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Adult children commonly take part in the day-to-day operations of the family farm - and often before they have any equity stake. They frequently receive less than fair value compensation for their contribution as the family works together to build the business.
Once the business has built up some equity, existing tax rules allow for the transfer of farm equity in the form of shares to be gifted to these adult children to compensate them for their past efforts. Once the child withdraws this equity, it appropriately becomes taxable. However, proposed federal tax changes could apply a punitively high rate of tax on this gifted equity.
The proposed changes will, in effect, be retroactive, as the proposed legislation is drafted to apply to previously gifted equity. Farmers who planned carefully for the future of their businesses using tax laws enacted at the time will have to review plans they might have for transitioning their agriculture business.
In the event a previously enacted succession plan involved a sale to a child that triggered a capital gain on a share of a farming company, precautions must be taken to ensure that value is not taxed again in the hands of the child. For example, it is possible shares may have been sold to a child and taxes paid on the resulting capital gain of up to 24 percent (the same rate that would result if it was sold to an unrelated party). However, the proposed federal tax changes will apply to those past transactions, causing an additional tax of up to 40 percent to the child as payments are made to the parents on the purchase of those shares. The result is double taxation on the same value and the outcome could be a 64 percent tax rate.
The federal government is accepting submissions from taxpayers with their thoughts on the proposed changes until October 2, 2017. As illustrations of situations like the above are brought forward to the finance department, the retroactive implications will be addressed. In the interim, Farmers will need to meet with their advisors as soon as possible to gain an understanding of the rules, the impacts a change may have on their current and future tax liabilities, and then determine what they can do to mitigate the negative consequences.
For more information on how these proposed tax changes may impact your existing or future succession plan, contact Wayne Paproski, CPA, CA, or Shanna Hoffman, CPA, CA, at 306.790.7900.
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