Far too many Physicians lose out on significant financial benefits by waiting until they are five, ten or fifteen years into their practice before they decide to incorporate. Don’t let that be you!
When you are a Medical Resident, especially one in the final year of your residency, it is important that you turn your mind to the business side of medicine. One of the first business decisions you should consider prior to starting your practice, is whether or not to incorporate.
Determining when to incorporate can be a complicated process. Factors such as your type of practice, expected income, current debt obligations, family structure, and total family income are all important variables that need to be carefully considered. Given the complexity of this decision it is strongly suggested that you consult with a Tax Lawyer and an Accountant prior to starting your practice to help devise the right plan to suit your needs.
Determining whether or not you should incorporate your medical practice is really a question of whether in your circumstances it is financially beneficial to do so. Again, this is largely dependent on your current cash needs, whether you have business partners, your desire to save money, and your ability to split your income with a spouse.
Although an individual professional assessment is necessary to make an informed decision on whether to incorporate or not, below, I have highlighted the two main advantages of incorporating one’s practice, followed by a few sample scenarios illustrating the possible financial benefit. The calculations below are based on tax rates as of January 1, 2015.
Main Advantages to Incorporating Your Medical Practice
The advantages that follow are based on a medical practice that falls under the Canada Revenue Agency’s definition of a Canadian Controlled Private Corporation (CCPC). CCPC’s receive beneficial tax treatment, including being taxed at a much lower corporate rate. Making sure your corporation falls into this category is another crucial reason why seeking advice from tax professionals is absolutely necessary.
One of the biggest advantages of incorporating is the ability to save more of your hard earned dollars by deferring tax and keeping money in your corporation. Because a corporation is taxed at a much lower rate on business income than an individual, there is a potential for a large tax deferral.
Physicians carrying on their practice in Nova Scotia as a sole-proprietor, pay tax on their income between $93,000 and $150,000 at approximately 43.5%, and income over $150,000 at 50%.
Alternatively, subject to certain restrictions, a qualified incorporated medical practice would be taxed at 14% for the first $350,000 in business income. Therefore a physician can effectively defer tax by up to 36% (50%-14%) on income in excess of $150,000 by retaining income earned in excess of $150,000 in the corporation.
It is important to understand that eventually the tax man will be paid when the money retained in the corporation is drawn out. However, the goal is to draw it out at a time and in a manner to minimize how much tax is actually paid.
The basic premise of retaining money in the corporation is akin to putting money in an RRSP. Essentially, the amount the physician would have contributed to an RRSP, is instead left inside the company and invested in the same manner as an RRSP. At retirement, instead of withdrawing funds from an RRSP or a registered retirement income fund (RRIF) to live on, the physician would sell corporately held investments and extract the after-tax proceeds through dividend payments. This method can outperform RRSP savings by taking advantage of capital gains exemptions and dividend tax credits. It also allows for greater flexibility regarding access to your savings.
Canada implements a progressive income tax system which results in high income earners paying a higher percentage in taxes than low income earners. Income splitting is a method of shifting income from a person at a higher tax rate, to a person at a lower rate for an overall savings on taxes paid. For example, in Nova Scotia, on $200,000 of employment income, one person would owe approximately $78,000 in taxes. Whereas if half of that income was transferred to another person, in other words two persons each earned $100,000, the total income tax owed would be approximately $62,000 ($31,000 x 2). This represents a total tax savings of $16,000.
Although an unincorporated physician can split income with a family member, the Income Tax Act requires that the amount split with a family member must be “reasonable” with respect to the work they did for the medical practice. Therefore, unless your spouse or other family member is working full-time for the medical practice, you would be unable to split a significant enough amount of your income to result in any substantial tax savings.
Alternatively, a medical corporation can issue shares to certain family members of the physician, and those shareholding family members can be paid in dividends. Dividends are paid out of the after-tax income held by the corporation and are not subject to a “reasonable” amount based on services provided to the medical corporation. In essence, a spouse can have no involvement whatsoever with the day to day operation of the medical practice and still receive a $60,000 dividend. Moreover, since dividend income is taxed more favourably than regular income, this $60,000 in dividend income results in additional tax savings.
Income splitting is maximized when you have family members who fall into different tax brackets. Moreover, unless the family member is very involved in the practice, tax savings can only be achieved with a medical corporation issuing dividends. It is important to understand that the money split among family members actually has to be given to that family member receiving the dividend and claiming it as income.
As previously discussed, the benefits of incorporating a medical practice are largely dependent on your specific circumstances. Below I have outlined five different scenarios applying the concepts of tax deferral and income splitting, in an attempt to briefly illustrate when incorporating is and is not advantageous. Keep in mind that there are many, many modifications that can be made to the below scenarios based on other variables. For that reason I stress again the importance of meeting with a lawyer and an accountant to discuss your scenario, and whether incorporation is right for you.
Scenario 1: Un-incorporated Medical Practice
A physician is a sole proprietor (not incorporated) and earns $250,000 in 2014. This physician would have to pay approximately $103,000 in taxes for a net after tax income of $147,000.
Scenario 2: Incorporated Medical Practice
A physician earns $250,000 in 2014 and is incorporated but does not have the ability to split income with family members and needs all of the money (cannot defer) for expenses. He/she decides to pay him/herself $150,000 in salary and take the remainder in dividends. The physician pays approximately $53,000 in taxes on the $150,000 in salary. The physician pays $14,000 in corporate taxes on the $100,000 left in the company. He/she can now pay a dividend of $86,000 ($100,000 less the corporate tax of $14,000) to him/herself and will have to pay approximately $32,000 in personal taxes associated with the dividend. The net after tax income for the physician is $151,000 ($250,000 – $53,000 – $14,000 – $32,000). Compared to Scenario 1, the physician receives an additional $4,000 ($151,000 – $147,000) after tax income but will also have to pay additional corporate tax return and start up costs. The small tax savings may not be worth the additional work/costs.
Scenario 3: Incorporated Practice + Defer income
An incorporated medical practice earns $250,000; the physician does not have the ability to split income with family members but can defer income in the company to future years.
He/she decides to pay him/herself $150,000 in salary and defer the remaining $100,000 to the future. The physician pays $53,000 (similar to Scenario 2) in taxes on the $150,000 in salary and $14,000 (again, similar to Scenario 2) in corporate taxes on the $100,000 left in the corporation. The net after tax income for the physician is $97,000 ($150,000 – $53,000) and there is also $86,000 ($100,000 – $14,000) left in the company that can be used to purchase investments (shares, mutual funds, property etc) at the corporate level.
Compared to Scenario 1, the physician pays $36,000 ($103,000 – $53,000 – $14,000) less tax. This is significant in-year tax savings and the dividends can be paid out in future years when the physician receives less income. Income earned on the investments will be taxed at approximately 25% for capital gains, 33 % for dividends and 51% for interest within the corporation.
Scenario 4: Incorporated practice + Income Split with Spouse
The incorporated medical practice earns $250,000. The physician pays him/herself a salary of $150,000 and then pays dividends equally between him/herself and his/her spouse. The spouse has no other income. The physician pays $53,000 in taxes on the $150,000 in salary and $14,000 in corporate taxes. Unlike scenario 3 where they left the remaining $86,000 ($100,000 – $14,000 in corporate tax), it pays out the remaining $86,000 as a dividend to the physicians spouse. The physicians spouse would pay approximately $14,500 in taxes associated with the dividend after receiving the dividend tax credit.
Compared to Scenario 1, the family pays $21,500 ($103,000 – $53,000 – $14,000 – $14,500) less taxes and is able to pay out all of the income in the year. In this scenario the net family take home from the $250,000 earned by the physician is $168,500; the Physician receives $96,500 and his/her spouse receives $71,500.
Scenario 5: Incorporated practice + Income Split with Spouse and Children (18+)
An incorporated medical practice earns $250,000. The physician pays him/herself a salary of $150,000 and then pays dividends equally between the shareholders him/herself, spouse, and 2 adult children (aged 18 and older). The spouse earns $60,000 and the adult children do not have income as they are full time university students.
In this scenario the physician would pay $53,000 in taxes on the $150,000 in salary and $14,000 in corporate taxes. Similar to Scenario 4, the remaining $86,000 is paid out in dividends. This time the dividends are paid out equally to the four family members; $21,500 each. The physician, spouse, and 2 adult children will pay approximately $8,500, $5,500 and $0 respectively in taxes associated with the dividend after receiving the dividend tax credit.
Compared to Scenario 1, the family pays $22,000 ($103,000 – $53,000 – $14,000 – $8,500 – $5,500 – $0 – $0) lesstaxes and is able to pay out all of the income in the year. In this scenario the net family take home from the $250,000 earned by the physician is $169,000; the Physician receives $110,000, the spouse receives $16,000 and the children each receive $21,500.
Should I Incorporate?
The list of advantages and disadvantages of incorporating one’s medical practice is beyond the scope of this post. Whether you’re a medical student, a resident, or currently a practicing Physician, receiving professional advice on whether incorporating your future or current medical practice is a question you can’t afford not to seek out. Connect with a member of our team to maximize your tax savings. To contact a member of our Taxation team call us at 902-469-9500 or 1-866-339-3400.