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.
As a physician, one of the significant business decisions you must make is whether to incorporate your medical practice. If you have chosen the incorporation route, you need to be efficient regarding how you execute on certain actions that could affect how you’re taxed, how you draw income, how you save and how you prepare for a successful retirement. Let’s look at some of the factors to consider as an incorporated physician, so you can benefit from an efficient approach to operating within your corporation.
1. Guidelines for tax deductions
A common myth about incorporation is that it allows you to deduct certain personal expenses to the corporation for tax purposes. This is generally not true. If the corporation pays personal expenses, such as automobile costs, the costs are not deductible to the corporation for tax purposes and the shareholder will receive a taxable benefit, which results in a double taxation situation. To be deductible to a corporation, expenses must be incurred for the purpose of earning income and need to be reasonable in the circumstances.
However, certain payments made at the corporate level may provide advantages. For example, because corporate tax rates are generally lower than personal tax rates, debt repayments related to the medical practice require less gross earnings when paid from within the corporation than at the personal level. This is as a result of higher after-tax dollars being available to make these debt payments. For health expenses, note that the benefit is for employees, not shareholders. Accordingly, compensation choices and retirement may impact access to health-expense tax deductions.
2. Associated corporations
Generally, the ability to use the small business deduction must be shared among members of a partnership and with associated corporations. If you are in a group or partnership situation, you may need to restructure your existing agreement if you wish to maximize access to the small business tax rate. Likewise, if you are married to another incorporated individual, you may face association issues. Since restructuring can be costly, you should weigh the costs against the benefits of incorporation.
If you continue to work in partnership or group arrangements, keep in mind there may still be tax-deferral or income-splitting opportunities when corporate income is taxed at the general corporate rate. Consult a tax advisor to determine the tax implications of any existing or potential agreement and your MD Advisor to help tailor your financial plan to this reality.
3. Passive income
Since “passive investment income” earned within a corporation does not receive a small business tax rate reduction and the corporate tax rate on investment income can exceed 50%, it’s important to consider opportunities to mitigate this second layer of tax.
This frequently contributes to an asset mix within the corporation that contains a relatively high equity allocation. Where corporate investment income tax is high, it may make sense to use corporate-owned permanent life insurance to shelter surplus investments within the corporation by eliminating the annual tax on investment income. It may also be powerful in an estate as a means to convert taxable assets to non-taxable assets, by using the capital dividend account (CDA).
The CDA is a notional account, which means it tabulates a running total of the non-taxable portion of capital gains or losses, as well as proceeds upon death, under certain life insurance policies. This account forms the basis for the payment of tax-free dividends.
The way you choose to be compensated from your corporation can be a complex decision. Key factors include current tax and cash flow, investment taxation, future tax and cash flow, provincial variations and risk factors. The route you choose can add further complexity to your financial plan. For example, a dividend strategy that changes RRSP and CPP contributions and benefits may alter both your investment strategy and your retirement plan. Seek advice from both your tax and financial advisors in your compensation decision.
After you retire, you will need to refocus tax planning in order to save taxes on income streams. The order and sources of withdrawals will affect taxes upon retirement. For example, when distributing from within a corporation, up to the first $36,000 or so in non-eligible dividend income, and up to $50,000 of eligible dividend income, is free of federal tax personally if it is the only source of income earned by the recipient. As noted above, capital dividends are also generally tax free personally.
Another potential source of retirement income for the incorporated physician is an individual pension plan (IPP), which is a form of registered pension plan. IPPs can allow you to make both lump-sum deposits and higher contributions than you could with an RRSP. Administrative costs apply when setting up IPPs.
6. RRSP contributions
While incorporation can reduce your current taxes from 50% to 14%, the current tax paid on eligible RRSP contributions is 0%. As noted earlier, compensation decisions can be complex but withdrawing a salary from the corporation could provide benefits like an RRSP deduction, or access to programs like the Home Buyers’ Plan and the Lifelong Learning Plan, which let you tap into your retirement savings to help buy your first home or pay for post-secondary education. Furthermore, the fact that spousal RRSPs also allow you to split income with a spouse may be an important consideration.
7. TFSA contributions
In some ways, a tax-free savings account (TFSA) is the opposite of RRSP contributions. For an incorporated physician, a TFSA may require you to pay more tax up front for the benefit of lower future tax. In circumstances like the use of the CDA and/or distributing income earned on investments, however, the upfront tax cost may be eliminated, making TFSA and corporate savings synchronization an important consideration. Even where there is an upfront cost, the TFSA elimination of future taxes can overcome that cost in long time horizons.
Protection from liability through incorporation is limited for professionals. The rules of incorporation for physicians make it explicit that you remain personally liable for all medical acts you have performed. The corporation could provide limited liability for corporate creditors, however, in situations other than those that apply in a professional context (e.g., a person who trips and falls in your office and intends to sue).
Other examples where significant risks can accrue include a U.S. citizen who is a shareholder of a professional corporation, or administration of an estate that includes a professional corporation.
When you think about the various factors that the incorporated physician must consider, it can be overwhelming to sort through on your own. That’s where your MD Advisor can meet with you to assess your personal circumstances and help you take an efficient approach to your corporation.