You've probably heard a lot of
talk about doctors incorporating their practices. If
the idea of your office becoming a corporation sounds
a little funny to you, you're not alone. Medical practice
incorporation is still a relatively new idea, only a
few years old in Ontario and not yet possible in Quebec.
YOU
WORK FOR YOU
The buzz is that incorporation means tax savings. But
that is not the whole picture, and there are benefits
to incorporation beyond its impact on your income tax.
But first, what does incorporation really mean? The
important thing to understand about incorporation is
that when you create a corporation, you are creating
a new legal entity that is distinct from you. That means
you and your practice are two different entities. A
corporation has many of the same rights as a person
— it can own property, it pays taxes, it can be
sued and it can go bankrupt. As an employee of your
corporation, you are just a shareholder and a director.
Legally, you and your incorporated practice are two
different people.
Like human beings, corporations
can enter into contracts. Your practice has contracts
with a lot of different people — employees, your
landlord, suppliers and utilities. Your practice also
has the potential to get you into trouble. If there
is an accident — a flood, a fire, any unforeseen
mess caused by someone in your practice, you and your
wallet could be on the line — unless you're incorporated.
Although the corporation will not change your liability
for malpractice — that is your personal professional
liability — if a contract sours or if an accident
happens that is unrelated to your medical service, it
is the corporation's liability that will come into play,
not yours.
If you get into a dispute with
your landlord, and he signed the lease with your corporation
and not you personally, normally he can only sue the
corporation. Naturally, the landlord would prefer to
sue you personally, because you have more money. But
because his relationship is with the corporation, your
bank account is safe.
THE
TAX STORY
Corporations do pay income tax, but they pay it at a
much lower rate than you do as an individual. Corporate
income tax for a small business in Canada earning less
than $400,000 a year ranges from 14.1 to 21.1%, depending
on your province. Ontario is second-highest at 18.6%.This
sounds incredibly low compared to individual income
tax rates, which can approach 50% for high-income earners.
But there is a catch — if you want to spend the
money for personal use, you need to get it out of the
corporation's treasury.
There are two ways to get money
out of your corporation — salary and dividends.
Paying yourself a salary brings
you back to square one. The corporation pays no income
tax on money paid out in salary — it is an expense.
But you are taxed on it in full the same way as you
would be if the corporation was not interposed between
your billing and yourself in the first place.
DIVIDEND
HEAVEN
Dividends are more interesting. A dividend is a special
payment corporations can make to their shareholders.
A dividend is paid out of the profits of the corporation,
so if your corporation made a profit of $1,000, you'd
have to pay the Ontario and federal governments $186
of that. Then you could issue a dividend of $814 to
yourself, your only shareholder.
You personally pay income tax on
the dividend, but dividends from Canadian corporations
have a special tax status that makes them more interesting
than ordinary income. A dividend is taxed at 125% of
its value — so a $1,000 dividend counts for $1,250
of income. But when you declare the dividend in your
income tax, it will generate a tax credit for 16.66%
of the actual dividend, in this case $167. The result
of this accounting operation is that the effective tax
rate on income from dividends is considerably lower
than on other sources of revenue.
RIGHT
FOR ME?
So when is incorporation beneficial to doctors from
a tax point of view? First of all, you should be making
more money than you need to live on, even after maxing
out your RRSP contributions. That means $19,000 for
2007. The advantage of the RRSP is that you do not pay
any tax on that money when you earn it, or the interest
and capital gains it bears, until you take it out of
the RRSP. In a corporation there is always tax to be
paid, even if it is at a lowered rate.
If you do have surplus income,
even after your RRSP contributions, you can use the
corporation to defer your income tax, or for income
splitting. Deferring is straightforward. You keep the
money in the treasury of the corporation, after paying
corporate income tax on it, and eventually pay it to
yourself in the form of salary or as a dividend. This
is useful if you plan to take a sabbatical or are planning
your retirement, because you can spread your income
out over a greater number of years and reduce the average
income tax rate as a result.
Income splitting can be more troublesome.
You can legitimately pay your spouse or child for work
they do for your practice, and deduct that from your
personal income tax, without creating a corporation.
But in order to declare a dividend
to your spouse or child, they need to be a shareholder
in the corporation. Each province has its own rules
on who can be a shareholder in a professional corporation,
and in whose hands the dividend will be taxed. Check
with your lawyer or accountant before cooking up any
clever schemes. At the very least, the time you spend
with them is tax deductible.
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PERSONAL FINANCE
