I’ve been an accountant for over 20 years and have worked primarily with physicians, dentists and other professionals for most of my career. Over the years, incorporation is the subject I’ve been asked most about.
- Should I incorporate my medical practice now?
- How do I incorporate?
- How does a medical corporation help me?
The questions are almost endless. And this blog post would be endless if I tried to address all aspects of incorporation. For this post, I will provide an introduction to incorporation. In the coming months I’ll expand on this basic information and show why most physicians should be incorporated.
What is Incorporation?
Incorporation is the creation of a legal entity called a corporation, also known as a company. A company is a separate legal entity that has many of the powers of an individual. It can earn income, acquire assets, enter into contracts, pay taxes, etc. When a physician incorporates, the medical corporation will carry on the business of the doctor’s medical practice.
Why Incorporate a Medical Practice?
There are many reasons for a physician to incorporate.
Income Tax Deferral
In British Columbia, personal tax on regular income between $136,000 and $150,000 will be taxed at 43.7% in 2014, and income over $150,000 will be taxed at 45.8%.
Alternatively, in a private corporation, the first $500,000 of business income is only taxed at 13.5%, and the remainder at 26%.
A doctor can defer tax of up to 32% on income in excess of $150,000 by using a medical corporation if funds are left in the company.
This deferral helps the company purchase assets, repay debt, and accumulate savings. The company has paid less tax and has more funds available for other uses.
This income tax reduction is only a deferral, and additional tax must still be paid when the doctor withdraws the funds from the company. However, with proper planning the additional tax can be minimized or even eliminated.
Canada uses a graduated income tax rate system where income at different levels is taxed at different rates.
Income splitting is shifting income from a high tax rate individual to lower tax rate individuals. Two people earning $100,000 each will pay $18,000 less tax combined than one person earning $200,000.
Unincorporated doctors can split income with family members by paying them a salary. However, an expense must be reasonable to be deducted from business income. A salary of $50,000 to a spouse or other relative who has little involvement with the medical practice would probably not be considered reasonable. If disallowed, the physician does not get a deduction and the relative still pays tax on the salary – instead of reducing tax, there is double tax.
A medical corporation can also split income by paying salaries, but the deduction of salaries by a company is still limited by reasonability.
The advantage that a medical corporation has over an unincorporated physician is that it can also pay dividends to the shareholding physician and family members. Dividends are paid from the after-tax income of a company and are not subject to a reasonability limit for income tax purposes. Dividend income is taxed personally at a lower rate than regular income to take into account that some tax has already been paid by the corporation.
Income splitting is maximized when all family members are in the same tax bracket. Unless family members are very active in the practice, this can only be achieved with a medical corporation and dividends.
Certain expenses such as 50% of meals and entertainment, club dues, and life insurance premiums are not deductible for tax purposes. The cost of a non-deductible expense is cheaper in a medical corporation because the company is taxed at a lower rate than the doctor. A doctor in the highest tax bracket must earn $9,225 personally to pay a $5,000 life insurance premium (Income of $9,225 less tax of $4,225 at 45.8% is $5,000) . A medical corporation only has to earn $5,780 to pay the same premium (income of $5,780 less tax of $780 at 13.5% is $5,000).
Tax-Free Sale of Shares
A significant benefit of incorporating a business is that the first $800,000 of capital gains on the sale of qualifying shares may be tax-free under the Lifetime Capital Gains Exemption. Unfortunately, unlike other professionals such as lawyers, dentists and optometrists, physicians are not usually able to take advantage of the capital gains deduction because medical practices in BC have limited value. There may be an opportunity to use the capital gains deduction where the company owns the medical office.
A company is a legal entity that is separate and distinct from its shareholders. Shareholders are not liable for debts and actions of the company. At most, they risk the loss of their investment in the company. However, legislation in BC specifically states that incorporation of a medical practice will not shield a physician from liability for professional negligence.
A medical corporation can still protect personal assets from liability for leases, non-guaranteed loans and other creditor claims against the practice. Corporate investment assets can be shielded through use of a holding company.
Other Tax Advantages
There are several tax saving strategies that require a corporation including Private Health Services Plans (PHSP), Individual Pension Plans (IPP), and death benefits. These benefits are beyond the scope of this article and will be addressed separately in the future.
Incorporating a medical practice can have a positive effect on spending habits. When not incorporated, medical practice income is deposited into personal bank accounts which are easy to access.
When a company earns the income, it is easier to view the money as belonging to someone else. Physicians are more aware of how they are spending when they have to subsequently take the funds out of the company.
Why Not Incorporate?
Incorporation is not without some drawbacks:
Incorporation adds an extra layer of complexity to a physician’s financial affairs. A company must maintain separate accounting records, file a separate tax return, and file T5 slips for dividends. More planning is required to transfer funds from the medical practice for personal use.
It may seem daunting at first, but over time the operation of the company becomes routine.
The added complexity of incorporation is more expensive. There will be legal and accounting fees for both the set-up and ongoing operation of the company. However, the financial benefits of incorporation are far greater than the added costs.
Risk of Changes in Laws
Nothing is certain in life except death and taxes. But the way our taxes are determined is always subject to change. A medical corporation is very effective for reducing and deferring income taxes based on the rates and rules in effect today. Who can say this will still be the case 20 years from now?…but who can say it won’t?
When to Incorporate?
Most physicians should and will incorporate. But it is not always advantageous. Incorporation is best for physicians with sufficient income who can use the company to save for retirement or who can split income with family members.
What is the Incorporation Process?
Incorporating a medical practice includes the following steps:
- Name reservation with the BC Corporate Registry.
- Preparation of incorporation agreement, articles of incorporation and determination of shareholders.
- Application to the College of Physicians and Surgeons for approval to incorporate.
- Filing of Incorporation Application with BC Corporate Registry.
- Submission of incorporation documents to college for medical permit.
- Opening of bank account and paying for shares.
After incorporation, other administrative start-up tasks include registration with tax authorities, notification to MSP and other revenue sources that the practice is incorporated, notification to insurance providers, etc.
This post is a simple introduction to medical corporations. Check the blog on a regular basis for future posts with more detailed explanations on this topic. You can also follow the blog by email for notification of updates.
If incorporation is something you are interested in, please contact me for more information or a consultation.