In 2001, Ontario introduced legislation allowing professionals to incorporate. Along with other regulated professionals, this allowed doctors, lawyers, dentists and accountants to form professional corporations. When the legislation was first introduced, these corporations had some restrictions. In addition to not having limited liability, all of the shareholders had to be professionals.
Fortunately for doctors and dentists, the legislation was amended allowing family members to be shareholders. The definition of family members includes a spouse, parents, adult children and trusts for minor children only. (Please note that for other professionals, the restriction on shareholders still applies.)
The family members can be issued only non-voting shares with the professional maintaining voting control. Having family members as shareholders of your professional corporation allows the opportunity for income splitting. When these changes first came out, good tax planning and the proper structure for the authorized and issued shareholdings, allowed a medical professional to split income with a family member via a dividend payment that would attract only minimal income tax as opposed to the high rates a professional might pay. However, new income splitting rules were introduced in 2018 significantly limiting this type of income planning for professional corporations to very specific situations including retirement and death.
There is another tax advantage to incorporation that was not affected by these income splitting rules, the low tax rates on small business income. The tax rate on up to $500,000 of taxable income earned in a small business corporation is 13.5% in 2019 in Ontario. If earned directly by a professional in the top tax bracket, the rate is 53.5%. To be able to take advantage of this low rate of income tax, the earnings must be left in the corporation. The personal income tax is deferred until the funds are withdrawn. The withdrawals could be in the retirement years, when the professional would likely be in a lower income tax bracket. With the deferral and potentially lower tax bracket, there can be significant savings to the professional.
In addition to the new income splitting rules introduced in 2018, new rules were introduced to reduce the amount of income eligible for the small business rate in cases where passive income (rent, royalties, interest, dividends, etc.) in excess of $50,000 is earned by a corporation. The new rules reduce the $500,000 of income eligible for the small business rate by $5 for every $1 of passive income earned in the prior taxation year. In situations where the passive income is in excess of $150,000 in the prior taxation year there will be no income eligible for the 13.5% tax rate. However, active income earned in a professional corporation that doesn’t qualify for the 13.5% rate will still only be taxed at 26.5%, a significantly lower rate than the 53.5% personal tax rate. As a result, these new rules do not preclude effective tax planning with a professional corporation.
In order to take advantage of these opportunities, the proper planning must be done in advance. There are also legal requirements which must be met to form a professional corporation. You should consult your advisors to ensure you are able to take the most advantage of incorporating your practice. For more information, please feel free to contact me at [email protected] or 613-236-9191.