In general, incorporation is a good idea when your expenses are a lot lesser than your income. However, physicians face a lot of educational and internship issues before they begin practicing professionally, and on top of that, they go through financial hardships. Also, when opening a practice, they want to make sure that they make the right financial decision.
There are many financial benefits to incorporating a medical or dental practice, but there are also a few potential drawbacks you should be aware of. Moreover, there are certain aspects—around tax and insurance, but they should be understood and considered with respect to your specific goals and situation. Incorporating their practice or not, is one of the concerns new doctors and dentists have to deal with. And the decision is hard, but let’s break it down to understand it better.
Tax deferral: In most cases, as soon as doctors or dentists begin work, they will be at the higher end of the income-earning scale. This simply means that, if they take no steps and pay taxes at their personal marginal rate, significant earnings will be taxed at a very high rate. The top personal income tax rate in AB is 48% for 2022. Generally, corporations, have access to small business deductions. This means taxes can be deferred by paying only 11% corporate tax. You can leave money in the corporation if your personal cash needs are less than your earning potential. This income will be taxed at a lower corporate rate, giving you more purchasing power. You could invest more money, which would result in more compounding and, most likely, bring you closer to your retirement goals. When you withdraw this income, you will pay less tax on it as your personal income level will presumably be lower. Not only, it helps with retirement or tax savings, but you could also use corporate retained earnings to fund a sabbatical, maternity, or paternity leave, or to simply take extended periods of time off.
Income splitting – This used to be very attractive until the TOSI rules became effective. If your spouse does not work, you could make him or her a shareholder in your corporation (this is legal in some provinces). By paying dividends from the corporation to your spouse/children, it was possible to split the income. But due to TOSI rules, those dividends could be taxed at the top marginal tax rate.
However, if your spouse or children work for your corporation, a reasonable amount of salary could be paid to the spouse. The salary must be reasonable.
Lifetime Capital Gains Exemption – In some cases, the practice of a dentist could be eligible for LCGE. This is a very generous income tax provision, allowing them to exempt up to $913,630 (for 2022) of capital gains in their lifetimes. This shows up on the tax return as the capital gains deduction, at line 254. In its simplest form, if a business owner selling a business with a $700,000 capital gain, then there would be $700,000 x 50% = $350,000 of capital gains reported at line 127, followed by $350,000 of capital gains deduction at line 254. This business owner has used $700,000 of the available exemption and would have $213,630 ($913,630- $700,000) of unused exemption available for future use. To meet this criterion, the shares must represent ownership of a Canadian Controlled Private Corporation that is carrying on business primarily in Canada. (As per CRA, primarily means 50% or more). Two other rules are very important, One is that, for the 24 months up to the disposition of assets, 50% or more of the business’ assets must have been dedicated to the earning of active business income. Non-active assets would include shares or debt instruments of unrelated companies, insurance policies, and bank accounts beyond those required to run the business. Secondly, at the time of sale, 90% or more of the business’ assets must be dedicated to earning active business income. For this reason, it is often necessary to purify a business before you plan a sale to avail of LCGE. Purifying the business simply means transferring inactive assets to the owner or some other entity in the form of a taxable dividend.
Access to the CDA (Capital Dividend Account) – It’s a notional account. It gets credited in three scenarios; Capital gains/losses realized by a corporation, life insurance death benefit, & transfers of funds within related corporations. If a life insurance policy is purchased personally, the death benefit is passed tax-free to the beneficiaries. The death benefit could be passed tax-free if the life insurance policy is purchased within a corporation with cheaper corporate dollars if the ACB is nil. In this case, the corporation has to be private, and it must be both the owner and the beneficiary of life insurance.
Shareholder`s Loan – A shareholder can take a loan from the corporation and can use it for various purposes. It could be used to purchase a house and make a down payment for it. This option can provide further tax planning opportunities.
Access to certain deductions IPP – Individual retirement plans like IPP can be set up through a corporation. The contributions towards IPP are deductible for tax purposes. It’s well suited for an incorporated professional if he/she is over the age of 40 and has a history of over $100,000 in T4 earnings.
Health Spending Account – Credits in the form of money ($) can be allocated into a Health Spending Account that you can use to pay for eligible medical and dental expenses. This could be done using pre-tax dollars just as if expenses were covered through the health/dental plan. The details of allowable expenses can be found here at Canada Revenue Agency.
A corporation can choose any year-end. You can choose a month when you are not too busy.
On the downside, there are greater setup costs, separate bank accounts, and annual tax filing requirements which involve a higher accounting fee.
Most importantly, when a doctor or dentist incorporates, their college must be informed. A doctor’s professional corporation may have to be owned solely by doctors. Similar restrictions may exist on the ability of a holding company or trust to own shares in a professional corporation.
Professional liability like a malpractice cannot be shielded by the corporation; an example of this could be interactions with clients or patients in a professional capacity. A corporation for Business and operational liabilities like interactions with staff, vendors & suppliers can be protected by getting incorporated. Also, professional liability insurance is a mandatory requirement to practice the profession.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.