INCORPORATING PROFESSIONALS

Ontario legislation enabling professionals to incorporate received Royal Assent in December 2000 allowing certain professionals (medical doctors, dentists, lawyers, accountants, veterinarians and chiropractors) to incorporate their own Professional Corporation. Additional changes to the legislation were passed December 9, 2002 removing the barrier that once prevented these corporations from investing surplus funds. However, the opportunity to incorporate comes with a number of considerations.

Is This Good News?

Definitely from an income tax perspective there can be some benefits obtained from the ability to incorporate - if the shoe fits. Access to the small business deduction and the enhanced capital gains exemption are the main advantages. (Professional partnerships will have to share the small business deduction, but something is better than nothing!). One downside to consider is that if the combination of the professional's salary along with the staff's salary is greater than $400,000, EHT will be payable on the portion of the payroll in excess of that amount at a rate of 1.95%.

Status of Liability Protection

For those excited about the possibility of limiting liability - sorry to spoil your fun. Incorporating your professional practice will not shelter you from professional liability, as you and your corporation will be held jointly liable.

Income Splitting - Say Awe!

Up until recently, the restrictive share ownership rules stated that the shares of the professional corporation must be owned by the professional or a holding company owned by the professional. As of January 1, 2006, the Ontario government relaxed these rules for both medical doctors and dentists, which will allow other family members to own non-voting shares of the professional corporation. At this date, there is no word on whether other professionals will be allowed the same treatment.

Should You Incorporate?

The answer to this question actually depends on your spending habits. Since a professional corporation will not shield the professional from liability, one of the only other advantages provided by the corporation is the deferral of income tax.

Another consideration is the capital intensity of your business. As the need to finance accounts receivable, inventories, and capital assets grow there is increased justification towards incorporation. Earnings will generally need to be retained within the business to fund this growth. Additionally, lenders will typically look more favourably on corporations with retained earnings then a sole-proprietorship without retained earnings. Therefore, the first $400,000 of income earned by a professional corporation in Ontario will pay tax at approximately 16% in 2010 (down from 16.5% in 2009) as opposed to paying tax at the top personal income tax rate of 46.41%. Remember, however, that this is a tax deferral, not an ultimate tax savings! If you take money out of the corporation it will be taxed again as a dividend in your hands. There is a minor tax savings (3.05% in the year 2010) if your income is earned this way. One would have to compare the savings against any additional compliance costs of having a corporation.

Long Term Investment and Capital Gains Exemption

If you aren't spending all that you earn and can leave some funds in the corporation, then the tax deferral of approximately 30% can accumulate to a nice sum over time. If there is a market for the shares of the corporation, proper planning with respect to the investment assets will enable the shares of the professional corporation to qualify for the capital gains exemption on a future sale. In most cases though, a purchaser is usually more interested in purchasing the business assets than purchasing shares of a corporation.

"Information contained herein is of a general nature. No action should be taken without seeking professional advice that takes into account current developments and the specific facts of a particular situation."

[Updated -February 20, 2010]