The incorporation of a professional corporation has many Canadian tax advantages and, as such, is a structure that we often recommend. However, if you are a US person (that is a US citizen or valid US green card holder) living and/or practicing in Canada, the tax advantages are significantly diminished and you will be looking at higher compliance and tax preparation costs than most non-US professionals.
Two of the main advantages of operating as a professional corporation are the lower corporate tax rate and the ability to defer tax by leaving the income in the corporation in years when it is not needed to fund the professional’s lifestyle. A small business corporation in Ontario currently attracts a combined 15% tax rate on the first $500,000 of active business income. The highest personal tax rate in Ontario is now 53.53%, meaning there is the potential for a 38.53% deferral. Additional tax will be paid when the funds are removed from the company as dividends but with proper planning it may be possible to convert some or all of this deferral into absolute tax savings. Many professionals use their corporation to invest and save for retirement and then withdraw the funds in later years when their personal income levels are lower.
Obviously, this is a very attractive structure for professionals. So what differs for a US person? Unlike in Canada, where a person is require to report on their worldwide income based on their residency, the US requires a person to report on their worldwide income based on their citizenship regardless of where they physically reside. For this purpose a US green card holder is held to the same standard as a US citizen.
The US has special rules for controlled foreign corporations (CFC) such as a controlled Canadian professional corporation. Generally, a US shareholder is only taxed on distributed earnings (dividends), however the special rules may require the US shareholder to include this on their 1040 US return Subpart F income. Subpart F income includes, among other things, income from personal service contracts and investment income earned by the professional corporation (even if not distributed as dividends).
Consequently, if you decide to defer tax on your income for Canadian purposes by leaving the income in the corporation you may be taxed on this income regardless for US purposes. The best thing to do in this case would be to distribute all Subpart F net income through salary or dividends in the current year to ensure sufficient Canadian tax is paid to offset the US tax otherwise owing. This step negates most benefits of having a professional corporation.
Regardless of whether or not you are a US person, determining the most appropriate entity for which to conduct your practice is a complex and highly individual decision. We strongly recommended that you consult with your DJB professional and your lawyer to obtain advice that is specifically tailored to you to assist with deciding if incorporation is right for you.
Article written by: Carolyn Teutenberg, CPA, CA