Each year I help over 500 clients file their Canadian and US tax returns as well as plan for both their Canadian and US investment accounts. I also regularly help new US clients plan for their move to Canada.
Our physician clients are some of the higher paid professionals in BC. Some making well over $500,000 per year. At these income levels average tax rates can be over 40%. For those that plan properly significant tax savings can be obtained by allocating income through a professional corporation between family members. To illustrate the opportunities for savings lets use the following case study:
- Family of 4, 1 physician working in BC, 1 spouse at home with 2 children
- Children aged 16 (Lisa) and 19 (Tony)
- Physician (Mary) income of $500,000 per year
- Spouse (Gerry) income $0
- Assume the following average combined BC and Federal tax rate on $500,000 to be 40%
If Mary were to report the full $500,000 on her personal income tax return she would pay approximately $200,000 of tax without any potential for deferral or additional tax savings. What if she was able to split some of this income with Gerry or the kids? This is in fact possible by using a corporation to earn Mary’s professional income. Incorporating a professional practice in BC can be relatively straight forward with proper tax and legal advice.
In most provinces physicians can incorporate their professional practices and issue shares to family members. Although family members will not have the ability to own corporate voting shares they will have access to dividend paying shares. A common share structure would be as follows:
– Corporation would issues voting shares to Mary
– Non-voting shares would be issued to a newly created family trust
– The beneficiary of the family trust would be Gerry and the 2 kids
This would allow Mary to allocate dividends to both Gerry and the 2 kids on future corporate earnings.
Let’s review the family’s income tax situation based on the basic incorporation above. The same $500,000 of net earnings would be taxed in the company at approximately 13% (assuming no salary is paid to Mary). Any dividends paid out of the remaining cash would be taxed at each recipients dividend tax rate. The integration of corporate earnings and dividends are beyond the scope of this article, however for illustration purposes lets assume the following:
- $200,000 salary is paid to Mary by the corporation at an average tax rate of 30%
- $100,000 is paid to Gerry in the form of dividends via the family trust
- $50,000 is paid to Tony in the form of dividends via the family trust (kids must be over 18 to receive dividends)
The planning is much more involved than the example above as income fist needs to be paid to the family trust and subsequently paid out to beneficiaries. Also there may be an argument to pay Gerry some form of salary from the corporation if application. However for purposes of this example let’s keep the figures simple.
So based on the new incorporation what is the family’s new taxes payable (please note that these are estimates only for illustration purposes)? On Mary’s $200,000 salary she will pay 30% or $60,000 of tax. Gerry will pay 15% or $15,000 tax on his dividends and Tony will pay $2,500 or 5% tax on his dividends. Note that the corporation has already paid tax on these earnings. Let’s assume corporate tax on the $300,000 of corporate income not distributed as salary is $30,000 (in fact the rate would be different based on the after tax net cashflow available to be paid).
Total approximate tax paid by the family on the $500,000 of professional income will be 107,500. That’s almost a full $100,000 of overall tax savings from the original example. Note however that there’s still $150,000 of income that has yet to be distributed from the corporation that would attract “dividend tax” once distributed. But, to the extent that this cash is left in the company personal tax can be deferred and invested corporately.
In the example above only Tony has been paid dividends as he is over 18 years old. Children receiving dividends from their parents’ corporation would have to paid high rate “kiddie tax” on corporate earnings. Therefore paying dividend is often not an option for children under 18. However once Lisa is over 18 this dividend splitting strategy would be available. Paying dividends to children over the age of 18 can help fund university or future housing costs at very efficient tax rates.
As you can see from the example above Mary and her family have saved a significant amount of tax by incorporating her medical practice. If you think you can benefit from such a structure please contact Phil Hogan at 250-381-2400 or via email at firstname.lastname@example.org to discuss your options in more detail.