October 2005

Incorporating Your Professional Practice

Physicians, dentists and most other professionals are now allowed to operate their practices through a professional corporation.

The primary reason for operating through a corporation is that it offers the practitioner a significant tax deferral advantage which can be used to increase the practitioner’s after-tax accumulation of wealth. The main drawback is that the corporate form does not provide the practitioner with any additional protection from professional liability or negligence claims.

A professional corporation will only pay tax of 19% on its first $300,000 of income, whereas a professional practising personally will pay tax at the highest personal tax rate of 46% on income in excess of $115,000. If after-tax income is retained by the professional corporation (resulting in a difference in tax rates of 27%) and invested for a sufficient period of time the practitioner will increase his after-tax wealth, even after having to pay tax on the dividends as funds are withdrawn from the company in the future.

The Government of Ontario has proposed to extend an additional benefit to physicians and dentists effective January 1, 2006. It is proposed that family members of the professional be allowed to become non-voting shareholders of the professional corporation. There is the potential for significant income splitting opportunities if this legislation is passed.

As an example, let us look at a married professional who earns $250,000 and whose spouse is not employed. If the professional were operating personally the family would retain $150,000 after taxes. However, if the practice were incorporated and the professional and the spouse were 50-50 shareholders, the family would retain $172,000 after taxes. By earning fees through the corporation rather than personally, the family’s annual cash flow would increase by $22,000.

Similar benefits could be achieved with children that are at least 18 years of age. For example, a professional may intend on funding their child’s post-secondary education. If the adult child is a shareholder of the company, they can receive as much as $32,000 of dividends per annum on a tax-free basis assuming they have no other income. Whereas if the professional withdrew a $32,000 dividend from the corporation to fund the costs of the education, he or she would have to pay $10,000 of personal tax on the dividend.

There is no indication at this time that the income splitting benefits will be extended to all incorporated professionals, although one would expect that the various professional bodies will lobby for equal treatment.

Having family members as shareholders of the corporation may have an impact on how the professionals’ family protects their assets. For example, will the new legislation extend liability for professional negligence to all shareholders? On a similar note, consideration needs to be given to claims on the shares by creditors of all shareholders. A benefit to having family members as shareholders is that it allows the professional to spread his wealth amongst family members and protect that wealth against the professionals’ creditors.

There are additional complexities for incorporating professionals that are currently members in partnerships that also need to be considered.

Professional practitioners should contact their advisors and consider the merits of incorporating in their particular situation.

Chris Bodnar, C.A.
Tax Partner, Crawford, Smith & Swallow, Chartered Accountants, LLP

Readers are urged to consult their professional advisors prior to acting on the basis of material in this newsletter. If you have any questions regarding the content of this newsletter, please contact Crawford, Smith & Swallow. Copies of the newsletter in PDF format are available on our website.