Beware the Alternative Minimum Tax when you sell your farm

Monday, October 3, 2011

Retiring farmers believe the capital gains exemption takes care of everything, but it doesn't. The AMT can still take a big chunk out of your returns

by MIKE MULHERN


When Dan and Diane Harkin sold their Winchester area farm last December, they expected their capital gains exemption would take care of any tax. They were wrong. When the dust cleared, the Harkins were hit with something called the Alternative Minimum Tax (AMT). Their tax bill was about $32,000.

The AMT has been around since 1986. It was introduced to address concerns that some individuals and trusts with high gross incomes paid little or no income tax, but the Harkins didn't see themselves falling into the high-earning category.

"We've been here 40 years and actively farming. We can hardly be called speculators," says Diane. However, they are not alone in facing an AMT bill after selling a farm property.

Allison Henkell, a Certified General Accountant and senior tax manager for BDO Canada LLP, says farmers who want to sell their properties need to plan ahead and anticipate all costs, including tax.

"If you've got a farmer who has a $750,000 gain on the sale of his farm, he uses the capital gains exemption on it so there's no real income tax, but then the Alternative Minimum Tax kicks in," Henkell says. This is how she explains it:
"Basically, the government says we're going to calculate the minimum amount of tax we expect you to pay in the year. That calculation includes 80 per cent of the gain on the farm, even though you could shelter it with your capital gains exemption. When you work in the exemption, this means that 30 per cent of the first $750,000 of the gain is subject to AMT.

"The calculation then  takes the lowest federal rate in effect in that year (15 per cent at the moment), applies it to the gain (after allowing for a $40,000 basic exemption) and says, 'This is the minimum amount of tax you're going to pay.' Then it compares it with the tax you are already paying . . . and, if your minimum tax is higher than your tax otherwise calculated, you're going to have a minimum tax liability."

She says the AMT catches farm sales, but it can also catch dividends for lower-income taxpayers, the sale of quota in certain situations and a number of other situations where various tax credits or deductions are claimed.

Henkell says it amounts to "tax payable on what was intended to be a tax-free sale, which is the sale of qualified farm property." If you're retiring, like the Harkins, the AMT turns into a permanent tax. However, if you have taxable income for years after the sale, you may be able to recover the tax.

"There is a seven-year pay-back period to allow you to get credit back for the (AMT) tax that you have prepaid," Henkell says, "but only if you have sufficient regular tax to utilize the AMT credit."

One of the ways to minimize the tax, according to Henkell, is to collect the proceeds from the sale over a number of years by taking back a mortgage, which allows for a capital gains reserve. "If you collect the proceeds over five years, you can spread the gain over those years and significantly reduce or eliminate the impact of AMT," she says.

Part of the problem with the AMT, Henkell notes, is that it's not an easy tax to understand. "The biggest problem with the AMT is when you sit across the table from someone and try to explain why this applies. There isn't a really easy general explanation I've managed to come up with."

Planning and being aware that the AMT could be part of the cost associated with the sale is the best way to deal with the tax, Henkell says. But what if it's a sale from parents to children where no money changes hands?

"The parents may say, 'I don't want any money from junior,' but we're going to transfer the farm at $1.5 million because mom and dad both have full capital gains exemptions. They do the transfer, they don't get any money and suddenly the AMT kicks in."  In that case, Henkell says, the AMT could be as much as $40,000 per person or $80,000 for the couple.

"If I'm doing planning and AMT is created for someone I know is going to have $60,000 or $70,000 worth of income in the next year and the year after, then it's okay because it is a temporary tax. At least you're going to get it back." In cases where there is no prospect of future income to recover the tax, planning is crucial, even if the plan is just to pay the tax.

Jason Bent, a farm policy researcher with the Ontario Federation of Agriculture (OFA), says the federation has been arguing that the tax should not apply to farm sales. "The issue that we face here is that it is frustrating the intention of the capital gains exemption," Bent says. The OFA has called on its federal counterpart, the Canadian Federation of Agriculture (CFA), to argue for an exemption at the federal level. The CFA agrees the AMT is a problem, but they have other more pressing tax issues at the top of their agenda.

Ron Bonnett, president of the CFA, says the AMT "is one of the issues we've identified, but it's not in the top three."  This fall, the CFA expects to discuss its top tax concerns with the standing committee on finance and with Finance Minister Jim Flaherty. "We tried to narrow it down to two or three taxation issues that need to be addressed immediately," Bonnett says.

Topping the CFA list is T5013, amended requirements for partnerships. "They recently changed the rules where partnerships with fewer than six partners will have to put a whole lot more paperwork in and this is going to cause a lot of problems with meeting deadlines and extra expense for accounting," Bonnett says, adding, "We're not even sure if people are going to be able to fill our all the forms in time."

Non-arm's-length sale of shares revolving around accessing the capital gains exemption when the transaction is with a family member is No. 2 on the CFA list and No. 3 is deemed proceeds or capital gain Section 55(2) of the Income Tax Act, which adds "significant barriers to splitting up a farm that is jointly owned by two siblings." 

Fourth on the list is "inter vivos transfers by individuals." The CFA argues that "during a farmer's lifetime, there is a provision in the Income Tax Act that allows the transfer of intangible agriculture assets, such as quota, but the provision is inexplicably removed upon death."  Fifth on the CFA list is the AMT.

A footnote to the Harkins' story. According to a Revenue Canada letter the Harkins received recently, they can expect to have their Old Age Security cheques clawed back after selling the farm.

The letter says "under Canada's public pension system, seniors with an expected net income of more than $67,668 in the 2011 tax year have to pay back all or part of their Old Age Security pension. BF

With files from Don Stoneman.