3 ways to create personal income from a farm corporation
Running your farming operation as a corporation is increasingly common, so it’s important to understand how this structure affects your personal spending for plans like retirement and wind-down of your farming career. Methods used decades ago by previous generations will not have the same success in today’s complex tax system.
Paying corporate farm taxes over time and using lower rate taxes provide future flexibility for personal spending.
Understanding that a corporation is only a tax deferral is key to reducing your overall business and personal taxes. Paying the low corporate tax rates on the business is important to enabling your operation to reinvest larger after-tax profits on equipment, land or livestock. Taking the money out of the corporation for personal spending on groceries, personal vehicles, and recreation is where the tax deferral of a corporation ends. Taking funds out to cover these personal spending needs requires paying personal tax rates.
Personal tax brackets are graduated with higher rates assessed on higher income levels. To reduce overall personal taxes, paying personal tax annually must be implemented sooner rather than later, regardless of your current annual personal spending. Every year, each taxpayer has a set of tax brackets that range from 0% to approximately 50%, depending on the province. Utilizing the low tax brackets annually is key to reducing your overall long-term personal taxes.
A strategy I encourage taxpayers to use every year, regardless of their spending, is to declare enough personal income to utilize the first two tax brackets for every shareholder of the corporation. This equates to approximately $100,000 (depending on your province) of before-tax income. A corporation with four shareholders would mean $400,000 of income to be extracted from the business. Some argue that they live a modest lifestyle and don’t need that much personal income to live, and the money can be more effectively used in the business to expand or pay down debt. This is where the shareholders’ loan comes into the equation.
Any funds not required to cover personal spending and personal taxes can be lent back to your corporation as a shareholders’ loan. The operation can then use these extra funds for business purposes. Funds not withdrawn for personal use will increase the shareholders’ loan. Typically, the shareholders’ loan has no interest or repayment terms. It simply ebbs and flows to cover the personal spending of the shareholders.
Building this loan over a period of years will reduce your personal taxes over time, regardless of the level of personal cash needed in any year. For instance, the shareholders’ loan could be used to fund a large personal purchase in the future, like a retirement home. Building up a loan to cover most or all of the funds needed over a period of years will allow you to take a large sum at once without affecting your income taxes. Since income taxes increase substantially as your income increases, this will more than cover any time value of money concerns with paying personal taxes early.
Here are three ways to create personal income from your corporation:
- If the corporation needs a deduction from its taxable income, a wage could be declared on which the shareholder will pay personal taxes and Canada Pension Plan premiums.
- If the shareholder personally owns land farmed by the corporation, land rent can be paid. This will not require Canada Pension Plan premiums to be paid, but Goods and Services Tax must be assessed and paid on it.
- A dividend could be declared from the corporation's after-tax profits. That means it’s not a deduction for the corporation, but the shareholders will get credit for the corporate taxes already paid by the corporation. A dividend must be paid to all shareholders of the same class, so it might take some extra planning if some shareholders have or want other types of income.
Regardless of how you earn the income from your corporation, paying taxes over time and utilizing the lower rate taxes available to you every year will reduce your taxes and provide more flexibility for future personal spending on your retirement.
Article by: Lance Stockbrugger