Incorporating a Medical or Dental Practice
Posted on: April 2, 2019
Incorporating Your Practise
As a resident, you may be approaching the end of your residency period and asking yourself, should I incorporate my medical or dental practice? First, as it may not be obvious, let’s clarify what incorporation is and some of the differences between incorporated and unincorporated practices.
When you incorporate a practice, you are creating a corporation which serves as a separate legal entity with its own assets, debts, revenues and expenses. Thus, an incorporated practise is run through the corporation itself. Whereas, an unincorporated practice would be run through the physician’s or dentist’s personal account, with all revenues and expenses recorded on their personal tax return.
Further, all assets, such as equipment and furniture for the practice, as well as liabilities, such as incurred debt, are held personally by the physician. Additionally, within medical practise, incorporation is different from the rest of the world in that a physician or dentist is still personally liable for any malpractice (outside of medical and dental liability, a corporation would limit legal liabilities to only the corporation’s assets).
A professional corporation provides some protection from creditors in the event that you borrow money. For example, if you take out a loan to finance a new office space or update equipment, the corporation will shield you from personal liability if you default on these loans.
Next, let’s examine the benefits and costs of incorporating.
The Benefits of Incorporating Your Practise
The Costs of Incorporating Your Practise
- Low Corporation Tax Rate. Effective January 1, 2019 in British Columbia, income in a corporation is taxed at the small business low rate of 11% on the first $500,000 of business or professional income. Further, Ontario is among the lowest provincial corporate tax rates at 11.5%. The tax rates when claiming personal income amounts are much, much larger – and thus, the benefit of tax deferral through incorporation is heavily realized. The tax percentages differ depending on which province the corporation is resident in, typically a corporation is eligible to pay tax at a rate within an 11-16% range. However, this tax deferral strategy depends on funds earned by the corporation are not immediately withdrawn by the shareholder because the withdrawn amount will be taxed on a personal level. Thus, this strategy is only responsible for professionals whose earnings are greater than their short-term personal expenses.
- More Room for Investing. The low corporate tax rate unlocks more funds for the corporation to invest. While investment earnings by a corporation are not eligible for the low corporate tax rate, this is offset by the unlocked funds. As well, the tax on investment earnings is reduced when dividends are paid out to shareholders. However, effective 2019, if total investment income exceeds $50,000, the $500,000 limits of business income eligible for the low corporate tax rate is reduced until nil at investment income of $150,000. Tax-sheltering strategies, such as life insurance products, may be used to reduce investment income at the corporate level.
- Income Splitting. Income splitting is the allocation of income from a high-income person (within a high-income tax bracket) and a low-income person (within a low-income tax bracket). Again, this is a form of shifting income to realize tax-savings. Income splitting is typically divided into two ways: salaries and dividends. A physician can pay a spouse or child to perform work for the practice (perhaps, administrative support etc.) – the salary must be reasonable for the work performed, or the amount that would be paid to an unrelated person for the same work. This standard is instilled by the Canada Revenue Agency (CRA). Many professionals have benefitted from paying dividends to family members or trusts of their corporations to reduce taxes. However, dividends should not be paid to children under the age of 18 due to the “kiddie tax” (which is that a child’s investment income is taxed at the parents’ tax rate). Further, dividends allocated to spouses and family members are now subject to a reasonability test, which is based on dividends paid out relative to the labour and capital contributions of the individual receiving. More on this topic can be found here.
- Capital Gains Exemption. Effective January 1, 2019 the lifetime capital gains exemption was increased to $866,912. Essentially, within a Canadian-controlled private corporation, upon the sale of shares, the first $866,912 are exempt from tax (however, it is important to note that this is applicable to the individual, and not the corporation).
- Added Costs and Complexities. If you are a physician whose earnings do not exceed your expenditures, for instance, you are paying off student or other debt, there is little to no tax benefit from incorporation. As a corporation is a separate legal entity, you will incur additional legal, accounting and tax filing fees due to the increased complexity of your financial and tax situation. However, if your earnings exceed your personal expenditures, the benefits of incorporation can greatly outweigh these added costs.
I spoke briefly about some of the recent tax changes for private corporations, in which dividend payments to family members are subject to be ‘reasonable’ and implications on the low corporate tax rate on investment income over $50,000. Despite these amendments, incorporation should still benefit the majority of physicians and dentists. Finally, as you can tell, when and why you should incorporate is a uniquely personal decision and depends largely on your debt repayment schedule, personal expenditures/spending requirements, income and investments.