Dental practices

Transfer Life Insurance to your Corporation

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One of the advantages of operating your medical practice or business using a corporation is the tax savings that you can have on the payment of your life insurance.

Generally most professional are paying their life insurance personally. To get the funds to pay the premium they earn a dollar, pay up to 53 cents of tax on that dollar and then pay 47 cents toward their insurance.

For example, if your life insurance premium was $4,700 you would need to earn $10,000 to cover the cost.

If you transferred your life insurance into your corporation, it would be the corporation that was paying tax on the income needed to pay your premium. Your corporation tax rate is much lower, 15% in Ontario for 2016. Your corporation would only need to earn $5,529. That is a 44.71 % savings.

An additional tax benefit might be available on the transfer of the insurance into the corporation if the fair market value of the insurance is greater than the tax cost, referred to as the Adjusted Cost Base. This topic will be discussed in a future article.

When you eventually need to collect on the life insurance, the funds are collected by your corporation and the funds can be paid out to the shareholders tax free using something called the Capital Dividend Account.

Before you make the transfer there are a few things you need to consider including:

  1. The Capital Gain Exemption – insurance could put you or your family offside when trying to claim the capital gain exemption.
  2. Tax on Death – insurance could affect the amount of tax payable on death due to the effect of the Stop Loss Rules.
  3. Creditor Protection – the proceeds of your insurance could now be exposed to the creditors of the corporation.
  4. Effect on your shareholder agreement, if you have other shareholders.

There are additional considerations where you are transferring a permanent (Whole Life or Universal Life) insurance product that will be dealt with in a future article.

Professional advice should be obtained before making any changes to your current structure.

Allowable Business Investment Loss

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When you make a good investment, CRA is very happy to tax you; however when your investment no longer has any value, getting a deduction can be difficult.
Generally a loss on the disposition of an investment, like shares or debt, is treated as a capital loss, deductible against other capital gains. As long as you have other capital gains, you will at least save a few dollars in tax.

The problem occurs when you do not have capital gains to shelter and you want to claim your loss against other income. In limited situations, CRA will allow you to claim a Business Investment Loss.
A business investment loss is basically a capital loss from a disposition of shares or debt of a small business corporation to which subsection 50(1) applies, or to an arm’s length person. One half of this loss is an allowable business investment loss (ABIL). Unlike ordinary allowable capital losses, an allowable business investment loss may be deducted from all sources of income for the taxation year in which it is recorded. Generally, an allowable business investment loss that cannot be deducted in the year it arises is treated as a non-capital loss which may be carried back three years and forward ten years, to be deducted in calculating taxable income of these other years. Any such loss that is not deducted by the end of the ten-year carry-forward period is then treated as a net capital loss which can be carried forward indefinitely to be deducted against taxable capital gains.

A detailed description of the rules related to claiming an ABIL can be found in CRA’s IT484R2r. The information is a little out of date; however the general concepts have not changed.

The rules outlined are very specific and you must fit precisely within them, otherwise you not obtain the benefit of claiming an ABIL. The other issue is that almost all ABIL claims are audited by CRA.

There are many ways to go offside and many ways to fix the problem with advance planning. For example, the corporation needs to be a Canadian Control Private Corporation (CCPC) using substantially all of its assets to carry on business in Canada within 12 months of the disposition.
If your investment does not qualify and if you have not yet disposed of the investment, you may be able to fix the problem. You may be able to make changes in order to have the corporation qualify as a CCPC; you may be able to have a non-resident operation either relocated to Canada or deemed to be resident in Canada.

The most important step is planning in advance for the disposition of the investment.

If you have an investment that has lost value and you would like to ensure that all possible steps have been taken to enable you to claim the loss in the most tax efficient manner, we can help.

15 ways to lose your ABIL deduction:

  1. 1. Investment was made to a corporation that is not a Qualified Small Business Corporation (QSBC).
  2. You waited too long to claim your write-off.
  3. The corporation did not have its assets used in Canada.
  4. The corporation did not carry on an active business within 12 months of your disposition.
  5. The investment was not made to earn income; your investment was an interest free loan to a spouse, child or their corporation.
  6. The investment was made to an individual, partnership or trust, rather than a corporation.
  7. Your section 50(1) election was not filed correctly.
  8. The disposition was not made to an arm’s length person.
  9. You honoured a loan guarantee to assist the owners of the corporation.
  10. You are found to be liable for unremitted employee withholdings.
  11. You have not disposed of all of your shares (including those owned by other family members).
  12. You have claimed a capital gains exemption in prior years.
  13. You have poor documentation or insufficient support, such as a missing loan agreement or share certificates.
  14. You are unable to provide cancelled cheques to support the original investment.
  15. You are unable to provide financial statements of the corporation.

Tax planning for a medical or dental practice

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Introduction

Doctors have lobbied hard over the years to obtain the same tax advantages as other small business people. The right to incorporate was a big win. Now most doctors are including a corporation as part of their structure. They are also including family members as shareholders.

I would like to start our review by looking at the long term savings of incorporation. If we assume that the value of the goodwill of your practice is $ 500,000,  a typical example would be as follows:

One time savings on incorporation:

  • Sale of goodwill to your corporation – immediate reduction in tax on what would have been paid on a dividend – $90,000
  • Purchase of in goodwill by the corporation – total savings over time – $ 45,000
  • Claiming the $ 824,176 (2016 limit) capital gains exemption on the eventual sale of your practice- $ 200,000

Annual savings on $ 500,000 of income:

  • Income splitting with low income spouse – $ 18,000 per year
  • Interest write off on personal debt – $ 12,000
  • Greater tax relief on other expenses – $ 500
  • Potential deferral of tax – $ 150,000

Below find the following topics:

Incorporation of a Medical or Dental Practice
Deferral of Income Tax
Lower overall tax rate
Income Splitting
Avoidance of Canada Pension Plan
RSP Contributions
Capital Gains Exemption
Further Temporary Tax Deferral
Sale of Goodwill to the Corporation
Other Tax Savings
Example of tax savings

Incorporation of a Medical or Dental Practice

General Rules

Incorporation of your professional practice is governed by at least two sets of rules. First is the Ontario Business Corporation Act (OBCA) which allows for the incorporation of various types of professional. The second set of rules will be found in different documents depending on the profession; for example, most medical professionals are governed by the 1991 Regulated Health Professions Act.

Who Can Hold Shares

For most professions the OBCA provides that all of the shares must be owned directly or indirectly by members of the specific profession. However there is an exception that allows ownership of shares for medical and dental professional corporations by family members. Family members include your spouse, children and parents.  They are permitted to own non-voting shares.

Children under the age of 18 must own their shares through a trust.

Medical professionals are prohibited from using a holding company to own voting shares of their professional corporation by the 1991 Regulated Health Professions Act.

Who Can Be Officers or Directors

All of the officers and directors of a professional corporation must be professionals, as well as shareholders of the corporation.

Corporate Name

The name of the corporation must include the words “Professional Corporation””in English or French. Further the name must comply with all other requirements of your profession, for example a dentist must include the word dentist in his/her corporate name.

Accumulation of Surplus Funds

The original OBCA legislation prohibited the accumulation and investment of excess earnings by the Professional Corporation (PC). The rules have now been changed to allow for the accumulation and investment of the surplus funds.

No Limitation of Professional Liability

Generally shareholders of a corporation are not liable for the debts of the corporation; however shareholders of an Ontario Professional Corporation will still be personally responsible for professional liability. Unlike the increasing popular Limited Liability Partnerships, each partner will be held jointly and severally liable with the Professional Corporation for all professional liability claims made against the corporation in respect of errors and omissions that were made or occurred while he or she was a shareholder.

Costs and Benefits of a Professional Corporation

The College of Physicians and Surgeons of Ontario has announced that the application fee for incorporation will be reduced from $750 to $350, effective for applications received after January 1, 2006. The application fee for dental professional corporations remains at $750.

The application fee for dental professional corporations remain at $750.

The Colleges also charge annual renewal fees; the annual fee charged by the College of Physicians and Surgeons of Ontario is $125.

In addition to the set-up costs, the only costs associated with a PC are the annual administrative and accounting costs of maintaining the corporation. Generally these costs are not significant.

RSP Contributions

Part of the tax plan usually includes replacing salary with dividends; as a result the professional may not have any earned income, which in turn means that he or she will not have any RSP contribution room.

Deferral of Income Tax

The 2017 tax rate paid by an Ontario corporation qualifying for the Small Business Deduction in Ontario is 15% compared to the top personal marginal tax rate of 53.5%. Where the profits of the corporation can be left in the corporation, the professional will enjoy a substantial deferral of income tax of about 38.5%.

Further significant savings can be had if the doctor defers the withdrawal of the funds until retirement since it is likely that the doctor’s tax rate in retirement will be lower than the current tax rate.

Lower overall tax rate

After the income has been taxed within the corporation, the funds will be paid out as a dividend, which will be taxed in the professional’s hands. In theory this second exposure to income tax should bring the total tax up to the same total tax that you would have paid if you earned the income directly. Prior to 2014 there was actually a significant savings of about 3.4% when earning your income through a corporation compared to earning it directly. Starting in 2014 the tax rate on dividends was increased so that there was no benefit of earning income in your corporation, unless you are able to income split order payment of the income until you are in a lower tax bracket.

Income Splitting

Now that dental and medical professionals are allowed to issue shares to family members, they will be able to allocate dividend income to these other family members. The savings from income splitting can be significant. For example, if you were able to split $300,000 between you and your spouse you would save about $ 18,000 per year.

Avoidance of Canada Pension Plan

Where the income of the corporation is less than $ 500,000, there will be no need to pay a salary to the professional; therefore there will be no CPP contributions. This will save about $5,128.20 per year (based on 2017 CPP rate). The downside is that the professional may not have a full pension from CPP upon retirement. Our suggestion is to ensure the professional puts the funds saved by not paying CPP into a savings plan. Odds are he/she will have more upon retirement in the savings plan than in the CPP.

$ 824,176 Capital Gains Exemption

The ability to incorporate provides the professional with the ability to sell his or her interest in the practice as shares, which means up to $824,176 (2016 limit) of tax free income.

For members of the medical professions, it may be possible to access more than $ 824,176 in tax free capital gains by having other family members own shares of their Professional Corporation.

Further Temporary Tax Deferral

You will be able defer your tax payments. In very general terms, we could defer all of your income tax for one year; however, part of that tax would catch up with you in the second year. If we assume you are earning $ 400,000 per year, your tax would be about $175,000. If we put the income through a corporation, you would have very long-term deferral (until you retire) of about $133,000. Depending on when you withdrew the funds from the company, you could have a very small taxable benefit related to the interest value of the excess funds withdrawn from the company.

Sale of Goodwill to the Corporation

Where the practice has a significant value associated with the goodwill, it will be possible to sell the goodwill to the new corporation for yet another tax break.

We would sell the goodwill to the new corporation at a price at or below fair market value. This would create a capital gain in the doctor’s hands. The top tax rate for 2017 on a capital gain is 26.75%. This would effectively reduce the doctor’s rate of tax on what would have been a dividend from 45.3% (top margin rate on non-eligible dividends) to 26.75%.

If the goodwill was worth $ 500,000, the approximate saving would be $72,750.

A further benefit would be that the corporation would now have a depreciable asset. Starting in 2017 goodwill purchased for $ 500,000 will be added to the new class 14.1 to be written off at a rate of 5% per year. If we assume a corporate tax rate of 15%, this will save the corporation another $ 38,750. This savings is spread out over many years, so the present value would be much lower.

Interest Expense Write-off

Now that doctors are allowed to have their spouse’s own non-voting shares of their corporation, we will now be able to utilize a fairly common interest write off plan.

Effectively we want to be able to convert personal debt, on which the interest is non-deductible, to investment debt, on which you can get a write-off for the interest payments.

On a $ 500,000 mortgage, where you are paying 5% interest, the savings could be as high as $12,000 in tax every year.

Other Tax Savings

The corporate structure provides a few other tax savings, for example:

Entertainment expense – generally 50% of meals and entertain expense is disallowed as a deduction. If personally you are at a 53.5% tax rate, this will cost you 26.75% in lost tax savings. If the expenses are incurred by the corporation at a 15% tax rate, the lost tax savings is only 7.50%.

Life insurance – generally life insurance is a non-deductible expense. If the life insurance is paid by the corporation, it is still not deductible; however you are using before personal tax dollars, therefore you are still saving the difference between the corporate tax rate of 15.5% and the total personal tax rate of 53.5%.