Is professional incorporation for you?

Greg Hilderman, CFP, CLU, CHFC
G2 Financial Group

CAR FORUM 2001;45(4):4-5

Why professional incorporation?

The reality is that a medical practice is a business, and one alternative to working longer hours is managing your practice more efficiently. With expert financial advice and planning, it is possible to realize $50 000 or more of tax savings by taking advantage of various strategies available through the incorporation of a professional practice. As a result, the physician can enjoy substantially more disposable dollars for investment purposes.

Let's look at some of the issues and tax strategies surrounding incorporation.

Tax deferral versus outright tax savings

In Canada, a corporation pays tax of about 21% on the first $200 000 of active business, whereas an individual pays an average tax rate of 46% (these numbers vary by province). If a physician's practice is incorporated, instead of immediately paying the personal tax at 46%, the corporation pays tax at the 21% level. Therefore, there is a tax savings of 25% on the first $200 000 of income if that income can be kept in the corporation. As well, the federal government has added a preferred rate on the next $100 000 of active business income. Although this extra $100 000 is taxed at a slightly higher rate, by employing the right investment strategies, the physician can still realize significant savings.

The tax saving is only a deferral until the physician decides to take it out of the corporation, at which time the difference between the corporate and the personal tax rate will apply. However, there are several strategies available that will create tax efficiencies on both the accrual and withdrawal of the dollars that could turn this tax deferral into an outright tax saving. This topic will be discussed briefly under tax sheltered investments.

Opportunities for income splitting

An incorporated professional can distribute some of their corporation's income to his or her spouse or to a family trust, and depending on a family member's personal tax rate, that person can enjoy substantial tax savings. A measure of income splitting with a family member or third party may be permitted by provincial legislation.

The use of salaries, dividends or deferred profit sharing plans can be effective tools for tax reductions. However, every province's regulations are different, which is why it is important to work with a financial advisor familiar with professional incorporation. Sound financial advice and planning can help you decide if you are able to split income with family members.

$500 000 capital gains exemption

Owners of small business corporations can shelter up to $500 000 of capital gains from tax when they sell the shares of their corporations. Most incorporated professional practices qualify for such treatment. The savings from using the $500 000 capital gains exemption ranges from about $100 000 to $125 000, depending on your province of residence. In certain cases, the exemption can be multiplied if family members are allowed to hold shares in the corporation.

Since such a corporation becomes a "regular" corporation when you cease practising medicine, the shares of the corporation can be sold to a third party, and the $500 000 exemption is used at that time. A financial advisor well versed in the area of professional incorporation can employ certain tax mechanisms where access to the exemption can be "locked in" so the potential tax saving can be enjoyed in the future when the corporation is sold.

Tax sheltered investments

Normally, the funds generating the deferred tax are invested inside a professional corporation. However, the income from those invested funds is taxed at a much higher rate than active business income. So how can you deal with this tax differential?

One extremely efficient and flexible investment solution to deal with the tax differential is to invest the funds in an exempt class life insurance contract and earn investment income within the contract. An important advantage is that tax on the income accumulating in the contract is deferred until it is withdrawn from the contract, and even then, there is the possibility that the funds can be withdrawn on a tax-free basis. The types of investments available are tremendously diverse and flexible. Another rather recent strategy is the use of mutual fund "corporations" to shelter passive income inside a professional corporation.

Is incorporation for everyone?

Like every patient, every medical practice is different. It's important to realize that incorporation isn't for everyone, and in some cases, a physician's existing business arrangements are just fine. However, even if it appears that a physician is spending everything they earn, I've found that when the right strategies are employed, significant tax savings can still be enjoyed. The end result will be to increase your retirement income, help you to retire earlier or, in some cases, both. All of this is achievable without restricting your current lifestyle.

One of the best ways to manage your practice more efficiently is to get the best opinion. Physicians interested in exploring professional incorporation should start by working with a financial advisor who has experience working with physicians and understands their specific needs. A financial advisor can recommend the steps to be taken so that you can start enjoying the advantages of professional incorporation and continue to focus on what really matters — your patients.

Greg Hilderman, a partner of G2 Financial Group, has been instrumental in reshaping how physician groups are compensated, focusing on improving their current and future lifestyles. Greg has worked with neonatologists, radiologists, thoracic surgeons, neurologists and oncologists, among others, in Alberta, BC and Ontario. He will be speaking at the 64th CAR Annual Scientific Meeting in September. Greg can be reached at 403 237-7799 or g2financial@home.com

© 2001 Canadian Association of Radiologists