Al Haubrich from the Robertson Stromberg firm, who has a particular interest in farm estate planning and intergenerational farm transfers, shared his top 10 reasons why a farmer should incorporate.
Deferred sales no longer available – A sole proprietor can no longer defer sales of inventory such as cattle or grain. He will pay considerable income tax if the inventory is sold. “Sometimes, a farmer makes significant year-end purchases to try reduce income,” Haubrich said. However, because a company pays tax at a lower rate, inventory can be transferred to a company and then sold by it.
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Tax deferral – A company pays tax at a lesser rate.
Debt payments cost less – Ifthe farmer has loans, the interest component is deductible, but principal repayment is made with after-tax dollars. If the company owns the asset on which the loan payment is made, the company has more after-tax dollars to repay the debt. Similarly, a farmer expanding his or her farming operation should have the company purchase the additional land or machinery because it has more after-tax dollars.
Income splitting – If one spouse’s income is higher than the other’s, more tax is paid by the family unit. The company determines what each spouse will be paid, assuming both are shareholders or work for the company, and what earnings will be retained by the company.
Using the $500,000 capital gains exemption – Farmers still have the benefit of this capital gains exemption. A farmer may be concerned it will disappear as did the $100,000 individual capital gains exemption a few years ago.
Estate freeze – The farmer may want future increases in farm value to go to the children or the spouse. By incorporating and creating the right business structure, a farmer can own the voting shares while the growth shares can be owned by the children, spouse or both, or a family trust, thus effectively doing an estate freeze.
Keeping the farm intact – The company remains a unit after death and shares can be allotted to children.
Tax savings for partners – If you have been farming in a partnership, incorporation represents an opportunity to save income tax. If your partnership contains large inventories of grain and cattle, it would be wise for each partner to sell his partnership interest to the company. Each partner can use the $500,000 capital gains exemption. The company can pay for these assets by loans, which it pays with after-tax corporate dollars and which are received by the individual as after-tax dollars.
“This is a unique tax advantage currently available for farm partnerships,” Haubrich said.
Easy-to-use structure – A company is a business arrangement that allows two or more individuals to pool their resources and management skills, often resulting in cost savings and improved output. A shareholders agreement can outline how they will work together in managing the company and how to divide assets when one leaves. An ideal time to incorporate is when a farmer is bringing a new person into the existing farming operation. In addition, Haubrich said, “lenders like to deal with corporate structures as they are used to dealing with companies.”
A company has limited liability – In the case of a negligence claim against the farming operation, the claim can only be made against the company. Personal assets are not threatened. However, in terms of loans, the banker will undoubtedly ask the shareholders to guarantee any loan.
Next week, we discuss whether the land should go into the company.
Don Purich is a former practising lawyer who is now involved in publishing, teaching and writing about legal issues. His columns are intended as general advice only. Individuals are encouraged to seek other opinions and/or personal counsel when dealing with legal matters.
