Incorporating your professional practice can yield many tax benefits. The most commonly known benefit includes gaining access to the small business deduction, which allows the first $500,000 of taxable income to be taxed at a corporate tax rate of 15.5% (13.5% by 2019). This low corporate tax rate allows the professional to defer a large amount of tax until the funds are withdrawn from the professional corporation. Family income splitting is another tax benefit that may be achieved by incorporating your professional practice. This article focuses on some additional items to be considered for a person owning or contemplating a professional corporation.
Private Health Services Plan (PHSP)
A PHSP is essentially health insurance for hospital or medical expenses (including dental) for an employee and their immediate family. Contributions made by the corporation on behalf of the employee are not included in the employee’s income. In addition, the contributions to the plan are deductible by the corporation. This provides an effective method to deduct expenses that would otherwise be personal in nature.
In the Canada Revenue Agency’s (CRA) view, a PHSP can only cover expenses that would have otherwise been allowed as medical expenses, meaning that vitamins and purely cosmetic surgeries would not be covered. Any plan that pays ineligible expenses would not be considered a PHSP, and would not get the favorable tax treatment. It should also be noted that a PHSP is permitted to provide different benefits to different classes of employees, such as part time, full time and executive level employees.
The shareholder benefit rules can come into play when dealing with an owner-managed professional corporation. As noted above, the PHSP is a tax free benefit to an employee. However, if the benefits of a PHSP are received because that individual is a shareholder, the amounts paid into the plan represent taxable income to the shareholder and the payments are not deductible by the corporation.
The CRA will ask certain questions to determine if the corporation provides the benefit to a person in their capacity as an employee, or shareholder. Is participation in the plan available to all employees? Would there be any reason to exclude some employees? Are benefits provided to all employees the same? If all the employees are shareholders, are the benefits provided similar to those in other organizations providing the same services?
To help avoid benefits being considered received by virtue of shareholdings, it is important that the professional is active in the business and earns, at least some employment income. If possible, adding other employees into the PHSP would be a further indicator that the PHSP is a benefit received by virtue of employment, and not because of shareholdings. Finally, the benefits provided by the PHSP should be reasonable in the circumstances.
Health and Welfare Trust (HWT)
A Health and Welfare Trust is a formal trust that the employer creates to pay health and welfare costs for its employees. The trust is not a PHSP; however, if properly formed it can be used to fund a PHSP. In other words, contributions to the trust are deductible and payments from the trust, for eligible medical expenses, are tax-free benefits to the employee. An HWT structure avoids using an insurance company because the trust, which receives contributions from the employer, is responsible for paying the benefits. Generally, the administration fees should be lower than an insurance company and more customized coverage options are available. An HWT can also be used to fund critical illness insurance; however, the portion of the amount that the employer contributed to the trust for critical illness insurance is a taxable benefit to the employee. The same issues regarding shareholder benefit rules apply to health and welfare trusts as well. In other words, it’s best if other employees are covered and the amounts are reasonable in the circumstances.
Employee Life and Health Trust (ELHT)
An Employee Life and Health Trust is similar to the HWT noted above in that they are both trusts funded by the employer to provide benefits to employees. The ELHT has specific legislation in the Income Tax Act, whereas the HWT is provided by CRA administrative concessions. One drawback of an ELHT in the context of a professional corporation is that benefits cannot accrue more favorably to a “key employee”. A “key employee” is an employee that owns at least 10% of the shares of any class of the employer. Furthermore, an additional rule provides that at least 25% of the employees in the plan are in a specific class, and at least 75% of the persons in that class are not “key employees”. As a result, the ELHT rules appear to be better suited to medium or large sized organizations.
Disability insurance proceeds are received tax free if you have paid the premiums yourself. If your employer has paid the premiums, and included the amount in your taxable income, then the amounts received are also tax-free. However, if the employer has not included the insurance premiums in your income, the amounts received under the plan are taxable income. Unless you plan to have a group disability plan for all employees, there is no benefit to having the disability premiums paid by the professional corporation.
Although life insurance premiums are not deductible by the professional corporation there are still tax benefits of having life insurance on the professional, owned and paid for by the corporation. For starters, the company is using after tax corporate dollars to pay the premiums as opposed to after tax personal dollars. Secondly, the death benefit is received by the shareholders as a tax free capital dividend. One drawback of corporately owned life insurance is that once the policy is in the company it is not simple to transfer it out. So if you have a practice that can be sold, the pros and cons must be examined.
In summary, the professional should seriously consider using a PHSP to convert what would otherwise be personal medical expenses into a deduction by the corporation. Using a health and welfare trust may be an efficient way to do this. Careful consideration should be given to the shareholder benefit rules when other employees are not going to be covered, or there are not any other employees. The professional should also consider corporately owned life insurance, should the need arise.
This article has been written for informational purposes only. It is based on the laws and administrative practices at the time of writing. Subsequent changes in the law and administrative practices could affect the views expressed at the time.
Article written by: Jeremy Doan, Macc, CPA, CA