Incorporation offers the flexibility to better manage your finances by allowing for the deferral of taxes on professional income and benefiting from lower corporate tax rates.
Personal tax rate (highest marginal tax rate): 53%
Corporate tax rate: 17.5%
Instead of being taxed at a rate of 53% on all of the income you earn, any surplus income that is not necessary to support your lifestyle can be retained inside your corporation and taxed at a rate of 17.5%, achieving a tax deferral of 35.5%. The surplus money in the corporation can then be invested for retirement allowing you to have access to more capital to invest. During retirement or during times when you find yourself in a lower tax bracket (sabbatical, maternity leave), when you really need the money (during retirement or a sabbatical).
CAPITAL GAINS EXEMPTION
Certain professionals, such as dentists, chiropractors, owners of medical clinics as well as others, may sell their practice to another professional. This may generate a substantial capital gain which is normally taxable.
However, once incorporated, a professional may sell the shares of their practice and be sheltered from paying taxes on the first $866,000 of capital gain generated (the limit changes depending on inflation and is $866,912 in 2019).
To be entitled to the capital gains exemption, your corporation must first qualify as a Small Business Corporation (SBC).
If your corporation is not eligible for the capital gains exemption, it may need to be purified using specific tax strategies.
Should the amount of capital gains realized on the sale of your practice exceed your personal limit of $866,000, it is possible to put into place a strategy that would shelter the difference using a family trust.
MULTIPLYING THE CAPITAL GAINS EXEMPTION USING A FAMILY TRUST
A family trust can allow you to multiply the lifetime capital gains exemption by using the exemption of other family members, including minor children.
In order to set-up this tax strategy, a family trust must be a shareholder of your professional corporation either at the moment of incorporation or later on through an estate freeze prior to the sale of the sale. It is important to make sure that the trust is added as a shareholder before your shares exceed a fair market value of $866,000. We often suggest getting a professional appraisal every couple of years to establish the fair market value of your practice.
Following the death of an incorporated professional, the corporation can pay the estate $10,000 tax free. In order to do this, appropriate legal documents must be drafted beforehand.
This amount may be used, for example, to help defray the costs of the funeral arrangements or to settle the estate.
TRANSFERRING A LIFE-INSURANCE POLICY TO A CORPORATION
By transferring a life-insurance policy to a corporation, it is possible to withdrawal an amount equivalent to the the fair market value (FMV) of your insurance policy with minor tax to pay. The amount of tax to pay on the transfer is calculated on the difference between the cash surrender value and the adjusted cost base of the policy.
In order to implement this strategy, the fair market value of the life insurance policy must be evaluated by an actuary. It is possible that the FMV of the policy is different from its cash surrender value.
There are three important elements that must be evaluated when deciding whether to implement this strategy: the fair market value, the cash surrender value and the adjusted cost base:
Fair market value (FMV): the highest price, expressed in dollars, that a property would bring in an open and unrestricted market between a willing buyer and a willing seller who are knowledgeable, informed and prudent, and who are acting independently of each other. Since the transfer of the life insurance policy is made to a corporation controlled by the professional;
Cash surrender value (CSV): total value of your policy, minus applicable fees associated with the redemption, the readjustment of the market value (interest penalties), non-reimbursed advances and unpaid monthly fees; and
Adjusted cost base (ACB): the amount equal to the paid premiums minus the cumulative cost of insurance.
A life insurance policy is an asset that may have a fair market value (FMV) which is different from its CSV. Many factors are taken into consideration when determining the FMV, in particular:
The insured person’s state of health;
The insurability of the individual at time of transfer;
The additional premium to set up a new policy;
Being diagnosed with a terminal illness where death is imminent;
Number of years since the transfer of the policy;
Paid premiums up to the transfer;
The presence of a surplus that is greater than the CSV.
SALARY VERSUS DIVIDENDS
As an incorporated professional, you are both the shareholder and employee of your corporation. Once incorporated, a professional can choose to pay themselves in the form of a salary, a dividend or a combination of both. Each option has its particular benefits and can be decided on a yearly basis depending on your particular circumstances that year. In summary, the major difference between earning a salary compared to a dividend is the added payment of deductions at source. This would mean that in addition to paying yourself a 100k salary, there would also be additional taxes to pay in the form of deductions at source. The form of remuneration is determined on a case by case basis with your accountant.