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.
Before incorporating your practice, you need to weigh the pros and cons of incorporation. Let’s start with the primary advantages of incorporation.
There may be an advantage to retaining money in a corporation and deferring the payment of tax at the shareholder level. Tax deferral enables you to reinvest money that would otherwise be paid in taxes.
Incorporation generally enables you to pay the lower corporate tax rate on the first $500,000 of active business income (when the earnings remain within the corporation). The tax rate on this first slice of income varies from province to province, but is approximately 14%. This means that, after the business has deducted all eligible expenses, any income remaining in the corporation could be taxed at a far lower rate than it would be if it were instead taxed in the hands of an individual.
Keep in mind that it’s the corporation—not you as the individual physician—that benefits from the reduced rate. For you to receive income personally, the corporation would need to pay you a salary, bonuses or dividends. As an officer of the corporation, you make the decision with respect to what type(s) of remuneration to pay from the corporation, and when. The important thing to remember here is that incorporating is most likely to be beneficial when corporate earnings remain within the corporation.
Income earned by a corporation may be paid out in the form of dividends to shareholders. Provincial legislation determines which family members may become shareholders of the professional corporation. As a result, tax savings can be achieved if the income flows out to those members who are taxed at a lower marginal rate than your rate. Income splitting with minor children is limited due to Income Tax Act (Canada) legislation commonly known as the “kiddie tax” rules. Under these rules, certain types of income received by minor children (including dividends paid from private corporations) are taxed at the highest personal marginal rate and without the basic personal exemption. You should discuss the tax implications regarding kiddie tax rules, as well as other attribution rules, with a tax advisor.
Salaries paid to family members must represent reasonable payment for the services being rendered, which means they must be comparable to an amount paid to any arm’s-length person for similar services. Corporate dividends are not subject to this test of reasonability.
Ideally, distributions from the corporation will occur during years in which the shareholder is in a lower personal income tax bracket—during retirement or on sabbatical, for example. The basic premise is to retain money you don’t require for lifestyle needs or any other purpose within the corporation when it would otherwise be taxed at a high personal rate, then withdraw it when a lower tax rate applies.
Disadvantages of physician incorporation
While there are important tax advantages to incorporating your practice, let’s look at a couple of key drawbacks:
Increased costs and complexities
The costs associated with incorporation include initial set-up costs, ongoing legal and accounting fees, and the potential for payroll taxes. It’s important to assess whether these increased costs would eliminate any advantages of incorporating. Higher costs are typically associated with additional services, such as setting up family trusts or revising wills. Finally, there is an additional administrative burden associated with the corporation’s record-keeping and bookkeeping activities: regular corporate tax instalments, annual corporate tax returns, separate bank accounts, directors’ resolutions, etc.
The corporation could benefit from business losses, not you
While it is unlikely that a physician would incur business losses in the corporation, should any such losses occur, they cannot be used personally by you as the physician shareholder. In essence, the losses are trapped within the corporation. These non-capital losses, however, can be carried back three years or carried forward 20 years, to be applied against corporate income earned in those years.
Many physicians just like you have been faced with the question of whether incorporating their practice makes sense. Now that you have a sense of the key pros and cons of incorporation, you can make a more informed decision that suits your unique situation.