Biggest Benefit is Reduced Income Taxes
There are both benefits and drawbacks to incorporating. On the whole, as a high-income earning doctor, and so long as you can save money to invest in the company, incorporating could help save you money, despite the increased administrative costs you will face.
What are the benefits of incorporating?
Some of the benefits of incorporating include:
- income splitting: this allows your family to save money on taxes by shifting some of your income to family members who are in lower tax brackets. New rules that became effective January 1, 2018 now substantially reduce the ability to income split. For years subsequent to 2017, you can only split income with family members who work 20 hours per week or more in your practice, or with aunts, uncles, nieces, nephews and non-resident family members. For years prior to 2018, you could income split with largely any family member.
- deferred taxes: with proper planning, you can maximize your tax savings by keeping the money in the business and withdrawing it at times when your income is lower.
- limited liability: incorporating may provide protection from creditors.
What are the drawbacks of incorporating?
Some of the downsides to incorporating include:
- increased complexity: running an incorporated business requires doing some things which are more complex (and costlier) than if you are a sole proprietor. For example, all of the professional income you earn must be handled by a corporate bank account (which is separate from your personal account). In addition to your personal income tax return, you will need to have a corporate tax return prepared.
- higher administrative costs: incorporating requires some initial set-up costs for legal, accounting and government fees, as well as ongoing higher costs for certain services because they are more complex, such as the costs for an accountant to prepare your taxes.
Minimize your taxes
After December 31, 2017, the ability to income split with family members has been reduced significantly. Generally, income splitting is only available to spouses when the main principal attains the age of 65 years or the spouse works in the business an average of 20 hours per week during the year or any prior five years that the corporation existed. You can also income split with aunts, uncles, nieces, nephews and non-residents. Certain other limited exceptions may be available.
Your FWH advisor can help you navigate the new complex rules regarding income splitting.
How does income splitting work?
As the higher income earner, you shift some of your income to someone with lower or no income. Because the individual is in a lower tax bracket, you will pay less tax overall as a family.
Salary or dividends?
When income splitting, you will need to decide whether to pay salaries or dividends.
Save more of your hard-earned dollars
The biggest benefit of incorporating is tax deferral, which simply means that you pay less in taxes now by leaving money in the corporation.
How does it work?
If you are not incorporated, you are taxed on the income you earn. As a high-income earning doctor, you likely fall under the highest income tax bracket so you would lose a large portion of your income to taxes. In Nova Scotia, the personal income tax rate is 50.32% on income from $173,205 to $246,752 and 54% on income over $246,752.
The key difference with being incorporated is that the earnings of the corporation are taxed at a much lower rate than personal income, so there is an incentive to keep money you don’t need for daily living in the company. For example, in Nova Scotia, the company’s income tax rate is only 11.5% on income below $500,000. You can invest and grow the money you leave in your company by investing these 88.5 cent after-tax dollars.
Because you only pay personal tax on this money when you withdraw it from the company, many doctors save money on taxes by withdrawing it during retirement when their income is lower and they are in a lower tax bracket.
How do I maximize the benefits of tax deferral?
It’s important to keep as much cash in the company as possible. In other words, only take money out of the company to pay for necessary personal and living expenses. The rest can be invested and grow within the company.
Proper planning is the key to maximizing tax savings.
In the 2018 Federal Budget, the Federal Government introduced new rules surrounding passive income (investment income) earned by private corporations with tax years beginning on or after January 1, 2019. If the previous years calculated Adjusted Aggregate Investment Income (AAII) for a private corporation (or corporate group) exceeds $50,000, it reduces the small business deduction by $5 for every additional dollar of AAII over $50,000. This will likely not be applicable in the early years of a doctor’s career, but will become an issue as wealth is accumulated inside of a corporation.
Your FWH advisor can help you manage AAII and maximize the small business deduction to the extent possible.
Protection From Creditors
If you have a family trust, incorporating can provide you with some protection from creditors for money that is kept within the corporation.
How do I get protection from creditors if I am using a family trust?
To get protection from creditors, a separately incorporated holding company is generally set up. When funds are transferred from your professional corporation to a holding company, the money will then be protected.
What if I am sued?
If the common shares of your incorporated medical practice (medco) are owned by a family trust, the value of the assets inside the medco would be protected if you were sued for a non-professional reason. However, you would not be protected from liability if a patient was to sue you, which would likely be for a professional reason.
If you were sued professionally, to get creditor protection, you would need to separately incorporate a holding company whose common shares are owned by the family trust.
Are there other benefits to having a holding company?
Assuming your malpractice or other insurance coverage satisfies creditor claims, the benefits of a holding company are providing you and your family with peace of mind should a claim arise that insurance does not cover fully.
Are there any downsides?
A holding company does not provide you with any tax benefits, and there are costs to preparing and maintaining the annual accounting records, financial statements and tax filings.
Save money by taking a few extra steps
Running an incorporated business is more complex than just being a sole proprietor. Besides the initial steps to incorporate the business, there are other things you will need to do:
- use a corporate bank account for all of the revenue you collect and professional expenses that you pay
- establish a fiscal year-end for your business
- file a corporate tax return, as well as a traditional T1 personal tax return
- establish a process for the company to periodically pay salaries and/or dividends to you and applicable family members
- file T4 and T5 slips reporting the salaries and dividends paid
The benefits outweigh the costs
The costs associated with running an incorporated business—such as having an additional corporate bank account and filing a corporate tax return—will increase the costs of you doing business. However, the tax savings you will receive from incorporating will generally be more than what you will pay for the other costs in the long run.
Higher Administrative Costs
Ahead in long run
When you incorporate, there will be some additional costs that you didn’t have as a sole proprietor. However, the money you will save through operating as a corporation will more than pay for the increased administrative costs.
What are some costs I have to pay for under incorporation that I don’t pay as a sole proprietor?
Some of the costs you will pay include:
- Legal and accounting fees to complete the incorporation process. You’ll also have to pay certain registration fees to the provincial government.
- You will need to prepare company financial statements and file both a corporate tax return and a T1 personal return. The cost of preparing financial statements and a corporate tax return is more expensive than filing a T1 because it is more complex.
- You will need to pay for a corporate bank account and corporate credit card. While it is advisable that sole proprietors have their own business account, it is not required like it is under incorporation.