The question I often pose to clients is whether they work with a “tax preparer” or a “tax advisor”. They are surprised by the question but equally surprised by the answer. A tax preparer simply collects tax information and enters the data into a software program. A tax advisor goes beyond these steps. A tax advisor makes recommendations to reduce the tax bill using appropriate strategies. Because the Income Tax Act is complex, tax planning for farm families is especially important.
Ryan Kitchen, a Chartered Accountant (CA) and partner of the Collins Barrow firm in Yorkton, Saskatchewan, provides income tax planning to individuals and corporations in the agricultural industry. Ryan has graciously agreed to share his publication, Tax Complications Upon the Death of A Farmer. Reading through his article clearly shows the importance of working with a tax advisor because of the many factors to consider. Additional farm-related publications may be found at Collins Barrow's website.
Tax Complications upon the Death of a Farmer
Even though Canada does not have an inheritance tax, a significant and unexpected tax liability can be left behind by a farmer at death without proper planning and preparation.
A deceased farmer is deemed to have disposed of all capital and depreciable property at its fair market value (FMV) immediately preceding death, with the beneficiary acquiring the property at the same value. Therefore, the FMV must be ascertained. The subsequent gain or loss is reported on the deceased’s final tax return and this value becomes the beneficiary’s cost basis going forward.
However, under certain circumstances, the Income Tax Act provides an opportunity for farmers to perform a rollover of farm property on a tax-deferred basis when property is transferred to family members, thus avoiding the deemed disposition at FMV rules. Farm property may also be transferred on a tax-deferred basis to children and grandchildren upon death. In such cases, the farmer’s estate may elect to transfer the property at any value between its tax cost and its FMV. The election optimizes the use of available accumulated loss carryforwards, available lifetime capital gain deduction, or any personal exemptions. Shares in a farm corporation or an interest in a family farm partnership may also be transferred on a rollover basis to children to use any available lifetime capital gain deduction.
If farm property is transferred to children prior to death under a purchase agreement and there is an amount still owing at the time of death, this debt may be forgiven without tax consequences if indicated as such in the deceased parent’s will. This strategy allows the parent to make the transfer today at FMV to trigger a capital gain, which is offset by the lifetime capital gain deduction.
Harvested grain inventory, livestock inventory, deferred grain purchase tickets held by the farmer, and the right to receive an interim or final payment from grain marketed through the Canadian Wheat Board upon death are all considered to be “rights or things” and can be reported in one of three ways:
1) It may be reported in the deceased’s terminal return
2) The value may be transferred to a beneficiary and may be excluded from the deceased farmer’s income, deferring the tax paid until the beneficiary disposes of it. The tax could be lower if the beneficiary has a lower marginal tax rate at the time of disposal
3) A special election may be made to report this income on a separate rights or things return. This optional return could significantly reduce any tax burden as it gives rise to a second set of deductions and exemptions for the deceased, and could potentially reduce the deceased’s income to a lower tax bracket. This election must be made within one year of death or 90 days from the notice of assessment of the terminal return, whichever date is later. This election is an “all or nothing” reporting matter and, as such, it is critical for the personal representative to ensure all such rights or things are identified up front.
When a farmer dies having an interest in a crop that has been seeded but not harvested, there are two options:
1) The unharvested crop may be included in the farmer’s rights or things return, stating its value at the time of death
2) The eventual sale proceeds may be taxed in the estate’s tax return or in the beneficiary’s return when harvested and sold.
Government contributions held in a farmer’s AgriInvest account are deemed to have been paid directly to the farmer immediately prior to death, unless they are transferred to a spouse or a spousal trust and vest within 36 months. Sometimes, it may be desirable to recognize the AgriInvest contributions as income on the terminal return rather than as a transfer. This would reduce the spouse’s or spousal trust’s income on later withdrawals from the account.
Alternative minimum tax (AMT) often arises when farmers make use of their lifetime capital gains deduction on sales of qualifying farm property. However, AMT does not apply on any returns filed for the year of death. Previous AMT paid may be applied to reduce ordinary tax in excess of the AMT, which typically would be payable on the terminal return, but this reduction does not apply to rights or things returns.
Mandatory and optional inventory adjustments added to income in the prior year are still deductible in the terminal return of the farmer. However, there are no provisions to apply the adjustments as income in the year of death. If the inventory was transferred to a beneficiary, a loss could potentially be created through the deduction of the prior year’s inventory adjustment, with no corresponding income to offset it.
Ryan Kitchen, CA, is a farm program specialist in the Yorkton office of Collins Barrow.