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As a tax specialist practicing in an area rich in agriculture, the end of each year brings about a common scenario of tax deferral and management for the average farm family. Anyone in the farming industry (especially those operating as individuals or in partnership) knows that year end is a time to figure out how much taxable income the farm generated during the year. It is a time to figure out how to “manage” the tax problem. For decades, farmers would fix this problem by purchasing inputs for next year’s crop and deferring as much grain income as possible to a future year. This common strategy provides consistency in reporting taxable grain income due to price fluctuations, production volume changes and input costs variations (among other items) and can result in the deferral of payment of income taxes to a future year thereby managing the current year tax bill.
This type of strategy will become less effective as the farm operation becomes more successful. As a farm matures, debt is paid down, there are fewer fixed assets to invest in and ultimately fewer expenses are available to reduce taxable income.
Under this scenario, many farm families find themselves in situations where the “old” tax plan (deferral) is no longer valid. Consequently, all those years of deferring income and pre-buying inputs may result in a very large tax bill. Usually a tax specialist is sought after to assist in alleviating this problem. Options and strategies may be available to resolve the income tax problem, but often, years of deferring income may prohibit their use. Rushed reorganization steps taken to ease the current year tax bill may eliminate the ability to take advantage of more beneficial strategies in the future.
The Income Tax Act does contain favourable provisions for farmers, farm partnerships and farm corporations, however; strict requirements must be met before they can be used. A common requirement found in those provisions is a holding period test that must be met before certain benefits (like the lifetime capital gain exemption) can be obtained. Other provisions may restrict the transfer of certain assets (like deferred grain income tickets) to a partnership or corporate structure as part of a business reorganization. Often, planning opportunities are “one time only” in nature and if missed or negated with prior reorganization steps are lost forever. Even worse, planning steps implemented without proper knowledge of the Income Tax Act can result in significant and punitive tax results, penalties and interest.
Something as simple as owning land jointly with one’s sibling or the gifting of farm land to a family member can have significant tax results. These “traps” are prevalent in the Income Tax Act and knowledge of their existence is the best defense.
Planning ahead is one way to ensure that you don’t get yourself into a difficult situation. Options and strategies do exist and can result in significant tax deferrals and outright tax savings; however proactive steps must be taken to ensure the requirements in the Income Tax Act are met. Each farming operation is unique and therefore requires careful consideration when deciding which option or strategy is appropriate. Effective income tax planning on an annual basis often goes hand in hand with succession planning, whether the farm is to pass to the next generation or will be sold to a third party. Efficiencies can often be achieved when these topics are discussed together and further tax benefits may result.
Tax planning is a process and not an event. The first step can be as easy as meeting with an agriculture tax specialist to discuss your current farming operation. A plan can be developed to deal with upcoming tax liabilities and to take advantage of the beneficial tax provisions available in the Income Tax Act.
For more information, please contact your local MNP Tax specialist.
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