ACTORES Y DEPENDENCIAS GOBIERNO CENTRAL
ACTORES DE LA ACADEMIA
Fast track:
Just as building a house requires a skilled plumber, electrician and carpen- ter, incorporating a medical practice also requires the right people to create a strong foundation. You will need to consult with a team, including a lawyer, accountant and financial advisor to make this work.
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hysicians incorporate their practice in order to save taxes. To determine if incorporation is a good option for you, ask yourself the following questions: Am I a good saver?Do any income-splitting opportuni- ties exist?
Am I comfortable with change? Do I have business debt? Am I well organized financially? Do I have a good relationship with my accountant/lawyer?
Am I considered self-employed and not an employee?
If you answered yes to most of the questions above, incorporation might be for you. As with any major business decision you are considering, speaking with an expert will help you make the right choice.
What is incorporation? Incorporation involves the creation of a new legal en- tity: the corporation. Shareholder(s), such as physician and, under certain circumstances, his or her family mem- bers, own the corporation’s shares, and the corporation owns the medical practice. The physician usually then becomes both an employee and a shareholder of the corporation. The tax treatment of a corporation is dependent upon the type of corporation and the type of income generated within it. A corporation that is a Canadian- Controlled Private Corporation (CCPC)
for tax purposes and that earns active business income (generally income from physicians’ activities is considered active business income—some exceptions may apply), but not investment income, may be eligible for a small business tax rate reduction on that income. For 2008, this results in a tax rate of about 16 per cent on the first $400,000 of income. (The provincial small business deduc- tion limit may vary from the $400,000 federal limit. The small business tax rate varies by province.)
Health and Welfare Trust: A physician can further reduce a tax bill if he or she can use the corporation to fund a per- sonal health services plan, which effectively converts uninsured medical expenses to a tax deduction from a tax credit. The net impact is that, instead of earning approximately $185 to pay for a $100 expense, he or she would only need to earn about $110.
Small Business Corporations (SBCs): SBCs are a subset of CCPCs where additional benefits such as qualification
for the $750,000 capital gains exemp- tion may apply. One of the criteria for a CCPC to be an SBC is that 90 per cent or more of its assets must be used in an active business carried on primarily in Canada at the time of the sale. In addi- tion, the assets of the CCPC must have been used principally (more than 50 per cent) in an active business carried on primarily in Canada for the 24 months before the sale. The rules gov- erning the $750,000 capital gains ex- emption are complex. Speaking with your advisor about the most strategic way to take advantage of this exemp- tion is strongly recommended.
Advantages
Tax deferral: There may be an advan- tage to retaining money in a corpora- tion and deferring the payment of tax at the shareholder level. Tax deferral al- lows the investment (and therefore growth) of funds that would otherwise be sent to the CRA. If you’re in a lower tax bracket at retirement, you will real- ize an absolute tax savings when funds are withdrawn.
Incorporation generally allows a physi- cian to pay the lower corporate tax rate on up to the first $400,000 of active business income, when the earnings re- main within the corporation. The tax rate on this first portion of income varies from province to province, but is generally about 16 per cent. This means that once a business has deducted all eligible expenses, any income remaining in the corporation is taxed at a lower rate than it would be if it were instead taxed in the hands of an individual. Worth noting is that the corporation, and not the individual physician, has benefited from the reduced rate. For the physician to receive income personally, the corporation would have to pay the
Incorporation
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46 New in Practice 2009: What medical residents need to know before entering practice
physician a salary, bonuses or divi- dends. As an officer of the corporation, the physician makes the decision as to when and what type of remuneration to pay from the corporation. The impor- tant thing to remember is that incorpo- rating is most likely to be beneficial when corporate earnings remain within the corporation.
Income splitting: Income earned by a corporation may be paid out in the form of dividends to shareholders. For those provinces that allow family members as shareholders of the professional corpo- ration, tax savings can be achieved if the income flows out to those members who are taxed at a lower marginal rate than the physician’s rate. Income split- ting with minor children is limited due to the Income Tax Act rules commonly known as the “kiddie tax” rules. Under these rules, certain types of income re- ceived by minor children (including dividends paid from private corpora- tions) are taxed at the highest marginal rates and without the basic personal exemption. The tax implications regarding kiddie tax rules, as well as other attri- bution rules, should be discussed 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 an arm’s-length per- son for similar services.
Tax savings: Ideally, distributions from the corporation will occur during a year in which the shareholder is in a lower personal income tax bracket, such as during retirement or a sabbati- cal. The basic premise is to retain money within the corporation when it would otherwise be taxed at a high personal rate, and withdraw it when a lower tax rate applies.
Note: If all funds are flowed through the corporation to the physician, the tax rate is comparable to simply earning the income as an individual, without in- volving the complexities of a corpora-
tion. It is critical to work with a profes- sional advisor to deal with the complex- ities of a corporation.
Disadvantages
Increased costs and complexities: The costs associated with incorporation in- clude initial setup costs, ongoing legal and accounting fees, and the possibility of payroll taxes and provincial capital taxes. It is critical to assess whether these increased costs would eliminate any advantages of incorporating. Higher costs are usually associated with additional services, such as setting up family trusts or revising wills. Finally, there is an additional administrative
burden associated with the corpora- tion’s recording and bookkeeping activi- ties: regular corporate tax instalments, annual corporate returns, separate bank accounts and directors’ resolu- tions, amongst others.
Other considerations
Tax deductions: A common myth sur- rounding incorporation is that certain personal expenses will be deductible to the corporation. This is usually not true. If personal expenses such as automo- bile costs are paid for by the corpora- tion, they cannot be deducted by the corporation for tax purposes. In addi- tion, the shareholder will receive a tax-
Combined federal/provincial top marginal tax rates for 2008
Capital gains Eligible dividends Non-eligible div. Other income
British Columbia 21.85% 18.47% 31.58% 43.70% Alberta 19.50% 16.00% 26.46% 39.00% Saskatchewan 22.00% 20.35% 30.83% 44.00% Manitoba 23.20% 23.83% 37.40% 46.40% Ontario 23.21% 23.96% 31.34% 46.41% Quebec 24.11% 29.69% 36.35% 48.22% New Brunswick 23.48% 23.18% 35.40% 46.95% Nova Scotia 24.13% 28.35% 33.06% 48.25%
Prince Edward Island 23.69% 24.44% 33.61% 47.37%
Newfoundland and Labrador 22.50% 28.11% 33.33% 45.00%
Nunavut 20.25% 22.23% 28.96% 40.50%
Northwest Territories 21.53% 18.25% 29.64% 43.05%
Yukon 21.20% 17.23% 30.49% 42.40%
Please note: These tax rates are current as of December 31, 2008, may be based on proposed legislation
(which has not yet become law), and are subject to change to legislation introduced after this date.
Combined federal/provincial tax rates for 2008
Small business General Investment CCPC PSBIT1
British Columbia 13.50% 30.50% 45.70% $400,000 Alberta 14.00% 29.50% 44.70% $460,000 Saskatchewan 15.50% 31.50% 46.70% $500,000 Manitoba 13.00% 32.50% 47.70% $400,000 Ontario 16.50% 33.50% 48.70% $500,000 Quebec 19.00% 30.90% 46.10% $400,000 New Brunswick 16.00% 32.50% 47.70% $400,000 Nova Scotia 16.00% 35.50% 50.70% $400,000
Prince Edward Island 14.20% 35.50% 50.70% $400,000
Newfoundland and Labrador 16.00% 33.50% 48.70% $400,000
Nunavut 15.00% 31.50% 46.70% $400,000
Northwest Territories 15.00% 31.00% 46.20% $400,000
Yukon 15.00% 34.50% 49.70% $400,000
1: Provincial small business income threshold
Please note: These tax rates and thresholds apply to CCPCs, are current as of December 31, 2008, may be based
on proposed legislation (which has not yet become law), and are subject to changes pursuant to legislation intro- duced after this date. Changes to tax rates and threshold amounts occurring during a corporation's fiscal year should be applied on a pro-rated basis. The federal small business limit is $500,000 effective January 1, 2009.
able benefit for the personal use of the vehicle equal to the amount of the ex- penses, which results in a double taxa- tion situation. In general, to be deductible to a corporation, expenses have to be incurred for the purpose of earning income and have to be reason- able in the circumstances.
Certain payments made at the corpo- rate level may, however, provide advan- tages. For example, since taxes are generally lower in the corporation than at the personal level, debt repayments related to the medical practice require less gross earnings when paid from within the corporation than if they were paid at the personal level, due to higher after-tax dollars being available to
make these debt payments. Liability: Protection from liability through incorporation is limited for pro- fessionals. The rules of incorporation for physicians make it explicit that a physician remains personally liable for all medical acts that he or she has per- formed. However, the corporation could provide limited liability for corporate creditors in situations other than in a professional context, such as where a person tripped and fell in the physi- cian’s office and wanted to sue.
Conclusion
Incorporation often makes the most sense for those able to retain significant funds within the corporation. It can also
make sense where income splitting is a possibility. Other potential benefits range from individual pension
plans to more efficient business debt re- payment, or perhaps access to the en- hanced capital gains exemption. That said, it is difficult to predict the exact value of the benefits associated with in- corporation on a long-term basis. There is always a possibility of change in the physician’s circumstances or in the tax laws, which could eliminate the tax ad- vantages of incorporation, or make in- corporation more beneficial. Multiple scenarios should be assessed with the assistance of knowledgeable advisors and considered in light of other conse-
quences mentioned above. ⌧
Incorporation example 1: Salary and dividend income
Unincorporated Corporation Year 1 Corporation Year 2+
Income (after expenses) $200,000 $200,000 $200,000
Salary ($122,000) ($122,000) Incorporation costs ($4,000) ($2,000) Net income $200,000 $74,000 $76,000 Personal income $200,000 $122,000 $122,000 Taxes – personal ($74,200) ($39,100) ($39,100) Net salary $125,800 $82,900 $82,900
Corporate net income $74,000 $76,000
Taxes – corporation ($11,900) ($12,200)
Available for deferral $62,100 $63,800
Total funds personal & corporate $145,000 $146,700
Tax deferral 12% 11%
Non-eligible dividend income $62,100 $63,800
Taxes ($20,100) ($20,700)
Net salary $125,800 $82,900 $82,900
Net income $125,800 $124,900 $126,000
Tax savings -1% 0%
Incorporation example 2: Income splitting through dividend income
Unincorporated Corporation Year 1 Corporation Year 2+
Income (after expenses) $150,000 $150,000 $150,000
Incorporation costs ($4,000) ($2,000)
Net income $150,000 $146,000 $148,000
Taxes ($51,700) ($23,400) ($23,700)
After tax cash $98,300 $122,600 $124,300
Tax deferral 19% 19%
Non-eligible dividend - Paul n/a $61,300 $62,150
Non-eligible dividend - Diane n/a $61,300 $62,150
Taxes - Paul n/a ($6,400) ($6,600)
Taxes - Diane n/a ($6,400) ($6,600)
After tax cash $98,300 $109,800 $111,100
Tax savings 8% 9%
Julie earns $200,000 after expenses. As a self- employed individual, she pays $74,200 in taxes, leaving her with $125,800. If she incorporates her practice, the corporation earns the revenues, which can be paid out to Julie in the form of a dividend. In this scenario, Julie pays herself a $122,000 salary in order to generate maximum RRSP contribution room for the 2009 taxation year. If she leaves the remaining funds in the corporation, she can benefit from a tax deferral of 12%. If all remaining funds flow out to her, Julie will be left with $124,900 in the year of incorporation, which provides no tax deferral and a cost of 1%. This example provides a good illustration of the concept of integration. Note: Both examples used generic tax rates in the com- putation of personal and corporate taxes. These rates approximate the average tax rates for Canada. The ex- amples were provided for illustrative purposes only.
Paul lives in a province where spouses can be share- holders of the professional corporation. In this exam- ple, Paul earns $150,000 after eligible expenses. As a self-employed individual, he pays $51,700 in taxes, leaving him with $98,300 after tax. If he incorporates his practice, the corporation earns the revenues which can be paid out to Paul and his wife, Diane, in the form of dividends. If Paul leaves funds in the corporation, he can benefit from a tax deferral of 19%. If all funds flow out to him and his wife, the couple will have a combined $109,800 after-tax in the year of incorpo- ration, which doesn’t provide tax deferral, but does allow for tax savings of 8%. Note that this assumes Diane and Paul have no other sources of income. It also would eliminate CPP income and expenses as well as Registered Retirement Savings Plan (RRSP) con- tribution room. A $21,000 RRSP contribution repre- sents deferral of approximately 14% of $150,000 and an immediate (top rate) tax reduction of about 6% (tax savings depend on income at time of withdrawal). In this situation, it may be beneficial to incorporate. The tax savings arise due to the graduated tax rate sys-
tem as well as the dividend tax credit, which basically allows an individual earning no other income to re- ceive a non-eligible dividend up to $37,000 or eligible dividends of up to $49,000 free of federal tax.
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Fast track:
Even though you may consider yourself too young to think about plan- ning your will, it is important in order to protect your loved ones from financial or emotional hardship.
Be aware of varying provincial laws regarding wills and marriage, common- law relationships and divorce.
It may not always be a good idea to choose a spouse or family member as your executor. Choose someone who will have the time and objectivity to ad- minister your estate with care.
D
uring residency or at the beginning of your medical practice, it is natu- ral for you to think you don’t need a will at such a young age. However, as with disability or life insurance, it is always better to be prepared. Without a will, your savings, investments and other as- sets will be distributed according to the inflexible and impersonal procedures of provincial law. If you die “intestate,” meaning without a will, your estate will be distributed under the provincial laws of intestacy. This may result in in- equitable and/or unplanned distribu- tions to family members. Moreover, you will not have the option of choosing a guardian for your children or financially supporting your spouse.Basic estate planning also includes de- ciding who you want to manage your fi- nances or make medical and other personal care decisions on your behalf, should you become incapacitated. You can appoint the same or different peo- ple to the financial and medical/per- sonal care roles in a document that is often called a power of attorney. Be- cause the legal name for these docu- ments varies across the country, you may also come across terms such as representation agreements, mandates and healthcare directives. “Living will”
is a popular name used for documents governing medical decision-making. You should review your will at least once every three years, or every time there is a major change in your per- sonal situation. If your will needs to be changed, it is important to have your lawyer or notary make the changes, be- cause handwritten changes can lead to legal problems. The following events could have a major impact on your will and could justify its review:
A marriage (or remarriage) would generally revoke your unrevised wills. If you marry and then die before updating your will, you will be considered to have died without a will, and your estate will be divided according to provincial law. A divorce does not revoke a will. Upon receipt of the final decree, the divorced spouse will be considered to have died before you and will automati- cally no longer have any right to your estate. Also, not all provinces and terri- tories automatically revoke gifts to a former legal spouse after a divorce.
A separation may not have any ef- fect on a will. If you die before modify- ing your will or preparing a separation agreement, the terms and conditions of your will prevail and your spouse could be entitled to your estate. After a sepa- ration, you should draw up a new will. Common-law partnerships or co- habitation situations should be exam- ined carefully when planning your will. Most provinces and territories do not provide for inheritance by common- law partners in the event of intestacy. Upon the birth of a child or grand- child, review your will in order to make sure that this new member of the fam- ily will benefit from your estate, and that the trust takes sufficient account of this family member in case of the death of your spouse or child. Upon the death of a family mem- ber or other beneficiary, review your will to make sure it contains the ap- propriate substitutionary clauses con- cerning the share of the deceased beneficiary. ⌧
New in Practice 2009: What medical residents need to know before entering practice