For a number of years, provincial governing bodies of regulated health professionals (1) and other professional organizations (2) have allowed the incorporation of the professional practice. The major tax advantage of incorporation, is the ability to defer tax by retaining income in the corporation that would otherwise be taxed at a much higher personal tax rate if you earned the same income as a sole proprietor or as a partner.
Commencing in 2006, family members of doctors and dentists may hold non-voting shares of the professional corporation. Other professional corporations may not have family members as shareholders.
Non-voting shares may include both non-voting common and non-voting special shares. Common shares participate in the value of the corporation, preferred or special shares do not. The advantage in having family members as shareholders is that the corporation may pay your parents, adult children and spouse, dividends taxed at lower tax rates to finance tuition and other personal expenditures as opposed to you receiving the income and having to pay more tax at your marginal tax rate to finance the same expenditure. Dividends are not paid to minor children because they will be subject to top rate tax or what is commonly called “kiddie tax”.
For 2014, a single family member residing in Ontario with no other income may receive about $35,500 in (non-eligible) dividend income without tax.
The licenced professional must hold the voting common shares directly as opposed through a holding corporation. The licenced professional is the only individual that may be an officer or director of the corporation. Veterinarians are the only professionals that may hold shares indirectly through a holding corporation. Pharmacists must own 51% of each class of issued shares, other family members may own 49%.
The non-voting shares held by family members must be held directly by them. Shares held for a minor child may be held by an inter-vivos family trust until the child turns 18. Alternatively, the shares may be held legally by trustees acting in trust for the minor child.
The difference between non-professional and professional corporations, is that there is no limit on the professional liability of a professional under the legislation governing the particular practice. Absent of a shareholder or individual guarantee, other corporate liabilities are limited.
For those residing in Ontario, by using a corporation, the first $500,000 of active business income is taxed at 15.5%; income above that threshold is taxed at 26.5%, for 2014. If you are already at the 2014 top individual marginal tax rate of 49.53%, you have a tax deferral of about 34% which is the difference between the corporate tax and the personal tax if the professional income is earned by a PC or earned directly by you. (See my webpage for combined Federal/Ontario tax rates http://lnsca.com/combined-federal-ontario-top-marginal-personal-tax-rates-for-2010-2014/ ). If you are already at the 2014 top individual marginal tax rate of 49.53%, corporate income is $500K or less,and you personally withdraw the entire after-tax corporate income as a dividend, the savings is about .1% for 2014 because the concept of integration between private corporations and individuals is now about neutral on earning active business income if you are at the top tax bracket. If you are not at the top individual marginal tax rate, the deferral will be less but the savings will be more because of how the dividend tax credit works. At whatever personal tax bracket you are at, if you income split with lower tax-bracket family members, the combined savings will be greater.
With family members holding non-voting shares, additional savings are available. For example, if you are in the top Ontario tax bracket and you need to pay $10,000 in tuition, you have to draw about $19,813 in salary or about $16,703 in dividends from the corporation in order to have disposable income of $10,000 to finance the tuition. As noted above, you may pay an individual with no other income about $35,500 in (non-eligible) dividends and they will have no tax payable. With tuition and educational refundable tax credits, with amount will be higher.
The illustration below compares earning professional or active business income through a corporation as opposed to earning the income as a sole proprietor. The second column notes the savings if you only require a salary of $175,000 to live on and to maximize your pensionable earnings and RRSP contributions plus taking the remainder in dividends. The third column notes paying discretionary dividends of $35,500 without a tax liability to two other family members who have no other sources of income,with a remaining dividend of $201,576 received by you in order to distribute the retained earnings or the annual after-tax corporate tax profits. As you can see, with income-splitting, the savings becomes greater. The tax deferral is the amount as defined earlier as the difference between the corporate tax and personal tax on the same professional income.
With some professions, a sister corporation owned by your spouse and other family members may be incorporated to perform the administrative and other non-professional services of your PC. Properly structured, the corporations will not be associated corporations. If they were associated, both corporations would have to share in the $500,000 small business limit. The sister company may bill your corporation cost plus a 15% mark-up which is generally the profit to the sister corporation.
For example, if your corporate taxable income is $700,000, your company would pay 26.5% tax on the income above $500,000 or $53,000. Assume the PC has $173,913 in transferable expenses. Provided the two corporations are not associated corporations, the sister corporation may bill your corporation $200,000 including the 15% mark-up, leaving your corporation with taxable income of $500,000 taxed at the 15.5% rate. The sister corporation will have income of $200,000 with expenses of $173,913, leaving a profit of $26,087 subject to tax at the 15.5% rate or $4,043. This translates into an annual tax savings of $48,957.The sister corporation will have less restrictions on ownership and more income splitting opportunities.
A contract outlining the services to be performed by the sister corporation should be prepared to support the services provided by the sister corporation to your PC and all invoices rendered by the sister corporation must be paid by the PC.
Doctors and dentists will prefer to use a technical service corporation as opposed to a management corporation because the HST payable on management fees is not recoverable by the PC. Services provided by a technical services company such as X-rays, providing lab work and providing reports may be an exempt supply not subject to HST.
Cost vs. benefits
You must weigh the tax savings and income splitting opportunities with the additional fees for accounting and tax preparation.
The professional corporation must carry on the business relating to the profession. It may invest surplus funds but may not invest in another non-professional business.
Access to the $800,000 capital gains exemption (prior to 2014, it was $750K) on the sale of qualified small business corporation shares may be available on the sale of shares or on the deemed disposition arising at death. Holders of non-voting common shares may be entitled to use their available capital gains exemption thereby multiplying the exemption by the number of eligible shareholders. Care must be taken to ensure not more than 10% of the fair market value of the assets are attributable to passive investments.
Tax instalments are not required in the first year of the corporation. The corporation may select an off-calendar taxation year. If a July year end is selected, accrued bonuses do not have to be paid until January which defers personal tax until the following year, providing the corporation with a deduction for the current year.
Flexibility with the remuneration, mix of salary vs. dividends, RRSP and Canada pension plan planning.
- Regulated health professionals may include:
- Doctors, dentists, chiropractors, pharmacists
- Audiologists, chiropodists, podiatrists, dental hygienists, opticians, optometrists, physiotherapists, psychologists, occupational therapists, nurses
- Other professionals may include:
- Lawyers, accountants
- Social workers
- Architects, engineers
Comparison of earning practice income directly or indirectly through a corporation
Assumptions: 2014 Ontario Professional income-$500K net; salary from PC-$175K; no other personal income; dividends to family members at $35,500 each