If a family-farm owner does not wish to offer shares of their familyfarm corporation to a spouse or adult children directly, an alternative planning strategy includes using
a family trust to own the shares of the corporation, rather than the individual family members themselves.
A family trust is an option to consider in addition to the tax planning strategies discussed in our previous column, including a variety of incorporation strategies. It is essential to obtain legal and accounting advice regarding your specific business and family circumstances before selecting such a strategy, but it can be advantageous to be aware of the reasons why such tools are beneficial in some farm situations.
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A family trust is established through an agreement between an individual who contributes initial property to the trust (called the “settlor”) and the individuals appointed as the trustees of the trust. The property used to settle the trust may be money or specific property such as a coin set.
The trustees are the guardians and managers of the trust, who hold the trust property on behalf of and for the benefit of various individuals who are named in the trust agreement as the beneficiaries of the trust. The owner of the family farm business could be a trustee, along with one or two other individuals.
After the trust is established, it can purchase shares in the family-farm corporation.
The advantage of a family trust is that if all of the income received by the trust from the corporation is paid to the trust’s beneficiaries each year, the trust pays no tax and acts as a tax-free flow-through vehicle for distributions from the familyfarm corporation to the beneficiaries. The beneficiaries of the trust would include the spouse, children and grandchildren of the owner.
The trust can have income and capital beneficiaries. Income beneficiaries are entitled to payments from the trust such as annual profits, but cannot receive any other property from the trust, such as shares in the corporation. Capital beneficiaries are entitled to receive property from the trust, such as shares in the corporation.
The trustees may decide how distributions of income and capital are made on an ongoing basis. They may decide to completely exclude certain beneficiaries from receiving an income or capital distribution and may determine the amounts of each dis-
tribution to the beneficiaries. This provides the trustees with control over the assets of the trust, which include the shares of the family-farm corporation, and control over the distribution of annual profits from the business so as to be able to minimize taxes by distributing income to the beneficiaries in the lowest marginal tax brackets.
Accordingly, via a family trust, the owner of a family-farm business can achieve income-splitting on a tax-effective basis with family members while maintaining control of the business.
As an additional planning tool, the owner of a family-farm corporation can incorporate an investment-holding company to be named as a beneficiary of the family trust. The shareholders of the investment holding company could be the farm owner farm and his or her spouse.
The dividends received by the family trust from the corporation may be flowed tax free through the trust to the investment holding company as a tax-free inter-corporate dividend. These funds may then be invested by the holding company, to be extracted at a later date when the shareholders are in a lower tax bracket, such as during the retirement of the family farm owners.
The cash that is flowed through the family farm corporation to the family trust and then out to the beneficiaries is protected from creditors of the farm business, enabling owners to isolate non-business assets from creditors. If the funds are required for the operation of the business, they may be loaned back to the family farm corporation, which loans should be documented with a general security agreement. The security interest created within such general security agreement should be registered in the applicable personal property security registry to ensure the lending beneficiary is registered as a secured creditor.
In addition, using a family trust to flow all excess cash from the business enables the shares of the family-farm corporation to remain eligible for the super-capital gains exemption upon sale by satisfying the required asset criteria for the exemption. The capital gains exemption allows an individual to receive up to a lifetime maximum of $750,000 in tax-free capital gains. While the exemption is also available to shareholders of the corporation and owners of specific types of assets used in the farming business (ie, not just beneficiaries of the trust), using a trust multiplies the potential to shelter several millions of dollars in capital gains from tax upon the sale without making family members direct shareholders of the family farm corporation.
Thus, a family trust may help you better manage tax liability during your career, as well as your estate to reduce capital gains for your beneficiaries. Legal, accounting and financial planning advice is essential to deciding whether, and how, a family farm may be the right choice for achieving these benefits for your farm.CG
Leilani Kagan is a tax lawyer with Thompson Dorfman Sweatman LLP who works with owner-managed businesses and their families to provide tax-effective means of buying, selling and reorganizing their business and implementing their estate planning. She can be reached by email at [email protected].
