Professional Incorporation: Are you taking full advantage?

By Kash Pashootan

Many self-managed professionals are already reaping the benefits of professional incorporation. When you incorporate, significant tax advantages, retirement planning, and estate planning opportunities become available. Prior to incorporating, it’s important to weigh the benefits and attributes, as well as consider the specific rules that govern your profession when determining if professional incorporation makes sense for you.

Deferring Taxes on Corporate Retained Earnings

Incorporating your practice is the first step in reducing your taxes and increasing the cash flow available to you personally, and to your practice for expansion. One of the main reasons professionals choose incorporation is the ability to defer taxes on corporate retained earnings. Investing in your corporation allows you to take advantage of the federal small business tax rate of 11 per cent on the first $500,000 of active business income. If the money earned by a shareholder of the corporation stays in the corporation, personal tax will not be paid on the earnings until they are distributed to shareholders.  The lower corporate tax rate leaves greater after-tax dollars in the corporation to pay expenses and reinvest in assets. Current cash flow needs play a vital factor in whether professional incorporation makes sense for you. If all professional profits go towards supporting your lifestyle, the income tax benefits are greatly reduced.

Income Splitting

Income splitting is another tax strategy available as some professions allow family members to hold non-voting shares of professional corporations. Paying out dividends to family members instead of salaries is sometimes preferred, as salaries are subject to tests of reasonableness while dividend payments are not. This presents the advantage of having divi-dends taxed in the hands of more than one person, thereby reducing the overall tax rate. Where rules allow, consider issuing the non-voting shares to a trust instead of dependents in order to make the most of lower tax rates. Dividend-sprinkling shares can also be used as an alternative to trusts, which involves issuing various classes of common shares to each family member, permitting the corporation to pay dividends on one class of shares to the exclusion of the other.

Funding Your Retirement

Incorporation can help in your retirement years in several ways. Once you retire, it’s not necessary to discontinue the business and funds can be left in the corporation to grow. The company can retain the earnings and distribute them to you as dividends. In addition, to supplement your retirement income, it’s worthwhile to consider purchasing a Corporate Insured Annuity. It’s a tax-efficient alternate strategy that can provide higher after-tax income than earnings on investment funds held within the corporation, while preserving the capital for your estate. The corporation uses income generated from the annuity to purchase a life insurance policy on your life and designates the corporation as the beneficiary. The payments from the annuity are used to pay the insurance premiums and taxes on the annuity, with the remaining amount being used to supplement your income. Upon death, your corporation will receive the tax-free death benefit from the life insurance policy. Any death benefit in excess of the adjusted cost base of the policy is credited to your company’s capital dividend account, where it can then be paid out as a tax-free dividend to the designated beneficiary shareholders of the corporation.  Incurring non-deductible expenses such as life insurance premiums through the corporation can lead to significant tax savings. The cost of non-deductibility is less for a professional corporation as it pays tax at a lower rate than an unincorporated professional entity.

For self-managed professionals, it’s essential to consider all the aspects of professional incorporation when deciding if it’s the right approach. The corporate structure provides many tax advantages, financial planning, and estate planning opportunities. However, to fully realize the opportunities, it’s important to seek holistic advice from your financial advisor and a tax professional so professional incorporation can be considered with your overall financial strategy.

Kash J. Pashootan is a Vice President and Portfolio Manager with Raymond James Ltd. Information provided is not a solicitation and although obtained from sources considered reliable, is not guaranteed. The views and opinions of the author do not necessarily reflect those of Raymond James Ltd. Member – Canadian Investor Protection Fund.