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We’re ready to incorporate. Now what?

4.5 min read

The following is a fictional case study created by BDO.

Lisa and Rudy were 10 years into their farming career when they first considered incorporating the business. Initially a part-time venture, both were now farming full time and their efforts were paying off.

Incorporating can limit your income tax exposure, but it’s a decision not to be taken lightly.

The annual dance of spending money in November and December to soften the blow from income tax was getting old. Their accountant advised that if they were consistently netting over $100,000 a year, they should consider incorporating to limit income tax exposure, but cautioned that it was a decision not to be taken lightly. By incorporating, they would be creating another legal entity with tax obligations and reporting requirements, as well as costs to establish and maintain it.

They scheduled a meeting with their accountant to make sure they understood all the details of being incorporated and how it would impact their management going forward. Their accountant saw they had a list of questions, so she suggested they tackle them one at a time.

The company will only have two shareholders. Are there decisions we need to make surrounding share allocation and type of shares?

The goal should be to set up the shares to maximize flexibility for compensating Lisa and Rudy now and in the future. This step should also accommodate the requirements for getting assets into the corporation without triggering tax while still allowing for changes in the future.

Will the company pay dividends?

This decision will be made each year with the accountant to determine the type and amount of compensation to be the most tax effective.

Could we keep one bank account to pay all business and household expenses?

Could they? Yes. Should they? Definitely not. The accountant advised them to keep a separate corporate bank account, move funds monthly from corporate account to personal account and pay personal expenses out of a personal account. This is much cleaner for bookkeeping and formalizes the record-keeping for the business.

Should we roll all our equipment into the company? Is depreciation or capital cost allowance (CCA) treated differently in a corporation?

The CCA rates are the same in a corporation. Deciding whether to move assets into the corporation involves numerous variables and the answer will be different for every operation. It often makes sense for operational assets like equipment to be rolled into the company.

Are there capital gains considerations for land? How are capital gains treated in corporation versus sole proprietorship?

Individuals all have $1 million of capital gains exemption available to offset gains on the sale of qualified farm property. Some or all of it may be used if transferring land into the company. However, it’s important to know that the company doesn’t have a capital gains exemption.

What about retained earnings and shareholder loan – what do these terms mean and how should we be thinking about them?

Retained earnings are the cumulative profits that have been kept in the company since incorporation. Shareholder loans are funds that are owing to the shareholders either as a result of money loaned to the company or from the transfer of assets into the company. They can be repaid in the future without tax consequences to the shareholder or the corporation.

What additional services will we need from our accountant and lawyer?

The accountant instructs the lawyer on how to set up the company and what shares to issue based on the assets and liabilities being transferred in. The lawyer will also transfer title and mortgages for land going into the company. The accountant will work with the lawyer each year to keep the minute book up to date as the official corporate record of the company.

The company will file an annual corporate tax return, which may cost more than a proprietorship, but this is usually more than offset by income tax savings.

What happens to existing loans like the one owing for the initial purchase of the farm?

It can be transferred to the company if necessary. The lawyer may need to draw up new promissory notes or other supporting paperwork. All lenders should be notified of the change to a corporate structure.

We’re in our mid-thirties and have two small children. How does incorporating impact transition planning down the road?

It’s early days for Lisa and Rudy, but a good time to think about a transition plan even though their children are very young. There are options to consider within a corporate structure. To accommodate both children and a simple division of assets, Lisa and Rudy may eventually create a second corporation so there’s one for each child. They may also maintain land and assets outside the company to make it easier to disperse to the children when they’re adults. 

Their accountant commended them for their diligence and list of questions. She cautioned that there are a few time-consuming administrative matters to be dealt with initially — updating paperwork with the bank, updating the bookkeeping system, advising suppliers and vendors that they are now operating under a new name — but once the company is operational, the daily management should not be any more onerous than it was before.

Lisa and Rudy left the meeting feeling much better about their decision to incorporate, and they had a solid plan for managing their new company.

BDO is a trusted advisor for agricultural accounting, tax planning and business consulting. Visit their website or X.

From an AgriSuccess article.

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