Your money - Plan early for intergenerational transfers
Transferring any family-owned business from one generation to the next can be a complicated affair.
According to Lance Stockbrugger, CA, a grain farmer and senior tax manager with PricewaterhouseCoopers in Humboldt, Sask., you don’t need to set a definite retirement date years in advance. But deciding in November that this was your last crop can cause a lot of scrambling – and rarely gets the best results. Rather, start planning today.
Canadian governments of all political stripes have developed programs to help manage taxes, such as
a $750,000 lifetime capital gains exemption that applies to qualified farm property as well as qualified small business shares. While it’s almost impossible to completely avoid the taxman in a farm transfer, with enough advance planning it’s possible to minimize the amount of tax for both generations.
“The more time we have to plan and work towards an intergenerational transfer, the better planning we will be able to put in place. That’s likely to result in lower taxes, too,” Stockbrugger says.
Recaptured capital cost allowance (CCA) is a good example, he adds. Typically, farmers stop replacing or adding new equipment as they near retirement. After five years of not buying additional equipment and claiming full CCA allowance, they’ll have a very low capital cost pool for tax purposes and selling their equipment can generate a significant amount of recaptured CCA. This might be avoided by reducing CCA claims in the years leading up to retirement.
The best tax situation isn’t always one where no taxes are paid. That’s especially true in an intergenerational transfer when an aggressive tax reduction strategy for one generation creates tax problems for the other.
“Maybe Mom and Dad could most tax-effectively sell their operation to their children by selling them the shares of their farm corporation, but that’s not always the best scenario for the children,” Stockbrugger says. The couple can shelter capital gains of up to $1.5 million ($750,000 each) on a sale of shares, if they both have their capital gains exemptions still available to them, but the children are essentially buying inventory, equipment and other farm assets.
However, buying $1.5 million worth of shares instead of assets, they lose the write-off they’d get if they purchased the assets directly. Obviously, they’d do better buying the assets, but then Mom and Dad couldn’t use their capital gains exemptions and would likely have to pay corporate and personal taxes.
“In most cases, my job is to perform a balancing act,” Stockbrugger says. Most of his clients want to take an approach that lets the entire family, not just one generation, pay the least amount of tax. Understandably, they want to use all the tax advantages they can. “With a well considered plan implemented early, taxes can usually be minimized. Parents typically give the son or daughter a pretty good deal. And in return, the children will do whatever is necessary to make a plan that is most tax effective for Mom and Dad.”
One of the most common reasons that intergenerational transfers fail is because the older generation has difficulty giving up control and won’t let the next generation become involved in the decision making process. According to Stockbrugger, one problem is that this deprives the children of the opportunity to learn how to make independent executive decisions.
“I think it’s key that you start getting them involved in making business decisions early,” he says. “Maybe you start with simpler decisions, like a seeding plan, so they see the value of their input and they don’t feel like just a hired hand.” Responsibility grows over time and eventually the children take over major decisions – such as capital purchases – with minimal guidance or input from parents. Then the parents slowly fade out of the management role.
One solution that could help reduce tax problems is to have the younger generation start their own operation. In a grain and oilseed operation, for example, the children could start by renting some land and having an agreement to farm it with their parents’ equipment. This has two benefits: it creates a clearly separate business operation for income splitting purposes, and it allows the younger generation to learn all aspects of running a business. “They gain experience in the decision making process, bookkeeping, financing and the risks and rewards of ownership,” Stockbrugger says.
The new business will often grow over time, Stockbrugger says, either by taking on more of the operation or through expansion. Then the initial operation may be wound up or purchased outright by the younger generation and merged into their operation.
Protect your old age security
Canadians over the age of 65 who meet certain residence and income level requirements are eligible to receive old age security (OAS), a pension program designed to give all Canadians a basic pension income. Intergenerational transfers can cause the net incomes of the older generation to exceed the net income threshold, and they will have to repay part or all of their OAS. This recovery process has commonly become known as the OAS clawback.
If you were eligible to receive OAS in 2011, for example, you would have 15 cents clawed back for every dollar that your net income exceeded the $67,668 threshold. The maximum payment in 2011 was $524.23 per month ($6,290.76 per year). If your net income that year was $72,000, your benefits would be reduced to $470.08 per month ($5,640.96 per year) after clawback. Capital gains form part of net income in the clawback calculation so plan carefully to maximize your OAS pension entitlement.
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