Benefits of Incorporating

In the last several years, the Canada Revenue Agency (CRA) changed its rules concerning who can and cannot incorporate. Professionals such as doctors, dentists, lawyers, and accountants are now permitted to incorporate their professional practices.  The rules pertaining to each profession vary regarding how to incorporate and who is able to own shares in the professional corporation. In addition to the complex formalities associated with incorporation, small business tax rates and regulations differ from one province to the next.

Due to the various considerations involved in determining whether or not to incorporate, it is advisable to consult with a tax specialist to help guide with the process and make the appropriate recommendations.  

The first consideration regarding whether or not to incorporate your professional practice is always going to be cost. Some costs associated with incorporating a professional practice include setup fees, ongoing compliance, and tax reporting. You want to be sure that the benefits of incorporating are going to outweigh the costs.

Different accounting firms offer a range of services, and costs can fluctuate dramatically. In order to get an estimate of the costs that will be incurred as a result of incorporating, it is advisable to contact your advisor and/or fellow professionals to get your questions answered.

The next consideration that needs to be taken into account is the question of who is permitted to own shares in your corporation? Do you have direct family members you can income-split with and multiply your capital gains exemption? What are the rules and regulations in your province?

Other important considerations include tax deferral opportunities using the small business deduction, and income-splitting possibilities where share ownership by family members is allowed.

In addition it is important to consider other planning and tax opportunities that become available with a corporation such as the ability to increase retirement savings using an Individual Pension Plan (IPP), the opportunity to take advantage of the capital gains exemption upon sale of a practice, as well as the possibility of multiplying the $800,000 capital gains exemption when there are multiple shareholders.

The potential benefits of deferring income with an operating or holding company and paying the small business rate, as opposed to being taxed at the personal level can be substantial.

Before setting up a corporation it is best to determine whether the income that is generated by your practice is sufficient enough to support the after-tax lifestyle expenses of you and your family. Furthermore, you want to determine how much money will be retained in the corporation and whether that amount is enough to make the costs of incorporating worthwhile.

Now let’s discuss Client X. Client X is a successful surgeon. He earns an annual income of $475,000. Client X is currently taking all of his annual income and maximizing his Registered Retirement Savings Plan (RRSP) contribution each year. Client X is 36 years old and has been primarily focused on paying down his large student loans since after being a student for 10 years, Client X accumulated a significant amount of student debt. While increasing his wealth was important to Client X, paying off his student debt was paramount. After paying off all of his debt, Client X now wants to accumulate wealth in preparation for retirement. While Client X is earning a significant income, he is paying approximately $195,000 (46%) annually in taxes, which is the highest tax rate in his province of Manitoba. The solution for Client X is to incorporate his practice. Instead of personally earning $475,000, Client X could defer income into the corporation and therefore would only have to pay an 11% corporate tax up to the small business limit of $425,000 per year. Any funds deferred would be taxed at 11% as opposed to 46%, which is the highest marginal tax rate, and therefore there would be a deferral of 35%. With this larger pool of wealth, Client X can consider potentially investing in a holding company for example, and accumulate more wealth for his future. The longer the corporation retains its after-tax income without paying a dividend to the individual, the greater the deferral will be. Client X would like to maintain an annual income of $100,000. With an $18,000 annual RRSP contribution, Client X would personally be paying $22,854 in taxes.

At the corporate level, $375,000 taxed at 11% would equate to a $41,250 tax bill. As a result, we have effectively decreased Client X’s annual tax bill from $195,000 per year to $64,104. This leaves an additional $130,896 each year. As opposed to paying tax to the government, the corporation or a separate holding company could invest this excess money for Client X’s future. When the funds are actually needed, Client X can pay the deferred income to himself as a dividend. With the power of compounding interest, the additional $130,896 can have a significant impact on Client X’s retirement.

For further information regarding the benefits of incorporating, consult a tax professional to address your individual needs.

Aaron Migie, FMA, CFP, Financial Advisor,

Assante Capital Management Ltd., Winnipeg, MB (204) 977-8045,

(800) 296-8060, amigie@assante.com