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Lucky you, there is gravel in your farm land worth a lot of money!
Lots of money usually means income tax. What are the income tax consequences?
Generally, if the gravel company pays you or your company (if land is company owned) a specific amount per tonnage extracted, the tax man will treat the payments as income – 100% taxable.
For a company receiving the gravel payment, the income will usually be treated as investment income, taxed at the highest corporate tax rate of 44.67% on every dollar received.
Active Business Income
In order to change the gravel receipts from investment income to active income, taxed at the lower corporate tax rate would require some level of activity incurred by your company, for example:
However, this simply may not be feasible.
Investment income and active business income will be taxed as earned over the course of the gravel extraction contract.
If the Gravel Extraction Contract is structured at the outset as a one-time sale of all gravel for an overall lump sum amount, gravel receipts can be taxed as capital gains – only ½ of taxable gains are taxable.
The result will be a much lower overall tax situation – corporately and personally .
The key is to structure the Gravel Extraction Contract at the outset which provides you or your company with capital gains, and at the same time does not prejudice the gravel company.
This can be accomplished by:
Unfortunately, for capital gains the entire capital gain will be recognized over a maximum 5 year period with all taxes paid. For example, a 10 year Gravel Extraction Contract for an overall $5M lump sum, all taxes will be paid on the $5M gain over the first 5 years even though the $5M payment will be made over the 10 year contract period.
Therefore, one must be careful to ensure sufficient cash is received to pay income taxes over the first 5 year period. After this 5 year period, future gravel receipts will be received without future tax.
Unfortunately, tax law is not black and white. The tax man may disagree and try to reassess any gravel contract as income – not as capital gains.
But there have been successes in dealing with the tax man in the past, yet it may require going to tax court to obtain favorable capital gains treatment.
Upfront planning before entering into a Gravel Extraction Contract is a necessity because the tax results can be dramatically different.
For further information, contact Randall A. Hay, MBA, CA, or your local MNP professional advisors.
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