What are the pros and cons of incorporating your professional practice for new graduates and established practitioners?

Pros of incorporating your professional practice

Potential tax deferral on excess funds

Corporate tax rates across Canada are much lower than personal tax rates. Combined federal and provincial corporate tax rates on active income for companies that qualify for the Small Business Deduction range between 9 and 12 percent for the first $500,000. By comparison, the top combined personal tax rates across Canada range between 48 and 54 percent, and the top tax brackets vary.

Any money you leave in the company will not have personal tax paid on it until you withdraw the funds from the corporation for personal use. This creates what is known as a tax deferral. The value of the tax deferral comes from what your company or practice does with the money while it is left inside the corporation.

You could invest the funds, use them to pay down practice debt, purchase practice equipment, real estate, or an additional location. No matter what province you live in, these tax deferrals can be significant if you don’t require all the money you earn to live on.

Take the example of Jane, a doctor in B.C., who lives off the salary she pays herself from the company and can save an additional $100,000 per year. By being incorporated, Jane could leverage $42,500 per year of tax deferral, assuming the top personal rate of 53.5 percent versus the corporate tax rate of 11 percent on the first $500,000 of taxable income.

Assuming the company invests this money, over 10 years this would amount to an extra $425,000 in investments, which could have grown by another $165,000 if earning five percent annually net of taxes, totalling $590,000, set aside for her retirement.

Again, keep in mind that personal taxes would be payable when withdrawing the money from the corporation. Personal financial planning could help Jane project how and when to remove these funds from her company with the potential for a reduced personal tax rate at that future date.

Another example is Josh, a dentist in Alberta, who bought a practice and had $800,000 of corporate debt. Because he was incorporated, Josh was able to live off a salary from the company and save an extra $100,000 per year. Assuming the personal rate in Alberta is 48 percent and the corporate rate for the company is 11 percent on the first $500,000 of taxable income, Josh would have per year of tax deferral to repay the debt if it was held corporately versus personally.

Lifetime capital gains exemption

If your practice is saleable, being incorporated provides you with options and possible tax benefits. Being incorporated, you could sell the assets or the shares of the corporation. If you choose to sell the shares, and they qualify for the lifetime capital gains exemption, up to $1,016,836 (current maximum ) of the gain may be tax-free to you personally. Additionally, the 2024 federal budget proposed to increase this amount to $1.25 million effective June 25, 2024. If family members are included in the corporate structure, each family member shareholder could potentially use their exemption as well.

Be aware, there are several criteria which must be met to qualify for this exemption, and it may take up to two years prior to sale to ensure your corporation is eligible. Having excess cash in your company can put you offside and prevent you from utilizing this tax benefit.

Having the right corporate structure to be eligible for these benefits is important. You could consider hybrid options (combining a sale of shares and assets) that may also allow you to use your lifetime capital gains exemption.

Selling your practice is a crucial event, given that it’s likely one of the largest assets you will own in your lifetime. Getting good tax advice well in advance of any sale will help you make the most of your retirement.

Income splitting

Once a popular way to pull money out of the professional corporation or structure, income splitting (for example, with a spouse or kids), is not as widely available under current tax laws. However, if you have a spouse who is working at least part time in the corporation, there may still be ways to income split over the course of your professional career.

In addition, there is important planning involved in the early stages to help ensure that income splitting will be available following retirement or sale of the practice.

Income smoothing

Incorporating your practice can also offer the benefit of income smoothing — or smoothing out fluctuations in your personal income over time. Incorporating enables you to retain a portion of earnings within the corporation instead of receiving it immediately as personal income.

This allows you to build a reserve during profitable years that can be withdrawn during periods of reduced income such as parental leave or sabbaticals. This provides you with greater financial security and can help optimize tax efficiency throughout your career.

Potential eligibility for tax credits

Incorporating may make your practice eligible to enhance the amounts it receives from tax credits such as the Scientific Research and Experimental Development (SR&ED) tax credit. Your practice may qualify if you are affiliated with an accredited research institution and engage in research activities in your specialty area.

Activities that advance scientific knowledge or address technological uncertainties may qualify your practice. Incorporating your practice and applying for the SR&ED tax credit can help you regain some of the expenses incurred from research and development.

Cons of incorporating your professional practice

Complexity

Record keeping and additional returns can make incorporating more labour intensive than keeping your business activities in a proprietorship. For example, the Canada Revenue Agency only requires an income statement of business activities on your personal tax return.

When incorporated, your practice will have to file an additional income tax return which includes both the income statement and a balance sheet showing the assets and liabilities held by your corporation at a given time. It may be beneficial to bring an advisor on board to support you with these additional requirements to save time and simplify complexities — giving you more time to focus on your practice.

Incorporation costs

Setup costs can be an early deterrent to incorporating. You will typically need a lawyer and an accountant to advise on setting up a professional corporation. If you decide you would like to start earning passive income such as investment or rental income, there may be benefits and restrictions to be considered in incorporating additional companies aside from your professional corporation.

You must weigh the anticipated benefits of such structuring against the costs of setup. An accountant can assist you in determining the appropriate structure for incorporation and help determine the cost/benefit for you. Additionally, an advisor can assist you with tax planning strategies for your specific structure. This helps you keep more of your revenue — better positioning you to grow your practice and reach your goals.

Annual / ongoing costs

A professional corporation will need to file an annual corporate report to stay in good standing under provincial corporate laws. Also, a corporation will need to file annual corporate tax returns (T2) and may require annual financial statements.

These annual reports (and related cost of accounting and legal fees) can add up; you need to consider them as a cost of business over each annual period. Ensuring the accounting and related systems are set up efficiently from the start will help you control these costs and prevent them from eroding the benefits of incorporation. These systems can also provide an up-to-date view of your practice’s finances, reducing uncertainty and giving you more time to focus on your patients.  

Take the next steps

In most cases, as a professional, the decision to incorporate will often revolve around the statement, “It’s not a matter of if I should incorporate — it’s when.” The ability to hold excess funds in the company can heavily depend on your personal day-to-day and monthly cash flow needs. Are there extra living costs due to kids, mortgages, or other life endeavours? These are all important considerations that both new graduates and experienced professionals need to make when determining the right time to incorporate.

For more information, contact a member of MNP’s Professionals team. We have the knowledge to support your practice from start-up to succession and can work with you to build customized strategies in areas like tax planning to support your future success.