Ontario law allows a broad range of professionals to incorporate and continue to practice their profession through a professional corporation, provided that certain conditions are met and the consent of the appropriate governing body of the profession is obtained. Professionals entitled to incorporate in Ontario include physicians, dentists, accountants, lawyers, social workers, veterinarians, pharmacists, optometrists and nurses, among others.
Under the Income Tax Act (Canada), significant tax advantages may be available to professionals who practice through a corporation, rather than practising as an unincorporated individual. This is particularly true for physicians and dentists as a result of legislation that came into force on January 1, 2006. The new rules allow non-professional "family members" (a professional's spouse, children and parents) to hold non-voting shares of a physician professional corporation or a dentist professional corporation. These rules apply only to physicians and dentists and offer certain tax advantages that are currently unavailable to other professionals in Ontario.
The primary tax benefit available to incorporated professionals is commonly referred to as "tax deferral".
Tax deferral is the advantage arising from the fact that corporations are taxed separately from their individual shareholders and also pay tax at a lower rate than the personal rates applicable to unincorporated individuals. The tax deferral advantage is mainly attributable to the "small business deduction" rules, which enable professional corporations and other Canadian-controlled private corporations to pay tax at a preferential rate on "active business income" earned in Canada each year.
To illustrate using 2009 rates, the small business deduction effectively reduces a professional corporation's rate of tax to approximately 16.5% on the first $500,000 of active business income, as compared to the top personal rate of approximately 46.4% applicable to unincorporated professionals earning $126,000 or more annually. Therefore, an incorporated professional can defer the payment of approximately $.30 cents of tax on every dollar of taxable income earned simply by leaving money in the professional corporation. Assuming the incorporated professional earns $300,000 annually, the 29.9% spread between the applicable corporate and personal tax rates generates annual net tax savings of approximately $89,700. This additional after-tax money can then be invested by the professional corporation in the same way it would be invested personally by the individual professional, or applied to the repayment of practice debts. As a result, investment income builds up more quickly and practice related debts are paid off sooner. The payment of personal tax on amounts retained by the corporation may be deferred by the shareholders until such time as it is paid out to the shareholders by the corporation through dividends or salary.
In addition to tax deferral, a second important tax benefit known as "income splitting" will also be available to physicians and dentists who are permitted to introduce family members as shareholders of their professional corporations.
Income splitting is the re-direction of income within a family group to take advantage of lower tax rates, deductions and credits available to each family member. In effect, by transferring income from one family member in the top marginal tax bracket to a lower-income earner, more after-tax income remains in the family. This permits family members who are not active in the professional practice to share a portion of the professional corporation's after-tax income by receiving dividends on shares that they directly or indirectly own.
By way of example, a family member shareholder with no other sources of income (e.g., a university age child or unemployed spouse) may receive approximately $30,000 of tax-free dividends each year, without having to provide any services to the corporation or satisfy the test of "reasonableness" otherwise applicable to salaries if the family member was a corporate employee. If properly structured, income splitting may generate significant net family tax savings such that the professional's family, as a whole, will pay less tax than if the professional had earned all the income personally. Income splitting may also be used to provide family member shareholders with the funds required to pay for certain family household expenses that the professional might otherwise have to pay, resulting in a tax savings of up to $.30 cents for each dollar of taxable income.
Once a professional has reviewed his or her particular circumstances with a professional advisor and has decided to incorporate, the professional should anticipate the following steps as part of incorporation process:
• incorporate a professional corporation with a share structure and articles that comply with the requirements of the applicable legislation and the rules of the professional's governing body
• complete and submit an application for certificate of authorization issued to the corporation by the professional's governing body
• transfer the professional's personal goodwill and other assets associated with the professional's practice on a tax-deferred basis pursuant to section 85 of the Income Tax Act (Canada)
• enter into an employment agreement whereby the professional corporation employs the individual professional to provide professional services to third parties in exchange for salary income
• attend to various administrative matters, such as opening a corporate bank account, obtaining new stationary, business cards, invoices, advising creditors and insurers of the incorporation, etc.
• file an annual corporate tax return and renew the corporation's certificate of authorization each year
Once the professional corporation has been issued a certificate of authorization by the professional's governing body, the professional corporation may commence business operations.
Although incorporating a professional practice may add a level of administrative complexity to a professional's day-to-day affairs, the financial benefits of incorporating a professional corporation will typically outweigh this relatively minimal imposition. Similarly, the start-up costs associated with the incorporation process (legal, accounting, government filing fees, etc.) are relatively minimal as compared to the overall benefits, and will likely be defrayed by the resultant tax savings achieved in the first few months following incorporation.
Professionals considering incorporation should seek appropriate legal, tax and financial planning advice before deciding to establish a professional corporation.
For more information, please contact David Arntfield, or any other member of the McKenzie Lake Business Law Group.
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The foregoing provides an overview only. Readers are cautioned against making any decision based on this material alone. Rather, a qualified lawyer should be consulted.
