What are the pros and cons of incorporating your professional practice for new graduates and established practitioners?
What are the pros and cons of incorporating your professional practice for new graduates and established practitioners?
Whether to incorporate your practice is a major decision that can impact the trajectory of your career, your tax obligations, and your financial freedom. If you are considering incorporation, it is important to understand:
- Specific considerations for new graduates
- Pros of incorporating a professional practice
- Cons of incorporating a professional practice
Incorporation is a significant decision that can provide several benefits and drawbacks. Carefully weighing each of these factors can help you determine whether incorporating is the right option for your practice.
By Kirstie McGrath, Nolan Baerg, Brad Derbyshire and Jeremy Stimson
A common question that arises during many of our conversations and discussions with our professional clients is: should I incorporate? As with any significant business decision, there are several pros and cons to consider before incorporating your practice.
Incorporating is a complex matter. Making the right decision, based on your goals and circumstances, could provide substantial benefits and help save you from making costly mistakes in the long term. Additionally, there are specific considerations for new graduates who are thinking about incorporating — such as your student debt situation, bookkeeping capacity, and the impact on your tax obligations.
Let’s discuss the specific factors that new graduates should consider when determining whether to incorporate and review the potential pros and cons of incorporating your practice.
What should new graduates consider about incorporating?
You’ve worked hard to complete your education, gain your license, and open your own practice. Now you may be considering whether incorporating the practice that you’ve worked so hard to create is the right decision.
It is important to remember that there is no set timeline to incorporate your practice. While incorporating can bring many legal and tax benefits, it may not be the right fit for your unique needs as a new graduate depending on your current situation. Discussing the specifics with an advisor can help you determine whether incorporating your practice would be beneficial at this point in your career.
Additionally, asking yourself these questions can help you get started on determining whether incorporation is the right choice for your practice:
What big purchases or life events are coming up in your future?
You may be purchasing a home, getting married, or starting a family soon. Incorporating your practice adds additional expenses and complexities to your financial situation that are important to consider before making a decision.
What is my bookkeeping capacity?
You may currently be reporting a T4 tax form each year — and incorporating your practice requires you to track your income, expenses, and maintain receipts for tax purposes. It is important to consider whether you have the capacity to fulfill these additional bookkeeping requirements associated with incorporating. Bringing additional bookkeeping support on board may help you save more time to focus on your practice.
Where is your line of credit and student debt?
Many practitioners are paying off student loans — or may have taken on debt to open a professional practice. It may be more beneficial to focus on paying down your existing debts in the current high interest environment before taking on the additional financial responsibilities from incorporating your practice.
How will incorporating impact my cash flow?
Practitioners such as physicians may take on self-employment to gain additional income during residency — and now you may be paying tax instalments on that income. These instalments can have a significant impact on your cash flow and affect whether incorporating is the right decision for your practice at this time.
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.
Professionals
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.
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