In a year of income booms and busts, be smart with taxes

While the headlines talk mostly about the crop losses of 2021, it’s worth remembering that a fair number of Western Canadian fields were successfully harvested last year, and much of it of good quality.

The stark contrast between no crop at all in many cases and a decent crop in others has created some challenging financial situations — even those able to capitalize on record high crop prices may have to do some careful thinking come tax time. The old “pre-buy and defer” tactic may not be your best friend this year, says Rob Strilchuk, tax and agricultural business advisor with MNP in Edmonton.

A farmer himself, Strilchuk has some thoughts to offer those who are looking at potential income windfalls, as well as those who may have had to buy out contracts as their crop died and prices rose like a hot-air balloon.

BREAK THE DEFERRAL CYCLE

“We come upon so many files where farmers think their accountant has done a great job because they’ve never had to pay tax,” says Strilchuk. “They’ve fed into this evil wheel of deferral and it’s just not sustainable. You may have your tax money, but everyone else has your actual money stuck in pre-buys and deferred grain cheques.”

“Get help from a competent advisor and pay the tax at the appropriate tax bracket, or use that minimum small company rate” ROB STRILCHUK, TAX AND AGRICULTURAL BUSINESS ADVISOR MNP

He’s talking about how farmers bring down their taxable income by prepurchasing inputs for the coming year, or deferring the sale of grain or livestock thereby “saving” that income for the next tax year. But this only defers taxes owed, it doesn’t eliminate the eventual need to pay them. And it can cause grief at the bank if you have to borrow to pre-buy because your deferred grain cheque can’t be cashed until the beginning of the next tax year.

Now, getting taxable income to the lowest possible level is common practice for all Canadians, most of whom use RSPs to accomplish this. But when they eventually take that money out of the RSP, they have to pay tax on it. “For farmers, that money isn’t in an RSP, it’s in the bin or the pen or the shed,” says Strilchuk.

He’s not saying that it’s an altogether bad idea to defer some taxes — it’s not. But to defer them endlessly is a terrible idea because if you were to be hit by that proverbial bus tomorrow all that deferred income comes into the farm at once, pushing your estate into a much higher tax bracket and those taxes will have to be paid.

So if you’re one of the lucky ones who managed to sell crop into rising prices this year and you’re now looking for ways to not pay tax on any of that windfall income, Strilchuk suggests biting the bullet and paying some tax, at the right rate, now. Do some pre-purchasing to bring down your taxable income to the right level (not zero) and make the most of marginal tax brackets

THE JOY OF MARGINAL TAX BRACKETS

Strilchuk notes the difference between incorporated and unincorporated farm businesses. “For people in companies, it’s not the worst thing in the world if you pay tax on that first $500,000 of taxable income (cash-based profits) at 11 per cent,” he says, adding that this is an Alberta rate. “But for those paying personal taxes, there are marginal tax brackets they can utilize.”

Basically, the lower your taxable income, or tax bracket, the lower per cent tax you pay. At a Federal level, tax rates go from 15 per cent to 33 per cent across five income brackets, the lowest of which is up to $49,000 and the highest of which is $216,000 and over (figures rounded). But Strilchuk advises farmers to find out what their provincial tax rates are because those can be quite a pip. “In Alberta, a taxable income over $315,000 is taxed at 48 per cent. That’s federal and provincial rates combined.”

So if you’ve sold a decent amount of $20 canola this year, or $13 wheat, you could be looking at enough additional income to boost you into a higher tax bracket, particularly if you’ve been regularly deferring income in previous years.

Clearly, the goal is to try to get your income down to a tax bracket you can manage — it is not, to repeat, to avoid tax altogether. This is where pre-buying inputs for the next crop year does have a fit — typically fertilizer and seed, and sometimes machinery can figure into this calculation.

“Some farmers did not pre-buy last year because the crop input prices were so high at the end of the year,” says Strilchuk, adding that waiting for the cost of fertilizer to come down was maybe a bit na ve of farmers needing to reduce taxable income. “For those who had December year-ends, that window has closed and RSPs may be the last resort to get into a lower tax bracket — even if it’s for a short term.”

He explains that an extra $50,000 of personal income could be enough to move you from a 20.5 per cent federal tax rate to 26 per cent. “If you have built up available RSP room, you have until March 1 to take advantage of this tool,” he says.

“Get help from a competent advisor and pay the tax at the appropriate tax bracket, or use that minimum small company rate,” says Strilchuk.

BUYING OUT CONTRACTS

On the opposite end of the spectrum are farmers who sold crop that never materialized. Many found themselves having to buy back contracts at a much higher grain price than they originally contracted for.

“They did the right thing by selling a bit of crop at a time into rising prices, and then got penalized for it,” says Strilchuk. “For people who had crop insurance, that may cover the shortfall because crop insurance payouts (coverage) have been adjusted and are based on the fall prices under the variable price benefit clause.” He adds that this is what’s happening in Alberta where he practices, and farmers in other provinces should find out how this is being handled in their own jurisdictions.

Any contract shortfall not covered by insurance has to come out of your own pocket and that amount is deductible on your taxes. But, as Strilchuk says, if you lost most of your crop and are not insured, it’s unlikely you’ll have to pay taxes anyway. Buying out contracts with no insurance simply makes it worse.

For those signed up with AgriStability, there could be more options and support available, he says. “Make sure you have good records and good record keeping, particularly if you’ve had to buy out contracts,” says Strilchuk. “It’s an accrualbased program which matches revenue to the current year’s expense, so the better quality of accrual bookkeeping you have, the more accurate your claim will be.”

And you’re in luck if, last year, you bought private insurance not offered through a government entity. “Any payments from private insurance companies won’t count toward 2021’s income for AgriStability purposes,” he says.

If there’s one thing Strilchuk would like farmers to think about, regardless of what kind of crop year they’ve had, it’s that paying some tax every year is a sound business strategy. “Manage when you pay tax using the proper marginal tax rate — which is not necessarily the lowest one — in little bits over time so that you are not at risk of a big tax hit in the future. And if you are constantly fighting the deferral wheel, consider incorporation.”