Over the past few years, rising commodity prices have produced the best financial years ever for many farming operations, in spite of rising input costs.
Farmers who operate as sole proprietors or in partnerships may be exploring incorporating their operations, which can help reduce taxes.
Below are some considerations to think about if incorporation is being entertained.
Income taxes
One benefit to incorporation is being able to take advantage of the lower tax rates. For example, on the first $500,000 of taxable income, the small business tax rate in Saskatchewan is 15.5 percent, (dropping to 13.5 percent in July) and in Alberta, it is 14 percent.
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Presently, these are significantly lower than personal tax rates, which will be higher once your taxable income exceeds basic personal federal and provincial tax credit amounts ($11,000 to $17,000, depending on the province).
The lower corporate tax rate will allow you to pay down corporate debt more quickly than if the debt is owned personally. If, in a corporation, you get to keep $85 out of $100 earned, this will allow you to pay down debt more quickly than if you could only keep $75 out of $100 earned personally to pay down the debt.
An important consideration is that if you are going to flow all of the income from the corporation into your personal hands each year, you will not be taking advantage of the low corporate tax rate, because you will be paying personal tax on the amounts withdrawn. The low tax rate is only an advantage if you leave income in the corporation to pay down debt or reinvest into the farm.
Asset protection
Corporations are considered separate legal entities. This normally means that a creditor of the corporation would be unable to come after your personal assets in order to pay off the corporation’s debt.
Note that personal guarantees on corporate debt are sometimes required and in these cases creditors have access to personal items.
Income splitting
A corporation is a flexible structure that can allow you to involve family members to participate in the farming business. It allows you to split income between family members whether or not they are directly involved in the farming operation.
If you include your spouse or children as shareholders of the company, you are able to pay them amounts earned by the company through dividends.
When you operate a farm personally, you need to pay wages to split any income of the farm. This makes income splitting more difficult as you would need to pay at the rate you would pay to a person not in the family (an unfair rate of pay for work isn’t allowed).
Dividends can be paid to the corporation’s shareholders without a concern if the amounts are reasonable or fair for the work put in. This is an effective and legal way to split income.
You do not want to pay dividends to minors because there are some rules in the Income Tax Act that would cause these dividends to be taxed at a high rate, undoing any advantages of income splitting.
Other issues
Though there are significant advantages to incorporation, there are other issues to consider. Annual filing and start-up costs can add to the expenses of the operation. You also need to separate accounting records for personal and business expenses, which can add to administrative costs. In addition, any farm losses you experience in the corporation cannot be claimed against personal income from other sources.
For operations run as a sole proprietorship or partnership, losses can be used to reduce your income from other sources. In a corporation, the loss would need to be carried forward (or back in some cases) to reduce future corporate taxes.
Each person’s situation is unique and it is always best to analyze the pros and cons when making any decision. If you are considering incorporation be sure to discuss it with a professional adviser before you put your plan into action.
Colin Miller is a chartered accountant and senior manager in KPMG’s tax practice in Lethbridge. Contact: colinmiller@kpmg.ca. He would like to thank John Blow and Ebony Verbonac of KPMG for their assistance with writing this article.
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