Are you the spouse or common-law partner1 who is responsible for keeping your family’s finances on track? And is your physician spouse the higher-income earner? If so, as your spouse or partner’s medical practice grows, there are a few options that you should look at — as a couple — to ensure that your household doesn’t pay more taxes than it needs to.
Physicians do typically earn higher than average incomes, but their income for personal use may be far less than what the public perceives. A physician’s billings don’t reflect what’s actually taken home because practice earnings could be significantly less after overhead — expenses such as rent, employee salaries, supplies and insurance.
That’s why it makes sense to explore certain strategies available that might allow you to defer some personal taxes to future years and save tax effectively, over time.
Deferring taxes using a corporation
If your spouse or partner is a self-employed physician, incorporating could be a good option to balance out your household income and reduce taxes, at least for now. Having a corporation gives them control over the earnings they take home and allows surplus earnings to be retained in the corporation.
The corporation — not the individual physician — benefits from the small business tax rate on up to $500,000 of practice income. Here’s how:
- A medical professional corporation is a separate legal entity that owns the medical practice. Billings go through the practice, which is an independent small business.
- Practice earnings are reported on a corporate tax return and are subject to the small business tax rate of about 12%, depending on the province or territory — much lower than the personal tax rate.
- You and your spouse or partner can decide how much family income to draw from the corporation as salary or dividends, with the help of your accountant. This income is reported on your personal income tax return and is subject to your personal marginal tax rates — which top 50% after around $200,000 in annual income.
Any surplus earnings retained in the corporation can be invested and grow in value. However, there are advantages and disadvantages to incorporating a medical practice. It can be less attractive for those in a business partnership, and it isn’t possible for salaried physicians.
Using your power of “two” to maximize tax savings
Planning income and cash flow together, strategically as a couple, can help you lower household taxes. A coordinated approach lets you take advantage of tax savings that may be available to the partner with the lower income. For instance:
- Working for your spouse or partner’s medical practice. As a couple, you could opt to work together and split income drawn from the medical practice. You’d need to actually work in the practice, and be paid at market rates, for this tax strategy to work — but your income may have a lower marginal personal tax rate than your physician spouse or partner’s income does.
- Opening a spousal RRSP in your name. This works best when there’s a wide disparity in your incomes: Your physician spouse or partner could open and make contributions to a spousal registered retirement savings plan (RRSP) in your name. They would benefit from the income tax deduction for the contribution and you both could benefit from lower income tax rates in the future as withdrawals would be taxable to you at your marginal tax rates (provided the contributions remain in the spousal RRSP for at least three years). This may help lighten the tax load for some couples in the current tax year (through the tax deduction for RRSP contributions) and later on, as they split the income at the time the funds are withdrawn.
- Being tax savvy about planning time off. You may be able to reduce income taxes by deferring some taxable income until times when your household’s overall income may be lower — say, if you or your partner plans a parental leave or a sabbatical. Withdrawing from an RRSP or a corporate account at that time may make sense — it’s still taxable income, but it’ll likely be subject to a lower personal tax rate.
Looking beyond this year’s tax bill for longer-term savings
Tax planning can be stressful, but no one wants to pay more than their fair share when submitting taxes each year — or later, in retirement. Comprehensive financial planning can help you and your spouse or partner to generate the most tax-effective forms of income, guided by your goals for family life and through the later years of practice.
Your MD Advisor* can review your financial situation today and look ahead to suggest options for more tax-effective use of your household’s income, savings and investments over time. This forward-looking approach is the best way to save money in the long run.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
1 Legally married spouses acquire certain rights and obligations from the date of marriage. Life partners must either cohabit in a conjugal relationship for a specified period of time or cohabit and be the recognized parents of the same child to be considered common-law partners under tax or other legislation. Depending on where they live, common-law partners may not have the same rights as married spouses to property division (on relationship breakdown or death).