IMPORTANT NOTICE: Professional medical corporation information on MD’s web site is based on existing incorporation rules which may be impacted by proposals announced in the Department of Finance’s policy paper entitled “Tax Planning Using Private Corporations.” MD is monitoring these proposals and we will update our tax planning strategies accordingly should rules change. For more details, please read MD’s blog Tax Planning Using Private Corporations, What’s Next: A Summary of Finance Announcements.
When you incorporate your medical practice, you create a new legal entity, the corporation. That corporation owns the medical practice and shareholders own the corporation’s shares. The physician typically then becomes both an employee and a shareholder of the corporation.
The tax treatment of a corporation depends on the type of corporation and the type of income generated within it. Professional corporations eligible for the small business tax rate reduction would pay tax on active business income at a rate of about 14% on the first $500,000 of income.1 Professional corporations not eligible for the small business tax rate pay tax on active business income at a rate of about 27%. Professional income earned over the $500,000 small business threshold, and certain income earned through complex corporate and partnership structures, may not be eligible for the 14% small business tax rate.
In Quebec, professional corporations may be eligible for small business tax rates on only the federal portion of their taxes, so would have a lowest rate of about 23%. In Nunavut, there are no rules permitting physicians to practise as a corporation. While clinical care income, for example, is considered “active business income,” investment income generally is not. Investment income is taxed at a combined top corporate rate, which ranges from 49% to 55%, depending on the province. Just like personal taxation, some types of investment income (e.g., capital gains) are only partially taxable at these rates.
Small business corporations (SBCs) are another subset of corporations. While it’s unusual for a physician’s professional corporation to be an SBC, additional benefits—such as qualification for the $836,000 capital gains exemption (this amount is adjusted each year for inflation)—may apply, provided certain specific criteria are met.
Integration of personal and corporate taxes
The tax system aims for what is commonly known as “integration.” This means that the combined personal and corporate taxes on income earned through a corporation and distributed to the shareholder as dividends should roughly equal the total personal tax you would have paid on similar unincorporated earnings. However, at a minimum, there is a deferral benefit to being taxed corporately if surplus income is retained inside the corporation and a second layer of personal tax is deferred until a later date. In addition, if the income can be distributed at a time when a physician shareholder is in a lower tax bracket or to another shareholder who is in a lower tax bracket than the original recipient would have been, permanent tax savings are also possible.
In support of the concept of integration, two types of dividends can be paid from a corporation. Non-eligible dividends result in higher personal tax as they are paid from corporate income taxed at the lower corporate rate. Eligible dividends result in lower personal tax as they come from corporate income taxed at the general corporate rate.
An advisor can help you make the right decision
Incorporation often makes the most sense for professionals who are able to retain significant funds within the corporation. It can also make sense in cases where income splitting is possible. Other potential benefits range from individual pension plans to more efficient business debt repayment, or perhaps accessing the enhanced capital gains exemption. That said, it’s difficult to predict the exact value of the benefits you can derive from incorporation on a long-term basis. Changes in your circumstances, or in the tax laws, could either eliminate the current tax advantages of incorporation, or make incorporation even more beneficial. Because of the variety of potential consequences, you should assess multiple scenarios with the help of knowledgeable advisors.