One of the major benefits of incorporating a farm is that farm net income is then taxed at a corporate rate. The savings vary across the country (see February Country Guide) but for example are about 35 per cent lower than personal income tax rates in Manitoba and for Ontario.
In most cases, however, it’s a temporary saving. The taxman will catch up with you eventually, and along the way you need to be careful to protect your lifetime capital gains exemption.
“It (incorporating) is a great deferral mechanism,” says accountant Geoff Garland.
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Deferral is the key word. When money goes from the corporate account into your pocket, you get taxed. “If you’re going to take everything out as a salary, then there’s not the tax benefit,” Garland says.
You should also use other mechanisms to shelter or defer personal income tax before you invest in the added costs of incorporating. “Do you have room in your RRSP? Can you take advantage of income splitting?” asks Garland. “At the end of the day, will you pay more taxes?”
Also remember that your income will be taxed when you withdraw it, says farm adviser Carl Moore.
When the retiring farmers take the money out of the corporation, they pay the top rate of personal income tax, he points out. “It’s one of the biggest problems I find.
“Once you put land into a corporation, except in vary rare occasions, you lose your capital gains exemption,” says Moore. He advises his clients who really want to incorporate their farm to keep their land out of the corporation so they don’t lose their capital gains exemption of $750,000.
With a sole proprietorship, accessing that excemption is easy. “It’s half a page and five minutes on your income tax report,” says Moore.
“You’ll make more money using your capital gains exemption than you ever will farming,” says Moore. “And the best way to access that is as a sole proprietor.
“Essentially, if you’re in corporation the only way you can get the capital gains exemption, from the corporation is to sell the whole corporation,” says Moore. There are ways to access your exemption for the sale of shares from a corporation but it’s going to cost more in accounting and legal fees and your time.
Even if you keep the land out of the corporation, it isn’t always simple. Be careful not to lose your farming status, Moore says. If you’re considered just a landowner, it may also affect your exemption qualifications.
Also remember that if your assets are tied up in a corporation, you’ll have less flexibility, Garland says. If you want to take money out of the corporation to pay for a cottage or for a condo in Arizona, you’ll pay tax on it first.
Using the corporation to buy your retirement dream can be problematic too. “The Canada Revenue Agency is not fond of a corporation buying personal assets for an individual,” says Garland. It’s not illegal, but they will want to tax you on how much earning capacity you’ve removed from the corporation.
Moore has seen many parents leave their money in the corporation so they don’t pay taxes. They live in poverty until they die and have multimillions tied up in a corporation. “It’s very sad but instead of getting the money out for living, for education and for retirement, they look at the combined tax rates and they just don’t do it,” he says. “Many people live for the corporation.”
Whether you are in a corporation or a sole proprietorship, over a farmer’s lifetime on average, the taxes will almost be exactly the same. The overall small tax savings in a corporation are eaten up by additional legal and accounting fees. “Preferential income tax treatment is the biggest fallacy,” says Moore. “You pay taxes now or you pay it later.”
However, Moore concedes that in some situations corporations can save tax money. “It would be an advantage if your cash income is too large, say if you’re milking 500 cows and have no debt,” says Moore. But not too many farms have that problem.
