Is it possible? Could I sell my quota, sell my herd, sell my farm, and retire? Or will I merely be reducing the national debt. Will I retain enough cash to live prosperously? Will I be able to leave my children and grandchildren a healthy inheritance? Or will I find that the taxman has benefited more than I have? Will I be forced to farm until I pass on? Should I leave my children to sort out my affairs and satisfy the government? Or can I plan in advance for my retirement and keep the majority of the wealth that I have worked so hard to build.

 

Yes Virginia, farmers can plan for retirement.

 

In most people’s minds retirement means “simplify”. Rid yourself of the daily burden of work. Eliminate the risk of losing your hard-won net worth. Cash in your farming assets and enjoy your money. Transfer the farm to the kids and collect your monthly mortgage payment.

 

One of the realities in today’s farm environment is that many young people cannot afford, or do not want, to take over the family farm. This leaves the parents with very few options for retirement; the most obvious of which is to sell.

 

It is very true that a poorly planned, hastily arranged farm sale could lead to disastrous tax consequences. Imagine the farmer who sells all, takes back a mortgage, but fails to obtain a down payment sufficient to cover his tax. Imagine the tax on the sale of a herd, the sale of quota and the sale of two years of crops, all in one year. Taxable income over $103,000 attracts tax at a rate of 46.4%.

 

It is also true, with proper advanced planning, tax on a farm asset or share sale can be substantially reduced.

 

Start Well Before Retirement

The wise farmer begins his plan for retirement 3 to 5 years before hand. There are several ways to prepare for a sale or a wind down.

 

Maximize the low tax rate bracket every year.

The lowest marginal rate of tax is 22%. This applies to taxable income below $31,677. Farmers planning to retire should maximize this low bracket in the few years before, saving expenses for the year of sale. Some methods to accomplish this are as follows:

• Increase annual farm income by using the optional inventory to gradually build a cost base in livestock or grain inventory. This will reduce income in the year of sale.

• Pay reasonable wages each year to a spouse to bring him or her up to $31,677. This will enable you to build the optional inventory faster.

• Defer and accumulate RRSP deductions until the year of sale. Contributions may be made each year, but the actual deduction can be saved to use against income subject to higher rates of tax. Lump sum contributions can be made in the year of sale up to your total entitlement.

• If income is still below $31,677, consider reducing capital cost allowance claims. This will reduce income from the sale of buildings and equipment.

• Defer claims for drainage and land improvement expenses until the year of sale

• Farming corporations should pay salaries to its owner/managers to maximize their low brackets. The company can utilize the above tactics to defer expenses, as well as carry forward unused losses for 10 years. 

Maximizing the low tax bracket has the added benefit of increasing your Canada Pension Plan contributions. The additional retirement income could come in handy.

 

Although you will pay income tax in these years before retirement, the rate will be the lowest available. The tax savings could be as high as 24% of any expenses you are able to defer.

 

Sell crops in the year they are produced

Many farmers routinely defer crop sales until after their fiscal year end. This is an effective means of tax deferral. Imagine, however, the outcome of a spring farm sale while the entire crop of the previous year is still in storage. There will be no input costs to offset the income from the sale of the stored crop. Unless the crop is held until the following year, its sale proceeds will be taxed along with the herd sale, equipment recapture and other income items.

 

In the years before retirement you should gradually reduce the amount of crop carry over. This will reduce your overall tax in the year of a sale.

 

Reduce input prepayments

Input prepayments and crop sale deferrals have the same effect. As in the case of crop sale deferrals, the retiring farmer should gradually reduce the amount of input prepayment in the years before retirement.

 

Split the Sale

There is nothing that says all assets must be sold in the same year. If a sale can be timed around the fiscal year of the farm, some assets can be sold on the last day of the year while others can be sold on the first day of the next year.

 

For example, the land, buildings and equipment could be sold on December 31 while the herd and quota could be sold January 1. This would split the income between two years, and may also reduce or eliminate the “Alternative Minimum Tax” by splitting the capital gain between two years.

 

The Income Tax Act allows for the deferral of a capital gain over a period of up to 5 years if the taxpayer has taken back debt as part of the sale proceeds (10 years for a sale to family). The gain on quota, however, is not eligible for such a deferral.

 

One way to achieve the maximum deferral of a capital gain on land is to structure the sale agreement such that the down payment is applied to the quota, equipment or other assets. The mortgage or other debt is taken solely as consideration for the land. The amount of capital gain taxed each year will be 1/5 of the total gain on the land (or the pro rata portion of the gain based on the proceeds received in the year, whichever is greater). If the gain is eligible for the Farm Capital Gains Exemption, this deferral may reduce or eliminate the Alternative Minimum Tax that typically arises when a large capital gains exemption is claimed (the AMT is recoverable in future years as an offset to regular tax).

 

Transfer Some Assets to a Company

The rate of tax on the first $200,000 of active business income earned by a corporation is 19.2%. In some circumstances it may be advantageous to transfer assets such as crops, livestock and equipment to a company immediately prior to a sale. The assets are “rolled” to the company free of tax in exchange for a combination of shares and debt. The corporation then sells the assets to the purchaser, paying tax of 19.2% on the first $200,000 of profit. Income over $200,000 can be paid to the farmer in the form of a commission or wage to be taxed personally.

 

The corporation will now hold cash. The farmer can take out a portion of the cash tax-free. This tax-free amount is equal to the tax cost of the assets transferred in. The remaining cash (equal to the after tax profit on the sale) can be invested by the company and paid to the farmer as dividends over a number of years, keeping his personal taxable income as low as possible.

 

In some cases the income on farming assets may exceed $200,000. As an example, assume a farmer has livestock inventory of $400,000 with no corresponding bank loan. Planning for retirement a year in advance, the livestock could be rolled into a corporation at the beginning of year 1. At the end of year 1, the company would use an optional inventory to create corporate taxable income of $200,000. This would attract tax of approximately $38,400 and would create a cost base in the livestock of $200,000. On the first day of year 2 the farmer sells the livestock for $400,000. Corporate income in year 2 will be $200,000 (i.e. $400,000 less the $200,000 optional inventory from year 1). This will attract a further $38,400 of tax. Compare this corporate tax liability of $76,800 to a potential personal tax liability of 185,000 and you can see the advantage of this type of planning. As above, the cash is held in the company. It can be invested and withdrawn over time to minimize the resulting personal tax.

 

Sell Shares Rather Than Assets

Many of today's farms are incorporated. The sale of assets by the company usually results in considerable tax payable. The company is not eligible to claim a capital gains exemption on the sale of its land or quota. In addition, much of the cash that is eventually paid to the farmer from the company may be subject to personal tax.

 

A capital gain on the sale of shares of a Qualifying Farm Corporation is eligible for the Farm Capital Gains Exemption. That is, each individual shareholder will pay no tax on up to $500,000 of capital gain on a share sale. This is very attractive since the cash will be outside the company, and the shareholders will not have to continue to administer the company, nor wind it up.

 

In most cases the purchaser would rather buy assets than shares. He cannot depreciate shares, and he is purchasing a company with an unknown history. Structured properly, however, a purchaser of shares can achieve a “bump” in the cost base of the land up to its fair market value.

 

The seller should be willing to reduce his price to compensate the purchaser for his foregone depreciation. These amounts can readily be determined by a chartered accountant. The result is a win-win situation.

 

A well-planned farm sale can yield thousands of dollars more than a poorly planned sale. You should begin your descent (or ascent) to retirement long before the actual date. Your accountant should play a key role in the process. This article is merely an outline of the considerations in a retirement or farm sale. The actual plans and processes are as individual as the farmer is himself.