Year-end tax advice you don’t want to ignore

It’s year-end tax strategy crunch time. 

For those farmers who had higher crop returns or have experienced an especially good year, Dec. 31 is the deadline to take advantage of farm tax deferral strategies that can help manage extra income.

Tom Blonde, partner at Baker Tilly GWD, said that most farm businesses have plenty of tax deferral advantages to choose from. The key is to be strategic.

Why it matters: Tax deferral strategies can help farms manage extra income but the deadline looms for taking advantage of those options.

“Each year, most farm businesses can choose to take deductions or defer them to the next year, impacting how much tax and the rate they pay,” said Blonde. “This allows the business to manage fluctuations in income year over year, and in years when income is lower, you can defer deductions on things like capital expenses, equipment, tile drainage, etc. This strategy means you can minimize taxes payable during a higher income year by saving those deferrals in lower income years when you really need them.”

Farm businesses could find themselves paying a higher amount of tax using this ‘prepay’ strategy in the short-term in a lower income year, but tax deferrals can be claimed instead in higher income years where more tax could be saved.

For example, this could benefit someone who has an inventory of high-value grain that can be optionally claimed as income in 2022 and therefore mean less income would need to be reported in 2023.

“You’re paying more tax today to give you the potential to save even more tax in the following year,” said Blonde.

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Farm business structure matters

This strategy can be especially helpful to unincorporated farms. Sole proprietorships or partnerships are subject to a considerable increase in marginal tax rates after the $46,000 income mark per person (jumping from 20 per cent to almost 30 per cent and higher as income increases). Most incorporated farms have a more stable flat rate of 12.2 per cent on the first $500,000 in income, increasing to 25 or 26.5 per cent after that.

“It’s much more critical for unincorporated farms to strategically plan their tax deferrals to avoid significant taxes down the road,” said Blonde.

For unincorporated farms who find themselves with some extra income, Blonde recommends making tax decisions strategically to target a lower income bracket, especially if increased income is expected the following year, when you expect to sell your high-value grain inventory, for example.

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Choosing not to take the writeoffs on equipment depreciation or the new shed you built this year could pay off for you next year. And while this strategy may cause an increase in tax rates in the short term, the idea is that it should pay off in future years, especially if you predict a continuation of higher income.

Other strategies to reduce tax rates are to keep other sources of personal income low as much as possible, since personal income is combined with personal farm income for tax purposes in unincorporated structures.

Blonde also said that, if seriously concerned about tax rates this year, consider incorporating the farm. “There’s still time to make business decisions that can set you up for financial and tax planning success,” he said, noting the year-end deadline.

If you find yourself with more after-tax cash and don’t need the funds to invest in additional farming assets, you could use the extra cash to pay down the principle on farm debt to guarantee an additional after-tax rate of return. This strategy can be especially helpful as interest rates continue to rise.

“Paying down debt is like insurance against future interest rate hikes,” Blonde said.

Strategies for all farms

No matter the farm structure, there are a few strategies that can help safeguard against taxation. The trick is to employ them before Dec. 31.

The first is to share a little extra in wages. If a farm employs family, consider paying higher wages or a year-end bonus. This year it’s easy to justify the increase with rising inflation and labour shortages, but Blonde reminds farmers to be reasonable in the extra payout.

Investing in the farm is another strategy that can pay off in years to come. Upgrading equipment, investing in tile drainage or building new farm buildings can all be used as tax deductions whenever you choose to use them.

Blonde reminds farmers to plan these investments carefully, especially in the current environment where farm equipment and building supplies can be at a premium due to supply chain and labour disruptions as a result of the pandemic.

Of course, if you’ve left tax planning too late, or haven’t had time to properly research all the business structure and tax advantage options, RRSP contributions are always an option. And you’ve got a little extra time to plan since RRSP contribution deadlines aren’t until March 1, 2023.

“This also works for farms that have exhausted all their other tax reduction options, or have invested as much as they can into the farm. A personal RRSP investment can always help with tax strategies, and it’s a great way to invest in a non-farm asset,” says Blonde.

As always, it’s important for farmers to consult with their accountants and financial advisors to determine where they are in the tax arena and what options are available, including carry forward deferrals.

“Finding yourself in the position of having extra income is a nice problem to have,” says Blonde. “Every farm is different and requires their own tax strategies, so be sure to consult your own advisor to find the best advantage for your farm business.”