When it comes to determining whether you should incorporate your farm or not, you need to consider many factors—particularly the tax benefits.
Start with understanding your cash flow position. Do you use all the profits from your farm to pay yourself or does an off-farm job supplement income? Or do you have money left over at the end of every year that you want to reinvest in your farm? When you incorporate your farm, you only pay personal income taxes on the income that you withdraw. Depending on farm income and personal draws, the tax savings of having an incorporated farm can be significant.
For example, in Alberta, assuming your farm makes an average of $100,000 each year, your personal income tax will be about $28,000. However, if your farm was incorporated and you only need to withdraw $50,000 per year, you would pay $12,500 of personal income tax and the farm corporation would incur income tax at Alberta's small business tax rate of 11%, which is $5,500. Each province has a different small business tax rate but the results are similar. This allows you to retain these funds—about $10,000—that otherwise would have been used to pay tax. You can use these funds to pay down debt or reinvest in your farm corporation.
As your farm grows and income levels increase, these tax deferrals will become more substantial. An incorporated farm can grow to a significant size and still pay tax at the low corporate tax rate.
Since farming can be taxed on a cash basis, some farmers can pre-purchase feed or crop inputs to reduce their taxes each year—an option that is also available to farm corporations. However, instead of pre-paying expenses to reduce your corporate income taxes at a rate of $11 for every $100 of pre-purchases, you could instead invest that money in your farm if your yearly farming income is relatively consistent. Investments you make in your farm to help improve crop yields, livestock production, or even operational efficiencies might return you more than the 11% income tax you would save with that same money. It's a worthwhile comparison and will shift your focus from short-term tax savings to long-term business planning. With the corporate tax rates lower than personal tax rates, it allows you to focus on investing in and growing your farm instead of reducing your personal taxable income.
Another advantage of a farm corporation is, in certain circumstances, you have the ability to sell qualifying property to your farm corporation, such as land or quota. You can use your life-time capital gains exemption to shelter that taxable capital gain and create a shareholder loan owing from the farm corporation to yourself, all while incurring almost no income tax. As funds become available in the farm corporation, you can withdraw them tax free to the extent of your shareholder loan. This can assist you in managing your personal taxable income levels and allow you to have the option of withdrawing less funds to achieve the same net cash from your farm corporation compared to paying income tax on 100% of the funds you withdraw. This also allows you to maximize the cash available for you to reinvest in your farm. You should seek professional advice before proceeding with this type of planning as other taxes and possible costs need to be considered.
Additionally you might want to incorporate your farm for succession planning purposes. If you expect you will be transitioning your farm to your children, certain income tax provisions may make it easier to transfer the shares of your farm corporation to the next generation than the actual assets themselves. If inventory such as livestock, feed, or crops on-hand that are used to operate your farm is owned personally and you want to transfer it to your children, the Canada Revenue Agency requires it to be sold at fair market value. As the seller, you will have to pay the resulting income taxes. If the inventory is in a corporation, its value is included in the corporate shares that can be transferred to your children at any value between zero and fair market value. Depending on your situation, a farm corporation can also allow you the ability to transition ownership of the farm to the next generation in a tax efficient manner or to simplify your estate for income tax purposes. These are things that farmers need to consider at all stages of their life, not just at the end.
Further details can be found in our bulletin “Incorporating your Farm Business”. Our BDO professionals can help you assess if incorporating is right for you and your farm. Contact a BDO advisor today.