By Bud Arnold, CPA, CA, MAcc, Partner Baker Tilly, Guelph
If you’re thinking about farm succession planning, there are many areas to consider. One key consideration is determining how to include the next generation in the structure of a farm business while the parents are still involved. If you plan to include more than one generation at the same time, there are several ways you can include a child or successor as a partial owner.
When involving the next generation in the ownership of your business, it’s always important to think through your goals. These could be focused on the management side or getting the kids more involved in financial matters, investing their resources in the business and sharing in its growth. Once your family’s goals are clear, talk to your advisors about the structure that’s best for your business.
A corporation is one of the more formal structures available when you start a business. However, some farmers are reluctant to start a corporation because it’s expensive compared to some of the other options. It can also be somewhat complicated because a corporation is a separate legal entity, but it’s worth noting this option offers full control of how we structure the shares of the corporation. We can completely separate the growth in the current value of assets, the voting control of the business and the operating or managerial control of the business – which includes signing authority – among different people in the corporation. Depending on your goals for the business, that can provide many helpful tools for your succession plan.
When involving the next generation in a farm business, we generally need a little more formality, so we’ll want a written partnership agreement outlining who’s contributing what assets and how the income will be distributed out of the partnership. This agreement should also indicate how the value of the partnership assets will grow and how difficult decisions will be made. We still need to add some of the formality of a corporation, but one of the benefits of a partnership is it’s not a separate person for tax purposes, so we can usually avoid filing a tax return for the partnership. The record-keeping requirements are a little less arduous for a partnership, and it can help keep more flexibility regarding the distribution of assets. Since a corporation is a separate legal entity, taking assets out is a taxable event. With a partnership, withdrawing cash is not taxable, because partners pay tax on their portion of the income each year. Taking capital assets out can be a taxable event, but when you take out a capital asset, each partner could have access to the capital gains deduction, which isn’t available within a corporation.
When you form a joint venture, no additional entity is created for tax or legal purposes. It’s just a contractual relationship in which two or more parties enter into a particular business function together. In some farm succession planning, certain farm assets are placed into a joint venture and different parties are involved in determining how the operations continue. In a joint venture, each party reports their proportion of gross revenue and expenses. This adds flexibility because now one of the venturers can sell their share of the assets to somebody else – whether another venturer, sibling, child or anyone else involved in the succession – without impacting the rest of the venture. If someone no longer wants to be involved with the family business, the easiest way for them to be removed is through this structure.
Since 2018, tax on split income rules have limited some of the benefits of family trust planning, but one significant opportunity is still available. A family trust can hold farm property and the operations of the farm, while trustees of the trust control the property and distribution of any profits. That keeps control with the trustees (who are generally the parents) for the benefit of the beneficiaries (who generally include the kids). But where this becomes really helpful is when the trust owns the farm property and it’s sold. The capital gain on that farm property can be distributed between all the beneficiaries, and we can use all their capital gains deductions on that sale. In a succession plan where parents are looking to sell the farm at some point in the future and the farm is owned by a family trust, they might be able to make use of more capital gains deductions and enjoy significant tax savings.
All of the structures outlined above have different legal implications with regard to family law, contract law and commercial law. In addition to tax advice, we recommend you seek competent legal advice before deciding how to structure your farm business for succession planning.