Professionals and Incorporation – the “Tax In’s and Out’s”

Posted on July 4, 2013 by admin | Posted in General Business Articles, Professionals

The ability to incorporate.

In Ontario, most professionals have had the option of carrying on their practice through a Professional Corporation “PC” for several years. In addition, the Ontario Business Corporations Act was amended effective January 1, 2006 to allow more flexibility with respect to the ownership of shares of PC’s. The amendments now permit certain family members to own non-voting shares in PC’s and more income splitting opportunities for some types of professionals. Unfortunately, these recent changes were only made available to physicians and dentists.

The benefits of incorporation.

Incorporation can provide many benefits to a professional, some of these benefits are as follows:

  • Obtain a “tax deferral”
    Professional income retained in a PC can attract a tax rate that can be up to 31% lower.
  • Split income with other family members
    This can result in an overall lower personal tax rate on professional income earned.
  • Reduce the cost of funding non-deductible expenses (meals, entertainment, club dues etc.)
    The PC can fund these expenditures with $0.84 “after-tax” dollars as opposed to $0.54 “after-tax” dollars if they are funded personally.
  • Pay down business related debt over a shorter period
    This results in reduced interest costs and better cash flow.
  • Reduce the cost of funding insurance policies.
  • Potential access to the $750,000 capital gain exemption on a share sale (increasing to $800,00 as of January 1, 2014)
    If a purchaser will acquire shares that qualify, each shareholder could potentially receive up to $750,000 of the gain on the sale tax free.
  • Ability to utilize off-calendar year-ends
    This can provide for more flexible tax planning strategies with respect to accruing and paying out bonuses.

The steps involved in incorporating

In order to incorporate, a professional must file articles of incorporation. This is generally done by a lawyer, with instruction and input from an accountant. This is no different from most non-professional corporations; however, the PC must obtain a certificate of authorization from their governing body and meet certain restrictions with respect to naming the PC.
In order for the practice to be transferred to the PC on a “tax deferred” basis a special election form is filed. The lawyer also generally prepares the related transfer agreements and appropriate resolutions that support the elected amounts.
The PC must open a bank account and register for the appropriate income and payroll tax account numbers with the various government agencies. It is very important that all of the steps are carried out properly and the transfer is properly reported to the Canada Revenue Agency (“CRA”).

The PC must keep a separate set of books and records and prepare an annual financial statement and file a Federal and Provincial corporate tax return annually.

Making the decision.

In order to make an appropriate decision on incorporation, the professional must analyze the benefit of paying expenses and debt down in the PC versus personally, determine the amount of income that can be retained in the PC that can be taxed at a lower rate (i.e. a tax deferral) and determine the savings associated with splitting income annually with other family members via a corporate structure. This decision must be done on an individual case by case basis as each professional’s circumstances will be different. It is a good idea to visit your accountant to perform the appropriate analysis to compare the cost of incorporation versus the benefits that will be realized.

In order for a PC to be a viable option, the benefits must overcome the initial costs (generally in the first year) and annually outweigh the incremental compliance costs.

If you are considering whether or not to incorporate or wish to be consulted on your current corporate structure contact one of the DJB tax specialists.