EXAMINING OPTIONS IN A SUCCESSION PLAN
Originally published on February 6, 2003
In my January 9, 2003 column I concluded that determining expectations is the first step in a farm succession plan. This column will examine some of the options available to farm families considering passing the farm to the next generation.
Examining options is best viewed as creative problem solving. While every farm is unique, it has been our experience that there are three recurring themes that require the most analysis: the retirement needs of the retiring generation and how will they be met; viability of the succeeding farm; and ensuring non-farming children have been dealt with fairly.
The following lays out several farm succession strategies and implications.
■ Moneyless transfer of farm – gift during life or at death
If the retiring generation has sufficient non-farming assets to fund retirement and to treat the non-farming children fairly, then the farm may simply be given to the farming child either during the retiree's lifetime or upon death.
Farming parents may hold life insurance on their own lives in an effort to increase their non-farm assets at death.
From a farm succession perspective, it is necessary for the retiring generation to realistically address their retirement needs. Too often, in these times especially, retirees are dirt-rich and cash poor.
■ Sale of whole or part of the farm to farming child
In many cases, a portion of the retiree's farm equity is required to either fund retirement or future non-farming assets. This requires selling the farm. Capital gains triggered on the sale could be sheltered from tax by the capital gains exemption.
To do this, the parents may finance the succeeding generation's purchase by holding a mortgage on a portion of the farm. The mortgage can be forgiven at death or become part of the parents' residual estate.
When considering a family-mortgaged sale, realize that while the retirees are risking their capital, the succeeding farming child is risking his future. Both stakeholders must be realistic in their vision of where the farm is going. There is no point burdening the next generation with an unmanageable debt with no sign of viability. Debt service ratios are a good means of keeping score here.
If the farm can be divided into separate parcels, then a portion of the farm could be sold to finance retirement. If retirement is covered, then these separate parcels could be given to the non-farming children at death.
■ Retiring allowances
Farming proprietors might consider giving their spouses retirement allowances in recognition of their many years of service.
Farm corporations are able to issue the same retiring allowances to key owner-managers. You are able to roll over to a retirement savings plan prescribed amounts for each year of service before 1996, provided that you were not a member of a pension plan.
■ Incorporating the family farm
While the succeeding generation may have ideas as to how the farm can increase its profitability, it may require the strength of all of the net farm assets to secure the financing necessary to get things done.
The parents might consider freezing their farm value at the time the reins pass. This is especially important if there is considerable equity in the retiree's farm machinery. Machinery depreciates at an astonishing rate and who wouldn't want to buy Dad's combine after it has been used for 10 years? There are also tax provisions in place so no tax will be triggered on the transfer.
Again, the capital gains exemption could be used to shelter triggered capital gains associated with the transfer of farmland. The retiree's consideration received from the transfer of assets would be in the form of a promissory note and preferred shares.
Non-farming children could be entitled to shares in the company. These shares could be governed by an agreement that restricts the market for the sale of shares as well as insuring a market for the sale of shares within the family group.
■ Liquidation of the owners' farm company interest
If you are already involved in a farming company, then your shares may be a major part of your estate. They may also have limited marketability.
If your non-farming children have an interest in your company, then you will want to protect them from simply having a non-voting, minority interest that is non-liquid and incapable of ensuring a distribution of earnings. Family shareholders should be aware of dispute resolution mechanisms that are contained in the company's shareholders' agreement.
While Mom and Dad may think that everyone gets along, no one should assume that all of the family members have the same vision as to how things should be done. It is possible to divide farming operations into two or more farming companies.
This is probably preferred if you have two or more successors who don't view things the same way. There are complex rules here and you must start planning early before considering transferring shares to the next generation.
While having a will is an important part of a farm succession plan, it is only one piece of a large puzzle. Ask anyone who has been involved in a farm succession plan — it can take up to five years to implement it effectively. With that in mind, what are you waiting for?
Allyn Tastad, certified general accountant, is a partner in the accounting firm of Hounjet Tastad Harpham in Saskatoon at 306-653-5100, e-mail at email@example.com or website www.hth-accountants.ca. He is also involved in the family farm near Loreburn, Saskatchewan.