Host Alex Cheung and special guest Gareth Canning talk about a big decision many physicians face – whether to incorporate or not.
You’re listening to The Financial Literacy Podcast, brought to you by MD Financial Management.
Canada’s only national financial services firm dedicated to helping physicians and their families with their unique financial needs.
AC: Hey there listeners! Welcome to another episode of MD’s Financial Literacy Podcast series. My name is Alex Cheung. I’m so excited to have this opportunity to be your host today as we talk about a big decision many physicians face when it comes to their practice, and that is incorporation.
And as always, we’ve brought someone along with us to bring some of their own professional insight and advice, so let’s welcome Gareth Canning. Thank you so much for joining us today, Gareth.
GC: Thanks for having me, Alex. I’m so glad to have the chance to talk to physicians about incorporation and the benefits they could get from it.
AC: That’s great. As you know, our podcast is all about helping guide physicians through their unique financial experiences, and one of those experiences is deciding whether or not to incorporate their practice.
So, to get us started, could you tell us what exactly incorporating is and why physicians might decide to incorporate?
GC: Yea, I’d love to.
So first off, incorporation quite literally means turning your business into a legal corporation that owns your practice, and you become a shareholder or employee of that corporation. Instead of you earning income personally, your corporation is a separate entity that earns the income and pays its own taxes. For physicians, when you incorporate your practice, it becomes a Medical Professional Corporation, or MPC.
Now, there are a number of reasons as to why a physician may decide to take this route, but the main reason is that it comes with some major tax advantages. And that’s because the income earned through your corporation is taxed at a much lower rate than your personal income would be, for the first $500,000 of income that stays in the corporation.
So, to recap the benefits of incorporation, you’ll want to keep as much income in your corporation as possible, because the money you retain in the corporation can grow. Of course, you are going to need to pay yourself. There are a few different options, but I’ll talk about that a little bit later.
The funds you retain within the corporation can be used to pay off business debt faster, too. That’s another benefit that might make physicians consider incorporation.
AC: And saving up for retirement?
Incorporation opens up a lot of opportunity for investment and savings growth beyond what just your RRSP and TFSA would allow.
AC: Amazing. So, how exactly does incorporation work?
GC: So, incorporation creates a separate legal entity that now owns your practice. The physician would then become a shareholder, director, and employee of the practice.
As a separate entity, the incorporation is responsible for paying its own taxes. And this is where those tax benefits I mentioned would come in. Your corporation’s income is taxed at the small business rate, which is currently about 12%. A physician’s personal income tax rate, on the other hand, could be higher than 50%.
Now, in terms of how your corporation is structured, you as a shareholder own shares of the corporation. It’s possible for others to also own shares, but the rules for who this applies to varies by province. At the very least, it usually includes your spouse and children. Adding your spouse as a shareholder of your corporation is common as it opens up opportunities for income splitting in retirement.
Your corporation owns your practice and can also own property and insurance policies for your practice. Since it is a legal entity, it will also take on liabilities and lawsuits should you experience any, except in the cases of malpractice. In those cases, the physician is still personally liable.
As a physician, director, and employee, you are also responsible for the services offered and carried out in your practice.
AC: Right. So, the physician is still in control at the top of the ladder, but everything functions through the corporation so that they can benefit from the corporate structure.
GC: Yes, exactly.
AC: So, with all these benefits, why wouldn’t a physician want to incorporate?
GC: Well, incorporating doesn’t make sense for everyone. There’s a number of things to consider.
Remember, the small business tax rate savings are a tax deferral, not an absolute reduction. So, it can be important to find times, like retirement, to distribute money from the corporation at lower tax rates to lock in tax savings. Incorporating also adds the complexity of an additional structure, which comes with tax and legal costs. Basically, what all this means is that not every physician is suited to incorporation.
AC: So, does that mean there are certain criteria that a physician must meet in order to incorporate?
GC: Sort of. You don’t have to meet criteria in the sense that you need to qualify for incorporation. But there are some questions that a physician can ask themselves to see if they would actually experience those benefits that come with incorporating.
AC: Oh, great. So, what kinds of questions?
GC: Well, the first thing is you can only incorporate if you are self-employed. Partnerships and group practice agreements can lead to tax complexities that would cancel out some of the tax benefits that you would want to incorporate for in the first place. So, it’s always a good idea to get tax and legal advice when entering into practice agreements.
The second thing you have to consider is if the income you are generating is exceeding your living expenses and savings plans. The point of incorporating is to hold excess funds in your corporation where they are taxed at a lower rate. If you don’t have excess funds and are taking home all of your income where it is taxed at your personal rate, incorporating likely doesn’t make sense for you. Take a moment to consider whether that might change in the future – it may be worth incorporating if that change is soon or worth reconsidering incorporation when that change occurs.
Also, on the topic of excess funds, your corporation gives you more room for savings if you’ve run out of room in your RRSPs and TFSAs. If you don’t need this extra room, you may not need to incorporate.
Then there’s debt. I mentioned earlier how the lower tax rates from being incorporated can help you save faster, which could in turn allow you to pay off business debt faster. So, if you have a large amount of debt, incorporation could be beneficial to you. If you have no debt, or debt that you can manage with the current structure of your practice, that’s a factor to consider.
Your extra funds that you’ve retained in the corporation are also useful if you think your income will vary from year to year. For example, if you plan to go abroad to volunteer, if you want to take a sabbatical or parental leave, or even if you just enjoy having vacation time, the savings you’ve retained in your corporation can make those things easier.
AC: Right. And should a physician be meeting every benefit of incorporation before they decide to incorporate?
GC: Not necessarily. Every physician’s personal and family circumstances and goals are going to be different, so it really depends on if you feel that you are going to receive benefits that outweigh the cost of incorporating.
Of course, if you’re ever unsure about whether your circumstances will bring you those benefits, talk to an advisor. MD advisors understand the impacts of incorporation for physicians and will help you weigh your options. Along with guidance from your accountant and your tax advisor, you’ll be able to make the decision that works best for you.
AC: OK. Let’s talk now about how compensation works for an incorporated physician. How does a physician then pay themselves?
GC: Well, simplistically, you can pay yourself a salary through your corporation’s income, through company dividends, or you can use a combination of both of these. In any case, the higher the compensation, the less benefit there is to incorporation.
Using a salary, your corporation pays no tax, and this income is then fully taxable at your personal income tax rate. But paying yourself a salary connects you to the Canada Pension Plan and RRSP systems. So, you will build CPP benefits by paying premiums and create RRSP room. This can be really useful in helping you reach your retirement goals because you would be building tax-deferred retirement savings at an even lower tax rate than your corporation.
When you pay yourself using dividends, your combined corporate and personal taxes are similar to what you would experience with a salary. Except now, you won’t have the CPP and RRSP benefits.
Also, as your corporation builds investment assets, it will also have investment income taxes. While this may have additional complications, it may result in the possibility of tax-free distributions or refundable taxes when using dividends.
As you get to reach the later stages of your career, when you might not be working as a physician in the same way, you may not be able to pay yourself a salary anymore. So, paying yourself with dividends will definitely make sense at this point.
Generally, the best way to decide on compensation is really based on your career stage. A salary may work best for you early on, but as you progress through your career, switching to a combination of salary and dividends, and then eventually dividends alone, may be the path that works best for you.
AC: All right. So, a few things to think about there. We’re coming to the end of our time together. Is there anything else you wanted to mention before we sign off?
GC: Sure. I guess I’ll summarize by saying that I think the most important thing for listeners to keep in mind is that you don’t have to make this important decision alone. There are professionals available, like the advisers at MD and accountants, who specialize in knowing the incorporation process and when it works best for a physician’s individual circumstances. They can work together to guide you through this process so that you understand why it works or doesn’t work and can be confident in the decision you make.
And even if incorporation doesn’t make sense for you now, doesn’t mean it never will. So, check in with these professionals as your practice, and circumstances change to come up with a plan that works best for you in all the different stages of your journey.
AC: That’s great. Gareth, thanks again for joining us today. It’s been a real pleasure.
GC: Thank you so much for having me – I hope I’ve given your listeners some good things to think about on making a decision about incorporation.
AC: Absolutely! And of course, thank you again to all of our listeners for tuning in and supporting the podcast. We hope that you’ve enjoyed The Financial Literacy series and will continue to explore the excellent advice and resources MD has to offer as you continue on your journey as a physician. Once again, my name is Alex Cheung and I’ve really enjoyed hosting for you today. Take care and all the best!
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