Be careful with your tax management

[Ron]

Hello everyone.

I have read many of your topics comments and responses and enjoy some, understand others and agree with many.

Some background on myself: I am an accountant that works with about 400 producers ranging from 1000 acres to over 12000. Some are mixed farms as well. In addition to this I believe in the business of farming and operate my own grain farm inside a corporation. The truth is that my farm is profitable and always shows a black ink. I draw money out of this farm every year as rent and wages for my family living in addition to the off farm income my wife and I earn. I never put money into my farm from outside sources, it sustains itself.

My purpose of this topic is not to instigate many of you to critique my situation but to sit back and really look at your own, especially from the mindset that I am going to illustrate.

After working just about 15 years in the profession and more than that in the farming business I have worked with many types of people with variable conditions and circumstances. To try and find out why one producer is different that the other I ask various questions at our meetings.

The one comment that the producers that have done well have always said is that they have never avoided the tax. In other words, they have never gone out of their way to avoid paying or significantly reducing their annual income tax bill.

Now the first reply that I know someone will say is that you have to be profitable in order to pay tax. To some extent this is true and does make it easier, but think of it this way.

If you don't have outside income on the farm and your annual living, debt repayments, savings generation, inventory carryover etc comes from the farm you have made money. If it costs you in excess of $30,000 to cash flow your living costs, debt repayments etc you must make sure you are accounting for at least $37,000 on your annual tax return so that after you pay your tax and CPP you have $30,000 left to provide for those cash flow costs. If your debt is relating to equipment you will have capital cost deductions that will shelter some of your income. I caution those that living on capital cost will cause more problems down the road other than cash flowing $5-7000 in income tax each year.

The problem that is created if you don't pay the right tax amount each year is that the living needs cash comes from increased borrowing (Cash advances, line of credits etc). It costs money to service that debt in both interest costs and eventual repayments. This is where after many years farms experience cash flow problems, stress and the major decision, can I go on.

Its truly amazing what some producers do in order to avoid paying tax. An illustration: If you are in the lowest tax bracket below $36,000 in Sask, to reduce your tax by $1 you need to spend almost $4. If spending that $4 does not make you farm more profitable take the cheaper route and pay the $1. At least that leaves you with the difference of $3 which was already spent on your living in the past year. This "clears" the year and accounts for those living dollars that have been spent.

On the other hand, the next person will go and spend $30,000 which he has to borrow and eventually repay to reduce the tax bill to zero. His other choice would have been to pay $7000 in tax. Do the math, if you don't have the cash for the tax, you definitely don't have the $30,000 either.

Many of you comment on the design of the CAIS program and I am one to admit it does have flaws, it does need changes. Now if you understand the design and that it is a historical based program based on production margins, how do you think tax manangement effects it???

Well of course it does. If we are a tax driven producer, the easiest way to regulate tax is to prebuy inputs and defer grain sales. This hugely effects the margin information that creates your history and helps calculate CAIS payments.

In closing, if your farm has paid the right amount of tax your CAIS will work well for you and you will receive assistance. For those that have never paid tax from your farm income, you may have received your "CAIS" money in advance as it never left the farm in the first place.

The other thing I want to stress is that even though someone may be preparing these applications for you make sure you/they calculate the payment. If you just send in the form information, guaranteed you will not receive you proper entitlement. These errors can continue to result in lower claims year after year.

I am a proud farmer and an accountant. I believe I have the best understanding of the program and farm management. Some of the comments above are major mis-understandings that many of you have and are the result of your frustration.

A final question to all of you is that if farming is so tough out their then why are 2 farms that are beside one another different even though they may have the same acres, family size, equipment invesment, startup situation, etc. It is so amazing that one client is so profitable and the next one right beside is losing so much each year. I have clients all over central Saskatchewan that this is exactly true.

[farmers_son]

Interesting comments. Regarding CAIS and tax. I would offer the rather bold opinion that the CAIS program is designed to force producers to pay tax at least 3 out of 5 years in order to keep their reference margin. That is a general statement as there are revenues and expenses that are not included in CAIS calculations. It is my opinion that MAAO double counts increased livestock inventories as MAAO increases can increase reference margins as well as reference margins would be increased by size adjustments assuming cattle numbers had increased significantly over the five year period. Any comments? I do agree that it is necessary to calculate your CAIS payment before you send in your Supplementary forms otherwise you will not know if the CAIS people calculated your application properly or not.

If I might ask a tax question. It is difficult to transfer cows from one generation to another without paying tax unless the person who has the cows dies. However I think BSE may have provided a solution. I think it would be possible to transfer cows from one generation to another using relatively low bred cow prices at the beginning of 2005. Quite a few cows could be transferred between generations without involving a lot of money. Would a cheque have needed to have been written at the time or could it just be a deeded transfer? The cows could also be put into joint ownership, it would trigger some tax but at very low values per cow. Any comments on this or any other way to transfer cows between generations without incorporating.

I agree that it is not in our best long term interest to avoid paying any tax. I try to pay as much as I can but still stay in the lowest tax bracket. However a lot of farms are cashflowed with deferred income tax.

Regarding your question about the two farms. That could easily happen. Similar startup…as time passes the startup becomes less and less significant. Crop insurance would make a huge difference, some people have the rather foolish notion they can stand the risk themselves, they cannot. Based on conversations in other threads, living costs can vary quite a bit between farms and has a huge impact on farm cash flows as well as income tax paid. It appears to me that living costs can vary by as much as 24,000 per year between families and when you consider the tax paid on that it has a dramatic impact on cash available to run the operation.

[farmers_son]

Thank you for the response. You seem like a very knowledgeable operator. If you have any further questions I will respond as time allows. My schedule is pretty nuts right now for the next month but I am always interested in helping those who are willing to learn.

With regards to the question of the cattle transfer, you are correct in saying that an opportunity exists. You can transfer the cows with a simple buy sell between the 2 parties. You should have an invoice and exchange cheques. If the intention is to transfer at no cost, the seller can lend the money back to you (ultimately becomes a gift). Each party would report the purchase and sale of the animals. Can also spread over time so much per year.

Another option we have used to facilitate this type of transfer is the formation of a family farm partnership. If you have heard of this then you may understand the excellent tax advantages that may be available to the farm operation.

As for the comments about tax I guess I never intended anyone to feel pressured about what they have done in the past or that the program requires you to pay tax to maintain reference margin. The MAAO option is definitely the right choice for a livestock operation, generally limited benefit to some straight grain operators. I think you have done the right thing by trying to use the lowest tax bracket yearly. If anything you never lose by doing so and if a true loss occurs you can change your tax for that year, carry the loss back etc.

The comments are generally presented to make the readers think about what they have done in the past and possibly why the program is potentially not working as good for them as others or as it could be. I do honestly know and believe that the corporations have an advantage over personal because of the tax issue. You can easily requlate cash margins by avoiding deferals and prebuys if you are willing to accept the 18% tax cost cash flow.

[lakenheath]

Binser,

I am a famer and a Chartered Accountant. I farm 3800 acres and operate my own accounting practice.

I must caution you on you general tax advice to the farmers on this site. I am a staight grain farmer and in the past 4 years have had a profitable farm operation and have not paid tax. I take full advantage of pre-paying my next year's inputs in the fall and deferring grain sales to the next year.

One thing I have always told my clients is -

1) Don't farm for CAIS, farm to farm properly
2) Tax plan for tax savings not for CAIS

The MAAO option restores any reference margins effected by pre-paying and the deferral of grain sales ( using the MAAO as a straight grain farmer almost double my reference margin).

I also have to disagree with you math. If your taxable income nearing year end is $50,000.00 why not pre-pay next year's fertilizer bill. You have to pay it next year anyway. $50,000.00 x 18% tax = $9,000.00 in tax. $50,000.00 loan for 5 months at 6% interest = approx. $1,250. That is savings of over $7,000.00.

Deffering income tax has the potential to catch up with a producer, but every sitution is different. Once a producer's deferral/pre-payment catches up with them (meaning they are doing very well on the farm to be taxable), there are other options to avoid paying tax like purchasing feeder cattle and putting them on feed. This way the farmer avoids tax and has some income earning potential on the cattle (also a degree of risk involved if the market falls on the cattle).

I do not encourage my clients to pay tax. I warn them about the risks of deferring, pre-paying and purchasing feeder cattle. In today's farm environment where it seems like you are bound to run into a poor year more often than not, it is a great opportunity to take advantage of the cash basis filing of income tax that has been offered to farmers and avoid paying tax.

Again, I will repeat, avoiding tax does not have an impact on CAIS. There are ways around it.

Binser, be carefully giving generalized advice. It can be dangerous.

[lakenheath]

Binser,

Your question about the 2 farm neighbour in the same situation. I find that hard to believe. But, assuming they are in the same situation, you wonder why one is doing better than the other? It could be a number of things.

One is a better producer than the other. One is a better marketer than the other. One has poor money managing skills. I could go on and on.

Also, I would like to know wher you farm, how many acres you farm and what farming methods you practice to remain profitable every year in farming. Some of the best producers here is Saskatchewan have been hit by drought, frost, and grasshoppers. Pretty hard to stay in the black when those hit.

We have been fortunate to avoid those disasters in southwest sask. here. But if we did encounted them i definitely would not show a profit.

[lakenheath]

Couple more notes. Pre-paying fertilzer in the fall has more than one benefit. You get the benefit of tax deferral plus the benefit of cheaper fertilizer in the fall (which has been the case for most years).

Secondly, what is wrong with deferring grain tickets late in the year if the income from the grain ticket is going to increase your taxable income? Do you not want your clients to take advantage of the cash basis of income tax filing?

[farmers_son]

Lakenheath: If I may jump in here. I appreciate binser’s general advice on this site and your comments too. At this time of year income tax is my favourite topic.

I happen to agree with binser’s advice to not go out of your way to avoid paying tax. Deferring income or prepaying inputs does reduce tax but only the one time. The next year you have to defer the same amount of income or purchase the same amount of inputs again just to keep you taxable income equal to what it would have been had you not employed those strategies the year before. However tax was deferred. It does end up being a vicious never ending circle like a dog chasing its tail. More and more tax has to be deferred just to keep taxable income at a very low level. At some point you cannot defer any more and you get hit with the bill at a higher tax rate and all at once. Of course general statements have to viewed in terms of an individuals situation but it may have been easier to pay the tax as you went. I have heard of people who did as you pointed out and purchased more and more feeder cattle to entirely avoid paying tax. It ended up a wreck, they should have been paying some tax all along. I defer income but only to a point where I pay a reasonable amount of tax, not to pay no tax. At this point in my life I am paying a lot of principal on land loans and I have 3 teenage children so we are not living for nothing. I realize I will have to pay some tax.

I think we need to consider CAIS when farming and when filing income tax in fact to ignore the program would be folly. There is a huge amount of money in that program. There are ways around the impacts of avoiding tax on CAIS but once you go to MAAO you cannot go back.

[lakenheath]

I agree with you 100%. Every farmer's tax situation is unique and every farmer's risk tolerance is different. I am not saying to deferr and pre-pay endlessly. I am merely saying it is a tool that should be used carefully and has some potential benefit. I guess I should have mentioned I was speaking in the context of a corporate rate on income tax rather than personal bracketed tax.

Binser points are good and should be considered, but there are some tax planning opportunites with feeder cattle, deferring and pre-paying. But, you do have to be very on-top of things to manage your operation if you choose to use these tools.

[lakenheath]

Thankyou for your comments Lakenhealth

I agree with some of your coments but would like to turn a few back to you

1) The fertilizer purchase can always be a good idea if you are willing to risk the chance of a price change. Normally the price is higher but not always. Last fall my fertilizer dealer offer NH3 at spring 2005's price of 36cents, provided I stroked the cheque before the end of September. Now we are basically being offered the same rate more than 6 months later. Sometimes it works sometimes it doesn't.

You also can purchase the fertilizer Jan 1 of the year and not impact the cash margin for the prior year. Not everyone files on the MAAO option so changing that cash spread can be huge looking forward. The other thing to remember what if that operation did not need the additional expense to bring their position below $35000 or a no tax position. No sense bringing it down any further. And yes, I am fully aware of the inventory provision and how it can be used successfully to utilize tax brackets.

2) I agree fully with your 2 statements. I say "farm to farm CAIS will take care of itself" However, Tax planning for tax savings is just as volatile statement as you stating to me that general advice is dangerous. Not that I am knocking you I am just saying that everyone "be careful with your tax management" Your statements are true in that everyone's situation is different. If someone needs $50000 to live and doesn't want to change structure their is not a lot of choice.

3) Cash is king - The prebuying, cattle options etc are all great for those that have the ability to do so. Once again everyone's situation is different, risks with all, rewards for some.

4)Can everyone stay within the lowest bracket in today's world? I don't think so, especially if they are serious with their business. What is the long term cost of trying to keep them there? This is a blanket statement that needs to be evaluated individually.

5) There was one question on where I farm. Central Sask East. Yes we had frost in 2004, I never experienced it as hard as others. Neighbor's across the road had 6-8 bus of sample canola, I had 36 of #1. I definitely was lucky. I also run an adjusted CAIS margin in excess of $130 per acre because of I had 3-4 decent years in a row. The program will work for my operation to protect the downside.

6) I have clients around me with similar ratios and results. I know others don't have the same luxery and I feel for them. For those that want to learn my thinking I help them and we have increased their margins by $10-15 per acre per year by simply doing a few things different. There may be some tax consequences but most of these farms (corporate and personal) are used to paying $40-60000 per year anyway. We manage within the brackets available, I don't just make them pay tax.

7) In order to ultimately retain cash, the applicable tax has to be paid. The control you have is to make sure the tax is at the right rate and in the right structure.

[cowman]

Won't get too deep into tax management as it is something I truly hate, and choose to pay the accountant to give me advice. Usually I listen.
However I believe it is the duty of every Canadian to pay as little as possible...as it limits the evil politicians can do!

[farmers_son]

Ah, yes. But the challenge is how do you pay as little tax as possible and at the same time get as much of those tax dollars as you can from CAIS. Sometimes when you are wiggling around to not pay tax you are backing yourself into a corner where you will eventually get hit with a very big tax bill, usually when you can least afford it.

We used to hire an accountant to do our tax and give us advice. A couple of very bad incidents and I found out the hard way the accountants will offer advice and charge for that advice when they are not knowledgeable in the area. I now do all my own tax and my own CAIS and I am much more knowledgeable as a result. I really like the comfort I get from knowing what is going on. We used to sign those tax forms without really even knowing what was in them.

A new thing that is out there we need to be aware of is GAAR. No, not Grrr... GAAR stands for General Anti-Avoidance Rule. GAAR is new and its purpose is to grab those who exactly follow the tax laws but are really doing too good of a job of reducing their taxes.

[lakenheath]

Binser,

Your points are well taken. Seems you take care of your farm clients very well.

In the end it really comes down to the individual tax situation in every case. I inform my clients about the pro and cons of different tax planning stragies and go from there.

One thing we must keep in mind also is the potential for lower tax rates in futures years. Our governments seem to be hinting about lower tax down the road, and if we can safely and carefully defer some of our clients taxable income into those year we will realize real tax savings plus take advantage of the time value of money.

That being said, paying a small amount of tax each year in the lower brackets is not poor tax planning at all. It is safe and conservative cashflow planning and it will help prevent some farmers from going into the debt cycle who may not have the best money management skills.

It's interestng how many clients are so upset with the governments wasteful spending that they will opt to pay zero tax in the current, knowing that they may have to pay it down the road. I have no problem with that, as long as they are informed and know all the implications.

Personally on my farm, I pre-pay and deferr. I use the the MAA0 to off-set any effect that this has on CAIS (strickly a grain farmer) and once the pre-pay/deferr cycle catches up with me I will roll my operation into a corporation and pay tax at 18%. I realize this works for me for not for everybody, but I did enjoy not paying tax to our wonderful Liberal government!