Proposed Tax Changes, At A Glance

June 7, 2018 Angela Campbell

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Wondering what the proposed tax changes on private corporations are? Here is MD Financial Management’s quick snapshot of the proposals.

 

1. Income Sprinkling

Pre-2017 tax rules

Adult shareholders (age 18 and older) could receive dividend income from your private corporation regardless of the nature of their involvement in its operations.

This allowed you to sprinkle, or split, corporate income among adult family members who were shareholders, through the use of dividends.

Provided that these adult family members are in lower tax brackets than you are, significant tax savings can result.

Tax changes proposed

Income sprinkling is no longer allowed for shareholders like your spouse, unless you can show that they have actually contributed to your corporation.

The federal government refers to this as the “reasonableness” test. Basically, you would need to show that your spouse is:

  • working for your corporation,
  • contributing money to your corporation, or
  • assuming financial risks on behalf of your corporation

If your adult family member is already working in your business for an average of 20 hours/week, you do not have to consider the reasonableness test when paying dividends to them. If your spouse doesn’t meet the reasonableness test, any dividends paid would be taxed at his or her highest marginal rate.

However, the proposals do not apply once you reach age 65. At that time, you can income sprinkle with a spouse who is a shareholder without considering the reasonableness test. 

What you need to do next

Meet with your tax accountant and your MD Advisor.

If it makes sense in your situation, your spouse could try to meet the reasonableness test—by working for your corporation, contributing money to it or assuming some financial risk.

For more information

No More Income Sprinkling? Other Ways to Split Income

2. Passive Investment Income

Pre-2017 tax rules

When you incorporate your medical practice, you become the owner and shareholder of your corporation. The money you earn as a physician goes into your corporation (it’s called “active business income”). This income is taxed at the small business tax rate, which is approximately 15% on the first $500,000.

If you have excess earnings after you’ve paid for annual practice expenses, including salaries, this money can be invested within the corporation, in an investment portfolio. The income generated from this portfolio is referred to as “passive investment income.”

So instead of paying the personal tax rate on your professional earnings (this rate can be more than 50%), you pay the 15% small business tax rate. The money you save can be invested in your corporation, and those annual savings can be compounded year over year. You don’t pay the personal tax rate until the money is taken out some time in the (distant) future.

Tax changes proposed

The federal government has proposed an annual limitation on access to the small business tax rate based on how much passive investment income is earned within a private corporation. As your passive investment income increases, there is a corresponding decrease in the amount of your active business income that can be taxed at the 15% small business tax rate.

Tax consequences can vary widely depending on the levels of your active business income and passive income. You can mitigate the consequences by using various portfolio, product, and compensation strategies, even if you already have a multimillion-dollar corporate portfolio.

For retired physicians with no active business income, there are no consequences.

 

What you need to do next

In general, incorporation is still a valid strategy for physicians and can help you save for retirement or to make improvements to your medical practice. It may be years before you have to pay a higher tax rate (called the “general corporate tax rate”) on some of your active business income.

What’s more, there will likely be many opportunities for you to mitigate or eliminate the consequences of the new proposal. This is why it’s important to meet with your tax accountant and your MD Advisor to discuss your options.

For more information

Federal Budget 2018 Update webinar



The tax information discussed in this article has been simplified for illustrative purposes and is not meant to be used or relied on as tax advice.  If you would like to confirm the impact of the proposed tax changes on your personal situation, you should discuss your particular facts and circumstances with a tax professional.

 

About the Author

Angela Campbell

Angela Campbell, CPA, CA, is Assistant Vice President with the Taxation Services Team at MD Financial Management. She and her team of tax professionals provide tax solutions, tax planning and tax compliance for the MD Group of Companies.

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