Medical students, residents and new physicians are closely watching the private corporation issue and wondering about its impact on their future career.
Since the federal government proposed tax changes to private corporations, physicians throughout the country have had questions about how the changes could affect their financial plan.
Though young physicians have yet to incorporate, here are their questions and concerns.
1. What is the purpose of incorporating a medical practice currently, without considering the proposed changes?
There are two primary advantages to incorporating a medical practice: income sprinkling and tax deferral.
Income sprinkling: Currently, incorporated physicians can reduce their family’s overall tax bill by splitting their income with family members who are shareholders in their corporation and are in a lower personal tax bracket.
Note: The terms “income splitting” and “income sprinkling” are sometimes used interchangeably in the media. In fact, income splitting refers to the general strategy of splitting income to reduce taxes, whereas income sprinkling is a specific type of income splitting—it describes the payment of corporate dividends to various shareholders.
Tax deferral: Physicians with excess funds in their corporation (after paying the corporate tax and paying themselves) can allow the money to grow inside the corporation. The income generated within the corporation is called passive income. The advantage comes from deferring the personal tax payable until a future time when it’s taken out, instead of paying personal tax on it in the year that the income is earned.
2. What’s the difference between a public and a private corporation?
A public corporation is a company like a big bank, large insurance company or food retailer whose shares are bought and sold on the stock market. Depending on their province or territory, public corporations pay a combined federal and provincial/territorial corporate tax of about 26% to 31%.
Any corporation that’s not a public corporation is a private one. Private corporations can be owned by individuals such as physicians, dentists, lawyers or farmers. Canadian-controlled private corporations often qualify for the small business tax rate, which is about 15%.
The federal government’s proposed tax changes affect only private corporations.
3. If the proposed changes are enacted as written, will physicians still be able to incorporate?
Under the new rules, self-employed physicians will still be able to incorporate and access the small business tax rate on income they retain in their corporation. However, it is expected that the benefits of income splitting using dividends will be eliminated or constrained, as the payment of dividends to adult family members is proposed to be subject to a new reasonableness test.
As for the deferral benefit that results in the build-up of passive investments in a private corporation, the government remains committed to developing a new framework for the taxation of passive income that would result in a much higher tax rate than is currently applied. However, in October, the government announced it would allow a new passive income threshold of $50,000 per year, suggesting that a private corporation could have $1 million in passive investments (based on a 5% return on investment) before being subjected to any proposed tax rules on passive income.
It means newly incorporated physicians may have many years to build their passive investments before any proposed changes would take effect. For young physicians who are still a number of years away from deciding to incorporate, incorporation may still be a strategy worth exploring. Talk about it with your advisor, and make your decision based on your specific situation and financial goals.
4. How many physicians would be affected by the proposed changes?
About 60% of practising physicians in Canada own a medical professional corporation, and they would be affected by the changes. There are also physicians who aren’t incorporated but may own other private corporations who would be affected or may have family members who would be affected.
5. Will certain specialties be more affected than others by the proposed changes?
It’s important to distinguish the business benefits of incorporating from the financial benefits. Specialty practices with high capital requirements, such as radiology, ophthalmology and dermatology, should still get the existing business benefits of incorporating.
The proposed changes affect the financial benefits, which include income sprinkling and the tax deferral on passive investments (as mentioned in Question 1). In general, practices that have higher levels of retained corporate earnings are going to be more affected by the changes to the passive investment rules.
At the time of writing this article, we continue to wait for draft legislation to get a better understanding of the outcome of these proposed changes.
The government will now determine its next steps. In particular, it will decide whether or when to introduce a legislative bill in Parliament. MD Financial Management is monitoring this process and working closely with the Canadian Medical Association as it continues its advocacy efforts.
MD Advisors have tools to help you understand the consequences of the proposed changes, whether they are tax tactics like income splitting or broader concerns like your retirement plan.
Once the changes have been finalized and legislated, we will be able to help move your planning beyond understanding consequences: we’ll help you explore strategies that will support your long-term financial planning.