"Don't let the tax tail wag the
investment dog!" This caution is often offered by investment
professionals to clients suffering 'sticker shock' on
receiving their annual tax bill. You may have heard
it yourself. The thing to remember is that a large tax
bill is the result of gains and income realized over
the year. Better to pay taxes on gains than have no
gains at all.
While paying taxes when necessary
is understandable, paying more taxes than necessary
is not! Arranging and managing your investment portfolio
in a tax efficient manner is only prudent. The ultimate
objective of investing is to fund your current and future
requirements by maximizing your returns in a manner
consistent with your means, future needs and risk tolerance.
Here are a few items to consider:
1. The structure Hold your assets in a structure
that makes sense for your circumstances. This structuring
is part of the estate planning process and should involve
your family/tax lawyer, accountant and investment professional.
In addition to holding assets directly in individual
cash accounts and RRSPs, as a physician you also have
the option of utilizing personal corporations and/or
family trusts.
2. Incorporating A corporate
structure can make sense for collecting fees, paying
office expenses and holding assets for long periods.
When needed, funds can be paid out to shareholders as
dividends. The tax rate on dividends is now 21% (down
from 31%), so they're much more attractive. An added
benefit is that up to $31,000 dollars can be paid to
shareholders who have no income from other sources,
tax free. Dividends flow tax free to other corporations.
If family members are employed
by the corporation, effectively income can be allocated
in a tax efficient manner. Small business deductions
can often be taken advantage of to defer some corporate
tax. When the corporation is sold, it may qualify for
a lifetime enhanced capital gains exemption of up to
$750,000 (up from $500,000). There are several other
advantages, including the opportunity to shelter funds
in an Individual Pension Plan (IPP). For more on incorporation
do a search for "Incorporation" on www.nationalreviewofmedicine.com.
3. Family trusts As a physician
you might also look into family trusts, perhaps in conjunction
with a holding company. This can be a good way of both
creditor proofing and income splitting. As much as $42,000
can be distributed to children by way of dividends without
incurring tax. At the highest marginal rate in Ontario,
salary paid directly to individuals is taxed at 46%
while dividends are taxed at 21%. Funds may accumulate
within retained earnings of a small business corporation
after paying tax of 18.6%. By engaging the proper professional
team up front, your assets can accumulate in a more
efficient manner.
4. Mutual funds Once you've
structured your affairs, consider the kind of investments
that suit your needs and are tax effective. Mutual funds
are an option, but from a tax vantage point may have
some deficiencies. Mutuals tend to be mass marketed
to retail investors who are primarily investing for
their RRSP. Few funds are managed with tax efficacy
in mind and, depending on when they're bought, the purchaser
may be buying some capital gain exposure but not the
rewards that come with it. Watch for a future column
on pooled funds, yet another option for wealthier individuals.
5. Self managed Your other
alternatives are to self manage your investments or
hire an investment counsellor/portfolio manager (typically
1% to 2% management fee). Few doctors have the time
or inclination to self manage their portfolios. Working
with a portfolio manager, you'll likely want to generate
income in your RRSP and make capital gains non-registered
accounts since they're taxed at a lower rate than income.
At any point in time, your portfolio manager will be
weighing the tax merits of bonds (income) versus preferred
shares and common shares (dividends) and income trusts
(return of capital and income).
Throughout the year, your taxable
position should be reviewed with your portfolio manager
and tax advisor. You may opt to manage tax liabilities
by using flow-through shares and charitable giving.
Flow-through shares allow the investor to receive a
tax credit for exploration or other activities undertaken
by the company issuing the certificates. Charitable
giving has been made a lot more attractive recently
through allowing shares to be donated at current market
value without attributing the capital gain back to the
donor.
Regardless of which strategy you
choose to manage your taxes, always keep your longterm
goals and objectives at the forefront. If paying a little
more tax will enhance reaching those goals, pay the
tax! In other words, "Don't let the tax tail wag the
investment dog!"
Michael Sprung, president of
Sprung & Co Investment Counsel Inc, can be reached
at 416-934-7160 or [email protected]
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PHYSICIAN LIFE
