subject: Estate Equalization Of The Family Farm Corporation [print this page] If you own a family farm corporation in Alberta, you definitely have a very valuable asset in your estate. The family farm corporation probably makes up the bulk of all your assets, and is going to be a huge inheritance for any of your children who plan to take over the farm. What are your plans if you have more than one child, and some do not plan to be farmers?
A family farm corporation in Alberta has special tax laws that make it very advantageous to pass on the farm corporation to a child inheriting the business. The entire asset can be passed onto a child at its original cost base so long as the child inheriting the farm will actively farm it. This means that the many years of capital growth of the farm value are deferred from generation to generation while the land stays in the family. Once land and assets are sold off, there is a capital gains tax on all those many years of capital appreciation.
Making inheritance of the family farm fair for all children
In this article we will look at your options for compensating the non-farming children fairly while the farming child(ren) inherits the business. Ultimately we are recommending an Estate Equalization Strategy using Life Insurance in most cases.
Option 1: make the non-farming child a shareholder
You could make the non-farming child(ren) into equal or partial shareholders of the farm corporation, thereby letting them have a vested interest in the equity of the farm. They would also be eligible for dividends if the farm was to make a profit. If they were given full voting shares then the non-farming children would have considerable influence on the operations of the farm, and could vote on how the business is run. If they were given preferred shares then they would be first in line for dividends from the farm corporation once all expenses had been paid.
The problem with this strategy is that non-farming children inheriting shares in the company tend to muddy the waters of the family farm corporation. The farming child who is investing their sweat equity into the business is in fact working for their siblings. This would be a very similar arrangement to a business partnership where there is a managing partner running the business and investment partners who put up the capital and have little active involvement in running the business day to day. But, in this case, the siblings of the farming child are not investors, they were gifted their equity in the business.
This arrangement could also be coupled with a legal agreement that the farming child has a primary claim on the farm assets and can buy-out the shares of the non-farming children as the years go by. This puts a lot of financial stress on the farming child; often too much stress on the person and the business to make them accept this kind of deal.
Option 2: sell assets to pay-out the non-farming children
Another option would be to plan to downsize the farm, liquidate some of its assets to pay out the non-farming children. This strategy would allow the farming child to have a fully operational business without the influence of siblings or debts/obligations owing them. Often the remaining land and equipment are all paid for, but the size of the farming operation is significantly reduced. Remember, selling land and assets creates a capital gain and there will be significant taxes on this strategy, meaning even more land will have to be sold to realize a targeted net gain.
This is another stressful strategy, as land in Alberta has become very expensive. It would take many years, possibly a lifetime, to rebuild the family farm corporation back to the original size it was before it was broken up. Also, with the huge cost of equipment and input costs, a farm corporation tends to become more profitable once it reaches a certain size or critical mass, and then the risks of losing money year over year go down.
In order to expand the farm to reach its original size, the inheriting child would have to go into significant debt to repurchase land and assets to expand the business.
Option 3: pay the non-farming children off with credit
Here the family farm corporation would borrow money to pay out the non-farming children so that the farming child inheriting the business would own it free and clear of their interest. Again, this saddles the farming child inheriting the family farm corporation with significant debt to be repaid, squeezing his/her annual profits and limiting the ability to grow the business.
Option 4: non-farming children will not get much
In this strategy, the parents who own the farm let their non-farming children loose into the world and there is no inheritance from the farm unless they return to actively farm the land. This just does not sound fair. A child who likes farming stands to inherit a multi-million dollar asset while non-farming children get nothing (or very little in comparison).
This situation leads to family feuds, contested wills, and some of the ugliest legal fights you could image. Families are regularly torn apart over money, and the damage to relationships is often irreparable. Think long and hard about leaving non-farming children out of the will as it pertains to the farm corporation. It would even be a good idea to discuss the matter with adult children who are not planning on taking over the business. What do they think is fair, and what would they expect as inheritance from the estate?
Option 5: use life insurance to equalize the estate
When using life insurance to create an Estate Equalization Strategy, the family farm corporation can budget the expense during the life of the farming parents for the ultimate inheritance of the non-farming children. It would be best to have a family discussion about what a "fair" inheritance for non-farming children would be. Fair does not mean equal division of the farm between all children. The farming child who will inherit and run the farm corporation has already invested years of sweat equity into helping out running the farm, and he/she is taking on all the risk that a farm business brings.
When there is some kind of agreement on what a fair inheritance for non-farming children would be, a life insurance plan can be designed to meet that need. The life insurance could be a level amount of death benefit or a growing amount of coverage to keep up with inflation. The benefits of a life insurance policy are that it can be easily budgeted for during your life, as it costs only pennies on the dollar per year to own the insurance coverage. The final death benefit is a tax free payment to the family farm corporation, which in turn can be paid out to beneficiaries tax free.
If you have never before looked at using permanent life insurance to equalize your estate, you should definitely take a closer look. There is no more cost effective way to create large amounts of tax free cash for you family farm corporation, allowing the farming child to buy-out the interest(s) of non-farming siblings and not have to liquidate assets or go into further debt.
