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Is it time to incorporate your family farm business?

If you run your farm as a proprietorship or partnership and if your total income puts you in any but the lowest personal tax bracket you might want to consider incorporation for several reasons, including limited liability and preferential income tax rates.

When you incorporate your farm business it becomes a separate legal entity that can own property, incur debt, pay taxes and sue or be sued. Your farm corporation operates independently of you, unlike the proprietorship or partnership which are considered to be extensions of yourself. The corporation can issue shares to any number of entities individuals, partnerships, corporations and trusts.

THE POSITIVES OF INCORPORATION

Preferential income tax treatment

If you incorporate your business, your business income will be separate from your personal income and eligible for preferential tax rates that can offer significant tax deferral. Such deferrals could actually become tax savings if your personal tax rate is lower when you do take payments from the business.

When you operate as a sole proprietorship or general partnership, the sum of your business and personal income is taxed at your personal marginal tax rate.

The accompanying table, Top Marginal Tax Rates by Province for 2009, shows the sizable gap between personal and corporate small business tax rates. In all cases, the rate you would pay if you incorporated your business would be significantly less than half of the personal tax rates you would pay operating as a proprietorship or partnership, assuming you were paying tax at the maximum marginal personal rate.

Incorporation also offers benefits beyond reduced income taxes.

Limited liability

As a shareholder of a corporation, your liability in that business is limited to the amount you have invested in it. So, to some extent, you can protect your personal assets such as your home from creditors should your business ever fail. However, the act of providing personal guarantees to creditors tends to erode the limited liability aspect of corporations.

Capital gains exemption

When you hold shares in a business that qualifies as a family farm corporation under the Income Tax Act, you will have a capital gains exemption on the sale of those shares. This means you would pay no tax on the amount your shares have appreciated at the time you sell them up to $750,000. By comparison, the personal tax rates on the sale of a business operated as a proprietorship or partnership can be upwards of 23 per cent (the highest marginal rate of about 46 per cent applied at the 50 per cent capital gains rate), not considering any available capital gains exemption on qualified property.

Income-splitting flexibility

If your spouse or children are involved in the business as employees, shareholders and/or directors, you can distribute funds to them in a number of ways. These include salaries, consulting fees, dividends, directors fees, and even custom-farming arrangements.

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