Dentists, doctors, lawyers, accountants and other professionals have the option to incorporate. These corporations are often referred to as professional corporations (PC).
Whether a professional may operate through an incorporated entity comes down to the rules of the governing professional body and the province of residence. We will focus on British Columbia professionals for purposes of this article.
Personal tax rates
In order to fully understand the benefits of setting up a corporation, one first needs to look at the personal marginal tax brackets, and how they have changed over time. Let’s look at the combined provincial and federal tax rates and the income at which the top marginal tax bracket applies.
Ten Year Personal Income Tax (B.C. and Federal)
2012: Income over $132,406 had a combined tax rate of 43.70 per cent (B.C. 14.70 + Federal 29.00)
2013: Income over $135,054 had a combined tax rate of 43.70 per cent (B.C. 14.70 + Federal 29.00)
2014: Income over $150,000 had a combined tax rate of 45.80 per cent (B.C. 16.80 + Federal 29.00)
2015: Income over $151,000 had a combined tax rate of 45.80 per cent (B.C. 16.80 + Federal 29.00)
2016: Income over $200,000 had a combined tax rate of 47.70 per cent (B.C. 14.70 + Federal 33.00)
2017: Income over $202,800 had a combined tax rate of 47.70 per cent (B.C. 14.70 + Federal 33.00)
2018: Income over $205,842 had a combined tax rate of 49.80 per cent (B.C. 16.80 + Federal 33.00)
2019: Income over $210,371 had a combined tax rate of 49.80 per cent (B.C. 16.80 + Federal 33.00)
2020: Income over $220,000 had a combined tax rate of 53.50 per cent (B.C. 20.50 + Federal 33.00)
2021: Income over $222,420 had a combined tax rate of 53.50 per cent (B.C. 20.50 + Federal 33.00)
Over the past 10 years, there has never been a year where the top marginal tax rate has declined for higher-income individuals. Ten years ago, the top marginal tax bracket was 43.7 per cent; today, it is 53.50 per cent, an increase of 9.8 per cent.
The majority of the Professional Corporations that we work with are considered a Canadian-Controlled Private Corporation (CCPC). A CCPC is a private company that is resident in Canada. Provided they meet all the qualifications, a CCPC has some tax advantages that we will outline below. First, let’s look at the income tax rates on active business income with the small business deduction, for a CCPC. Like with the personal tax rates above, we have combined both the provincial (B.C.) and the Federal.
Ten Year Small Business (CCPC) Corporate Income Tax (B.C. and Federal)
2012: Jan. 1 – Dec. 31 combined Small Business Rate 13.50 per cent (B.C. 2.50 + Federal 11.00)
2013: Jan. 1 – Dec. 31 combined Small Business Rate 13.50 per cent (B.C. 2.50 + Federal 11.00)
2014: Jan. 1 – Dec. 31 combined Small Business Rate 13.50 per cent (B.C. 2.50 + Federal 11.00)
2015: Jan. 1 – Dec. 31 combined Small Business Rate 13.50 per cent (B.C. 2.50 + Federal 11.00)
2016: Jan. 1 – Dec. 31 combined Small Business Rate 13.00 per cent (B.C. 2.50 + Federal 10.50)
2017: Jan. 1 – March 31 combined Small Business Rate 13.00 per cent (B.C. 2.50 + Federal 10.50)
2017: April 1 – Dec. 31 combined Small Business Rate 12.50 per cent (B.C. 2.00 + Federal 10.50)
2018: Jan. 1 – Dec. 31 combined Small Business Rate 12.00 per cent (B.C. 2.00 + Federal 10.00)
2019: Jan. 1 – Dec. 31 combined Small Business Rate 11.00 per cent (B.C. 2.00 + Federal 9.00)
2020: Jan. 1 – Dec. 31 combined Small Business Rate 11.00 per cent (B.C. 2.00 + Federal 9.00)
2021: Jan. 1 – Dec. 31 combined Small Business Rate 11.00 per cent (B.C. 2.00 + Federal 9.00)
Ten years ago, the combined small business corporate rate was 13.50 per cent. Today the rate is 11.00 per cent, a decrease of 2.50 per cent.
Tax advantages of professional corporations
The main advantages of incorporating a practice are the ability to enjoy low corporate tax rates and defer personal taxes. As noted above, a CCPC is eligible for the small business deduction. The first $500,000 of income is currently taxed at a combined federal and B.C. rate of 11.00 per cent. Any business income that exceeds $500,000 is subject to the combined federal and provincial income tax rate of 27 per cent.
Hence, in some cases, CCPCs may pay bonuses and/or salaries to shareholder employee(s) to reduce the corporation’s taxable income to $500,000 or less to take advantage of the lower small business tax rate.
Key benefit of a corporation is deferral
When a CCPC makes a distribution to its shareholders, the distributions are taxable in the hands of the shareholders. As distributions can be discretionary, the longer the funds are left in the CCPC, the greater the deferral advantage will be as the funds are taxed at the lower corporate rate versus the higher personal rate.
By deferring taxes within a CCPC, funds that otherwise would have been paid to the government as taxes can used for portfolio investments to generate a return. Next week we will discuss holding companies and how the professionals we work with use them for deferral.
Lifetime Capital Gains Exemption (LCGE)
When individual shareholders sell their shares of the CCPC, they may be entitled to claim the Lifetime Capital Gains Exemption (LCGE), up to $892,218 (2021), to reduce potential capital gains on the sale, provided that the PC qualifies as a Qualified Small Business Corporation (QSBC). To qualify as a QSBC, the following criteria must be met:
• At the time of the sale, the QSBC shares were owned by the owner of the QSBC (or their spouse, common-law partner, or partnership through which they were a member); and
• For the 24 months before the sale of shares, the corporation was considered a CCPC and over 50% of the fair market value of the assets were used in either active business, certain shares/debts of connected corporations, or a combination of the two.
We encourage our clients who have a CCPC, and are looking to retire in a few years, to plan and meet with their tax adviser and Portfolio Manager. Later in our series of articles for business owners we will outline some more advanced tax planning opportunities for PCs that includes refreezing or thawing your estate.
Personal liability protection
A professional who carries on a professional practice as a sole proprietor is personally liable for professional negligence, any wrongdoings or breaches of contract. If a claimant is successful in bringing an action against the professional, the courts may seize the professional’s personal assets to settle the claim.
The possibility of carrying on a professional practice while limiting their exposure to having their personal assets seized is very attractive. A Professional Corporation is a separate legal entity and can limit the liability of its shareholders.
A key difference between a regular corporation and a Professional Corporation is that a Professional Corporation does not offer protection from personal liability when there is professional negligence.
Before incorporating a Professional Corporation, it is important to understand the rules for liability as it will depend on the professional’s province of residence and the legislation that governs the specific profession. Most of the medical and dental professionals that we work with also maintain insurance coverage.
Set up costs and ongoing costs
Incorporating a PC will result in legal and accounting costs. Annually there are costs of maintaining the structure such as legal records and tax filings. Such costs should be weighed against the potential tax and non-tax benefits of a PC.
Administratively, carrying on a practice through a corporation will result in more additional accounting reporting requirements. We typically forward information to our clients’ tax professional to lessen this burden.
Plan to avoid double taxation
Upon the death of a taxpayer owning shares of a PC, and the eventual extraction of corporate funds by the estate, the same corporate value may be taxed two or possibly three times. However, strategies are available to mitigate the amount of tax paid, referred to as “post-mortem tax planning.”
The discussion on post-mortem tax planning is complex and beyond the scope of this article. We work with our clients, who have a large balance in retained earnings within a corporation, to also have a plan to avoid excessive taxation.
Income exceeds your cash flow needs
For some of our clients that have large cash flow needs, they may not be able to retain money within a corporation. If daily living expenses result in earnings all flowing out through wages, then the tax deferral advantage is lost. The tax deferral advantage discussed is only available when corporate earnings are retained inside the PC and not distributed to its shareholders.
Once distributions are made from a PC, including wages and dividends, these would be subject to the professional’s personal marginal tax rates. If a professional requires a substantial portion of their professional income to fund their lifestyle needs, then incorporating a PC may not make sense.
Income splitting opportunities
Prior to 2018, the PC could be used for income splitting. Generally, income splitting is achieved through the introduction of family members as additional shareholders. The PC would distribute dividends and/or pay salaries to family members (individuals who were at lower marginal rates); this may result in absolute tax savings for the family.
Nonetheless, the new Tax on Split Income (TOSI) rules were introduced to restrict these perceived benefits to split income with specified individuals that are not actively engaged in the business or do not contribute a “reasonable amount” of capital or labour to the related business. This rule was effective on Jan. 1, 2018.
Incorporating a PC can provide professionals with access to different types of remuneration options (salary, dividends or a combination of both).
Not all tax advisers have the same strategy with respect to the remuneration. We will speak with our clients’ tax adviser and obtain an understanding of the strategy that they use in the current year and obtain a longer-term outlook for both financial plans and minimizing tax over our clients’ lifetime.
A shareholder who receives a benefit from their PC must include the value of the benefit on their personal income tax returns. In most cases, monies taken from the PC are either reported as a wage or a dividend to the professional.
However, there are some not so obvious benefits that need to be reported as well. Some examples of these benefits would include the value of the personal use of corporately owned assets or deemed interest benefits on funds advanced to the shareholder. It is important to consult a tax adviser when there are transactions that involve the shareholder and their immediate family.
In most situations, a PC is beneficial for high-income professionals. It is always advisable to seek the advice of a tax and legal professional to ensure you are making the correct decision and to discuss how best to structure the company or companies to minimize tax over your lifetime.
Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management, with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138, email firstname.lastname@example.org or visit greenardgroup.com/secondopinion