With the Build a Practice workshop coming up quick, we thought you’d like a sample of one of many topics that will be addressed by our qualified professionals from the Financial Literacy Council, Divisions of Family Practice, and CMA.
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Incorporation for Physicians – Should I Incorporate?
As many residents approach the end of their residency, they often find themselves asking whether they should incorporate their medical practice. This is not a topic to be taken lightly as there are many variables and individual circumstances that can influence one’s decision. In this article, I will provide an introduction to incorporating a medical practice along with the advantages and disadvantages of doing so along with some of the new tax changes that were introduced recently.
What is Incorporation?
Incorporation is the creation of a corporation which is a separate legal entity that can have its own assets, debt, revenues, and expenses. A corporation limits legal liability to the corporation’s assets; however, this limit general does not extend to medical liability in which case a physician would still be personally liable for any malpractice. An incorporated physician would run his or her medical practice through the corporation. In contrast, a physician who is not incorporated would run the practice personally with all revenues and expenses being recorded (and therefore taxed) on their personal tax return. An unincorporated physician would hold all assets (e.g. furniture and equipment) and liabilities (e.g. debt) personally.
What are the Benefits of Incorporating?
For physicians, incorporation is mostly done for the tax benefits:
Tax Deferral – Low Corporation Tax Rate
Effective January 1, 2018 in BC, income in a corporation is taxed at the small business low rate which is 12% on the first $500,000 of business or professional income (this will be lowered to 11% effective January 1, 2019). In contrast, an unincorporated physician would be taxed at graduated rates resulting in close to 30% on the first $144,489 of income and 43.7% on any additional income. Personal income above $150,000 and $205,842 would be taxed at 45.8% and 49.8%, respectively. As one can tell, there is a large difference in tax rates on a corporate level and on a personal level.
Of course, it must be noted that funds withdrawn from the corporation by the shareholder would still incur tax on a personal level; tax deferral only works if funds are earned by the corporation and not immediately withdrawn by the shareholder. As such, the deferral strategy is ideal for professionals whose earnings exceed their personal expenditures.
The low corporate tax rate leaves more funds for the corporation to invest. Although investment earnings within a corporation are not eligible for the low corporate tax rate, this is offset by the fact that there are more funds to invest at the start. The tax on investment earnings is reduced when earnings are paid out to the shareholders.
Starting in 2019, if total investment income exceeds $50,000 (assuming a 5% return it would require investments of $1 million) the $500,000 limit of business income eligible for the low tax rate would be reduced such that it would be nil once investment income reaches $150,000. However, investment income could be reduced at a corporate level through tax sheltering strategies such as life insurance products.
Income splitting is the allocation of income from a high income person (in a high tax bracket) to a low income person (in a low tax bracket). A physician at a high tax bracket can therefore shift income to family members in low tax brackets to realize tax savings. There are two main approaches to income splitting:
- Salaries: A physician can pay a spouse or child to perform work for the practice (e.g. administrative support). However, the Canada Revenue Agency (CRA) requires that the amount paid be reasonable for the work performed; this is defined to be the amount that would be paid to an unrelated person for the same work.
- Dividends: Starting in 2018, dividends paid to related shareholders will be subjected to a reasonability test although there are certain exemptions (e.g. paid to the spouse of a shareholder that is aged 65 or over, and family members aged 18 or over who work at least 20 hours a week in the year or any past five years ). Dividends should not be paid to children under 18 due to “kiddie tax” that would be applied to the parents.
What are the Disadvantages of Incorporating?
Costs and Complexity
Since a corporation is a separate legal entity, it greatly increases the complexity of one’s financial and tax situation. As a result, there will be additional legal, accounting, and tax filing fees. A physician who is using all of his or her earnings (e.g. paying off debt) would see little to no tax benefit from incorporation; in this case incorporation is merely an unnecessary expense. For many others however, the benefits of incorporation can significantly outweigh the costs.
Other Items to Consider
Recent Tax Changes for Private Corporations
There has been much discussion and debate over the past year with respect to the proposed tax changes for private corporations. Due to feedback from various groups, some of these measures have been significantly amended from the original draft. Although these changes now require dividends paid to family members in most cases to be reasonable as well as create additional tax implications on investment income over $50,000, incorporation should still benefit the majority of physicians.
Should I Incorporate? If so, when?
As mentioned previously, an individual’s unique circumstances such as debt repayment, spending requirements, income levels, and investment plans would influence whether incorporation is suitable and at what stage in their career it should be done. One is advised to consult with their accountant or financial planner to determine whether incorporation is a suitable option.
This article is courtesy of Richard Wong, CPA, CA of Wolrige Mahon LLP. Richard has extensive experience in providing accounting and tax services to physicians and other health professionals. For more information, Richard can be reached at firstname.lastname@example.org or at 604-691-6886.