Incorporation – The Right Choice for Your Practice?

Presented by:Mark Donato, CFPSenior Financial Consultant

Wednesday September 26, 2012

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Agenda Advantages of incorporation

– Tax deferral

– Income splitting

Incorporation myths and facts

Is incorporation the right choice for me?

– Questions to consider

Q&A – MD Advisor Panel

Should I incorporate my medical practice?

Running the numbers

2012 Tax Rate Comparison Corporation Individual

Active Business Income

<$500,000 15.50% 45.00%

>$500,000 27.50% 45.00%

Investment Income

Interest 47.00% 45.00%

Non-eligible dividends 33.33% 33.00%

Eligible dividends 33.33% 26.00%

Capital gains 23.50% 22.50%

Total tax example: Corporate small business rate x Personal non-eligible dividend tax rate

1 - (1-0.1550) x (1-0.3300) (1-0.5728) = Total tax of 43.41%

The Tax Deferral Advantage

Integration

A general tax policy designed to ensure that:

– Income earned and distributed by a Canadian Controlled Private Corporation (CCPC),

– is subject to (virtually) the same amount of total tax,

– as if the same amount of income was earned by an individual taxpayer directly.

Should I Incorporate? Case 1 - Mary Mary is a single GP who has been paying down debt and

saving in her RRSP. 

She has now paid off her mortgage and is considering incorporating her medical practice.

In order to meet her current lifestyle needs, Mary, along with the help of her accountant, has determined that she would need to pay herself a salary of $150,000 from the corporation.

This salary level also allows for continued RRSP contributions.

Case 1: The Numbers

TaxedCorporately

Deferral advantage 42,425 44,537

Income (after expenses) SalaryOngoing incorporation costsNet income

Unincorporated

Year 1 Year 2+300,000 300,000 300,000

(150,000) (150,000) (5,000) (2,500)

300,000 145,000 147,500

Corporation

Income

Corporate net incomeTaxes - corporationAfter-Tax Income (Retained in Corp.)

145,000 147,500

(22,475) (22,863) 122,525 124,637

Personal incomeTaxes - personal

Net salary

300,000

150,000

150,000 (122,000)

(52,100)

(52,100)

178,000

97,900

97,900

TaxedPersonally

Combined Personal & CorporateAfter-Tax Income 178,000 220,425 222,537

Mary will benefit from tax deferral on the savings she retains in her professional corporation.

Mary can also use RRSP contributions (from her salary of $150,000) for additional tax deferral.

Conclusion: Incorporation is a valid option for Mary.

Case 1: Conclusions

Should I Incorporate? Case 2 – Joe and Julie

Joe is a young GP, married to Julie. They have three children and a large mortgage on their principal residence.

To meet Joe’s cash flow needs, the corporation would need to pay him a salary of $132,500 as well as a dividend distribution equal to the funds remaining in the corporation.

Due to Julie’s income level there are no splitting opportunities.

Case 2: The Numbers

Increase (decrease) in savings 4,328

Unincorporated Incorporated

2,903

137,312

139,425

(88,909) (89,597)180,903 182,328

Personal salary income

Taxes - personalNet salary

300,000 132,500 132,500

(122,000)

178,000

TaxedPersonally

Personal non-eligible dividend income

Income (after expenses)SalaryOngoing incorporation costsNet income

Year 1 Year 2+300,000 300,000 300,000

(132,500) (132,500) (5,000) (2,500)

300,000 162,500 165,000

Income

TaxedCorporately

Corporate net incomeTaxes - corporation

165,000 (25,575)

162,500 (25,188)

137,312 139,425 After-Tax IncomeDividend Distribution (non-eligible) 137,312 139,425Funds retained in Corporation 0 0

Combined Personal & CorporateAfter-Tax Income 178,000 180,903 182,328

For Joe and Julie: Little savings retained in the corporation means minimal tax deferral

Due to the additional expenses of incorporation, there is little tax savings

Incorporation for Joe would mean more administrative work and very little (if any) tax savings

Result? Joe may decide not to incorporate

Case 2: Conclusions

Key Considerations: Tax Deferral

In order to defer taxes, earnings must be retained within the corporation.

The tax deferral advantage is greater when funds retained in the corporation are taxed at the small business rate rather than the general corporate rate.

Should still consider RRSP contributions and the Tax Free Savings Plan (TFSA).

Looking Long-Term: Realizing the Benefits of Tax Deferral Reducing tax now so you can invest the money and make

more money over time can be, at least partially, a temporary benefit.

Turning tax deferral into tax savings:

– To maximize the amount you will receive personally, drawing the money out at the right time is essential.

– It may be possible to withdraw funds and incur little or no tax: early retirement, leave of absence, and income-splitting

The Income Splitting Advantage

Share Ownership Regulations

Legislation governing incorporation differs between provinces and includes restrictions on who can own shares of your medical professional corporation.

– Can family members, trusts, or even other corporations own shares? Your MD Advisor can provide this information as well as help with analysis.

– Speak to your legal advisor for recommendations regarding the structure most appropriate for you.

Back to our example with Joe who has high cash flow needs which prevent him from realizing deferral benefits.

Again, we assume the corporation pays Joe a $132,500 salary so that he can maintain his RRSP contributions.

Julie, Joe’s wife, earns no income for this example.

Simplified Case The Income Splitting Advantage

The Numbers Unincorporated Corporation

Year 1 Year 2+

300,000

300,000

300,000

(132,500)

(132,500)

(5,000)

(2,500)

162,500

165,000

(25,188)

(25,575)

137,312 139,425

Available for deferral (or paid as a div.)

Ongoing incorporation costs

Income (after expenses)Salary

Corporate net income

Taxes - corporation

Income

TaxedCorporately

300,000 132,500 132,500(122,000) (44,000) (44,000)

139,425

137,312

Salary - JoeTaxes - JoeNon-eligible dividend income - Julie

Taxes - Julie (25,004) (25,693)

TaxedPersonally

178,000

After-Tax Income 200,808 202,232

Increase in After-Tax Income 22,808 24,232

Key Considerations

Splitting income with a spouse or adult child (or both) who is in a lower tax bracket than yours can provide for very attractive tax savings.

“Kiddie tax” rules negate the benefits of splitting income with minor children.

Speak with your tax advisor about attribution rules which may also negate the benefits of income splitting.

Physician Incorporation

Myths & Facts

Incorporation Myth #1

Greater expense deductions? No

– No—same rules for deducting expenses

– Expenses must be incurred to earn income

– The amounts must be reasonable

– Proof of payment is required

Other considerations:

– Medical / Dental expenses (Health & Welfare Trusts)

– The use of “cheaper” after-tax corporate dollars

– Non-deductible expenses (i.e. 50% of meals & entertainment)

– Repayment of business debt

Incorporation Myth #2

Limited liability

– No—physicians still liable for professional acts

– Limited liability for corporate creditors

The Real Advantages

Tax deferral

Income-splitting

The use of sophisticated products:

– Individual Pension Plans for retirement planning

– Health & Welfare Trusts

– Permanent and Term Life Insurance policies

More efficient business debt repayment

Advantage: Retirement Income Planning Withdrawals from a corporation are part of overall

retirement planning.

Integrate with other tax-advantaged products such as RRSPs or Individual Pension Plans.

Plan for Old Age Security clawback and CPP start date.

Incorporation Dilemmas

– Disability insurance

– Partnerships and Alternate Funding Arrangements

– Employees

– U.S. Citizenship

Incorporation Disadvantages

– Losses do not flow through to shareholders

– Risk of changes to tax laws

Incorporation Dilemmas/Disadvantages

Initial set-up costs

Ongoing annual fees for legal and accounting support

Additional administrative burden

– New bank & investment accounts for professional corporation

– Regular corporate tax installments and source deductions on salaries

– Tax information returns (T4s, T5s)

– Annual corporate returns; director and shareholder resolutions

Incorporation Costs Time & Money

Is Incorporation the Right Choice for Me?

Questions toconsider

Questions for You

How much debt do I have?

Am I a good saver?

Does my lifestyle allow me to retain a sufficient amount of money in my corporation over a long-term period?

Am I willing to split income with my spouse and/or children?

Am I well-organized financially?

Do I handle financial complexity well?

Am I averse to the risk of legislative change?

Do I have a good relationship with my accountant/lawyer?

More questions for You

How might incorporation impact my saving strategy (RRSPs, TFSA, insurance)? 

What is the opportunity for income splitting in my situation?   

What are your thoughts on my compensation plan? 

Do you see any significant ramifications for my investment, risk management, retirement, or estate plans?

Questions for your MD Financial Consultant

Questions for your Accountant

Have you incorporated many physicians?

What expenses can I expect to pay from the corporation?

In my particular situation, how much tax could I save by incorporating?

How sensitive to change are these savings?

Could I benefit from a permanent life insurance policy or an Individual Pension Plan?

How will I set up the books?

What mix of dividends and salary should I have?

What legal structure should I have for my situation?

Can I use the enhanced capital gains exemption?

What range of fees will I be expected to pay?

More questions for your Accountant

Questions for your Lawyer

Have you incorporated many physicians?

What are the limitations of incorporation in this province?

What happens to the corporation in case of marital breakdown?

How much will your fees be?

Incorporation is a complex issue.

MD’s goal is to ensure that you receive valuable advice tailored to your specific situation.

We will work with your current advisor to ensure this is achieved.

Be sure to consult your:

– MD Advisor & personalized MD Team

– Accountant

– Legal counsel

What next?

MD Delivers Total Wealth ManagementTeam based approach synthesizes a full range of professional perspectives to create an integrated plan

Thank you!

All tax calculations are for illustrative purposes only and are based on tax legislation enacted or proposed as of May 31, 2012 (unless otherwise indicated). Actual tax amounts will vary according to your specific facts and circumstances.

MD Management Limited does not intend to provide taxation, accounting, legal or similar professional advice to clients or potential clients. The information contained in this document is not intended to offer such advice, nor is it to replace the advice of independent tax, accounting and legal professionals

MD Physician Services provides financial products and services, the MD family of mutual funds, investment counselling services and practice management products and services through the MD group of companies. For a detailed list of these companies, visit md.cma.ca.

The information in this presentation is for information purposes only and is not intended to be used as direct investment, legal or tax advice. Please contact your MD Advisor before acting upon any of this information or before implementing any investment or tax strategy.

Questions?