Case Study: Dividend Income Challenges: No Income Splitting; Exceeding the Tax-Rate Threshold

August 8, 2017

 

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

Many physicians face challenges when determining how to handle dividend income in a tax-efficient manner. Two common scenarios related to the question of practice incorporation involve dividend income without income splitting, and dividend income that exceeds the tax-rate threshold for small businesses. Find out how the tax implications change based on incorporation or non-incorporation.

You may also want to read other case studies on income splitting through dividend income and salary and dividend income.
 

CORPORATE

ACTIVE BUSINESS INCOME

 

Tax Rates

< $500,000

14.00%

> $500,000

28.00%

INVESTMENT INCOME

 

Tax Rates

Interest

51.65%

Dividends

38.33%

INCORPORATION COSTS

 

Fees

First year

$4,000

Second year

$2,000

 

INDIVIDUAL

SALARY/SELF-EMPLOYMENT INCOME

 

Tax Rates

< $45,000

24.00%

$45,000–$90,000

33.00%

$90,000–$140,000

40.00%

$140,000–$200,000

45.00%

> $200,000

50.00%

DIVIDENDS1

 

Gross-up

Tax Credit

Non-eligible

17.00%

14.00%

Eligible

38.00%

25.00%

TAXES

Basic personal amount

$11,635

Maximum RRSP contribution limit

$26,010

1 Non-eligible dividends receive a preferential tax treatment that results in an effective tax rate of approximately 42% in the highest bracket. Eligible dividends receive a preferential tax treatment that results in an effective tax rate of about 35% in the highest bracket. Dividend tax credits shown are as a percentage of grossed-up dividends.

NOTE: The following example is presented for illustrative purposes only. All content and data in this article are based on estimated combined federal and provincial tax rates and credits for 2017. Actual tax rates and credits will vary between provinces. In calculating tax, only the basic personal non-refundable tax credit was considered and the assumed corporate and individual tax-related figures appear in the two tables immediately above.

Scenario 1: Dividend income without income splitting

Paul earns $150,000 after expenses and is single. As a self-employed individual, he pays $47,240 in taxes, leaving him with $102,760. If he incorporates, the corporation earns the revenues, which can be paid out to Paul in the form of a dividend. If Paul leaves funds in the corporation, he can benefit from a tax deferral of 17.5%. If all funds flow out to him, Paul will be left with $102,054 in the year of incorporation, which provides no tax savings. The potential benefits should be weighed against the consequences of incorporation to determine whether or not incorporation is worthwhile.

 

UNINCORPORATED

INCORPORATED

 

 

YEAR 1

YEAR 2+

Professional income (after expenses)

$150,000

$150,000

$150,000

Incorporation costs

($4,000)

($2,000)

Net income

$150,000

$146,000

$148,000

Taxes

($47,240)

($20,440)

($20,720)

After-tax cash

$102,760

$125,560

$127,280

TAX DEFERRAL

17.5%

17.5%

Non-eligible dividend

$125,560

$127,280

Taxes

($23,506)

($25,906)

After-tax cash

$102,275

$102,054

$101,374

TAX SAVINGS

–0.7%

–1.3%

 

Scenario 2: Dividend income exceeds the tax-rate threshold for small businesses

 

Paul earns $600,000 after expenses and is single. As a self-employed individual, he pays $269,740 in taxes, leaving him with $330,260. If he incorporates and leaves funds in the corporation, he can benefit from a tax deferral of 24%. If all funds flow out to him, Paul will be left with $324,416 in the year of incorporation, which provides no tax deferral and no tax savings. Income in excess of the $500,000 small-business limit is subject to the general corporate tax rate and can be allocated to the general rate income pool, from which eligible dividends can be paid.

 

UNINCORPORATED

INCORPORATED

 

 

YEAR 1

YEAR 2+

Professional income (after expenses)

$600,000

$600,000

$600,000

Incorporation costs

($4,000)

($2,000)

Net income

$600,000

$596,000

$598,000

Taxes

($269,740)

($96,880)

($97,440)

After-tax cash

$330,260

$499,120

$500,560

TAX DEFERRAL

24.0%

24.0%

Non-eligible dividend

$430,000

$430,000

Eligible dividend

$ 69,120

$ 70,560

Taxes

($174,704)

($175,200)

After-tax cash

$330,260

$324,416

$325,360

TAX SAVINGS

—1.8%

—1.5%

 

In both scenarios above, the incorporated physician benefits from tax savings. Your MD Advisor can guide you through the scenarios to determine if you will realize tax savings by incorporating your practice.

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