Last updated: Oct. 8, 2021
Whether you want to shelter farm income from high personal tax rates due to increased off-farm income, or your profits surplus is beginning to go beyond your personal expenses – you may be asking yourself if your business structure needs a revamp.
Back in 2016, an average of 51.71 per cent of farms reported being a sole proprietorship, but with new census data on the way in 2022, this number will likely decrease as incorporation rates rise.
Does that mean it is the right choice for you? Well, you may also consider these other reasons to incorporate:
- Your corporate tax benefits outweigh the costs of extra administrative duties,
- You want to reinvest portions of capital into expansion,
- Your debt servicing demands a large portion of profits; or
- You want greater flexibility for closing or selling your business.
A key benefit to incorporation is the preferential income tax rate. When you operate your business as a sole proprietorship or partnership, you include all your business expenses and income – including farm and off-farm income – on your personal tax return.
What does this mean? Well, the sum of your business and personal income is taxed at your personal marginal tax rate. However, if you incorporate, your business income will be eligible for preferential small business tax rates that can offer significant tax savings.
For example, if your income hits $250,000, your personal tax rate might average out to 33% federally. The federal tax rate for incorporated businesses is 15% and could be as low as 9%. Applicable provincial tax rates would also apply.
Canadian controlled private corporations can take advantage of the small business tax deduction. This allows them to pay a lower federal tax rate on the first $500,000 of active business income.
In addition to tax benefits, incorporation offers several other benefits:
As a shareholder of a corporation, your liability in that business is limited to the amount you have invested in it. To some extent you can protect your personal assets such as your home from creditors should your business ever fail. However, many financial institutions do request a pledge against personal assets to secure business loans.
Fiscal year flexibility
You can choose a non-calendar fiscal year for income tax reporting. Depending on the cycles of your specific business, a calendar fiscal year may not be the best for income tax reporting. When you incorporate, you can choose any fiscal year that works for you.
Income tax deferral
Incorporation may allow you to defer income taxes by delaying when you take payments from the company from one year to the next. Such deferrals could become tax savings if your personal tax rate is lower when you do take payments from the business.
Group insurance and retirement benefits
Corporations can create a registered pension plan and obtain tax-deductible group health and life insurance plans for their employees and family members.
Income splitting flexibility
If your spouse or children are involved in the business as employees, shareholders and/or directors, you can distribute funds to them in several ways. These include salaries, consulting fees, dividends, directors’ fees and even custom farming arrangements.
Additional means of compensation
You can take money out of your incorporated business in various forms, including rent, capital dividends and loans. The company can even pay you a retiring allowance, which could be transferred to your RRSP.
Capital gains exemption
When you hold shares in a business that qualifies as a family farm corporation, you may be able to claim a $1-million lifetime capital gains exemption on the sale of the shares or property.
Determining if the farm property is eligible for the $1-million lifetime capital gains exemption requires considerable analysis – we recommend consulting with a qualified tax professional.
Transferring ownership of the farm to the next generation can be a complicated process. Incorporating your farm can ease the burden of succession planning.
You are not required to change ownership of specific assets such as property or equipment, if they are owned by the corporation. You are “simply” changing ownership of the corporation’s issued shares – for example when you add a child or grandchild as a shareholder.
While these benefits are compelling for many farm businesses, there are some negatives to be aware of:
- If all your income is needed to make it through the year, incorporation won’t help you save much tax. The benefits of incorporation decrease to the extent you must withdraw from earnings to cover personal and living expenses.
- Initial set up fees, more paperwork, and a complex return (called a T2) can result in the need for professional services and bring additional costs.
- You must leave at least some business profits in the company as retained earnings to benefit at all. Or you can reinvest some profits in the business or purchase other investments. If you draw too much income from the business, you’ll just have to pay additional personal tax on salaries or dividends.
- If you are expecting tax losses from your business, it wouldn’t be wise to incorporate. Tax losses incurred by a corporation are deductible only to the business, not to you. Since start-ups often have losses in the first few years, it’s usually wise to defer incorporation until your business is profitable.
- With incorporation, you also lose personal tax benefits. For instance, if you place land that includes your personal residence inside your corporation, you could potentially lose your capital gains exemption on the sale of that personal residence.
- Finally, transferring assets out of a corporation can trigger high tax rates and winding up a corporation can be quite a headache. As well, government scrutiny and regulatory compliance increase substantially.
The bottom line is that each farm has unique business needs. With both positive and negatives, it is best to consult your tax and legal advisors to determine whether incorporation is the right fit for you.
Free Download: The Ultimate Guide to Incorporated Small Business in Canada
Many incorporated business owners feel intimidated by the demands of tax season and the corporate filing requirements of the Canada Revenue Agency (CRA). This is completely natural.
While there are numerous benefits to incorporation, it also comes with complex obligations. The complexity and administrative burden of these requirements leave many businesses struggling to keep up.
That’s why we’ve created “The Ultimate Guide to Incorporated Small Business in Canada“. Not only will it help you get organized for tax season, but it will help you make sense of your obligations under a corporate structure and to take advantage of the benefits!
Need help with corporate filing obligations?
For more than 65 years, we have worked with tens of thousands of farm and small business owners across Canada. We optimize their tax returns, maximize their tax savings and support their back office needs with bookkeeping and payroll. Our legal services including minute book filing and annual returns.
To find out more about how we can support your business, take 15 minutes to connect with us so we can get to know each other. Request a consultation here.