Incorporating a professional practice has been around for more than 10 years, but we are always amazed at how few are incorporated. There are some significant financial advantages to incorporation that many of you might be missing out on.
Let’s start at the beginning; when should you incorporate? There is no one easy answer but we feel there are four independent reasons to incorporate. Let’s discuss each of them:
More money than you need to live on!
“What are you talking about, I need everything I make?” This of course is a typical reaction, but what we are talking about is personal life style needs and the money you need to buy groceries, make mortgage payments, pay for vacations and other daily living expenses. What we see is many professionals who are not incorporated saving money in TFSA’s , investment accounts, insurance policies etc., and paying personal tax (at the top rate) on the funds to make these investments. Why pay tax before you make these investments and lose 30%? These funds are much better off left in the corporation and invested there after paying the corporate taxes. To step back a bit, the corporate tax rate in Ontario is 15.5% on professional net income up to $500,000. For an individual the rates range from 0% to 46%. The difference is about 30% at the top rate. If you make a profit of $150,000 and you need $60,000 to live on, the tax that is deferred is about $27,000 ($90,000 times 30%). This is a big difference. Many believe that you will pay the deferred tax someday and that may be right, but at what rate and when? How long can you put these tax savings to use? If you have 10 years to work and you can save or defer $27,000 a year, you realize a savings of $270,000.
You have significant business debt!
In most cases you start your practice with significant business debt; you renovate, upgrade equipment or buy a practice. When this happens it makes sense to incorporate for the same reasons as above. With the lower tax rate on income earned in a corporation, you have more after tax funds to repay debt. The difference can be significant.
You have other sources of income!
This is an area of tax savings and investment strategy that many professionals don’t recognize. Many of you have saved and have investments that earn dividends, interest, or other income. What we often see is a doctor who has investments outside of their corporation earning dividend income, and this is usually just reinvested. You pay tax on this income regardless, and the rate can vary from 23% to 46%. So instead of reinvesting this, use it to live, reduce your salary or dividend from your corporation and buy investments through your corporation. You pay less tax overall (as much as 30% less) and probably own more investments at the end of the day.
Sale or Purchase!
In all situations you need to consider setting up a professional corporation when you are about to sell your practice. In the vast majority of cases, the tax savings by selling the shares of your corporation are significant. The reason for this is that you get to take advantage of the $750,000 tax free capital gains deduction. There are many conditions that must be met in order to use this deduction, so you will need to give yourself some time to plan and get organized, but the savings can be huge.
How do you incorporate?
There are many places you can get information about how to incorporate. The College has very clear rules they ask that you follow. The following are some key points that should be considered:
- Get your accountant to help you prepare a feasibility study to make sure incorporation makes sense given your own circumstances.
- Contact a lawyer that is familiar with the incorporation of optometrists. Not your real estate lawyer or friend, but someone who has experience with optometrists.
- You need to transfer the assets of your practice into your professional corporation so you will need to assign reasonable values to equipment, goodwill, leaseholds, inventory and any other assets that will be transferred. Your accountant or a valuator can help you with this step. This is an area that you need to consider carefully because at this step low tax dollars can sometimes be withdrawn to repay personal loans.
- Consider all the administrative items like getting a new HST number, payroll account, bank accounts, visa accounts, notifying insurance, updating signage, updating employment contracts, etc. These are one time tasks and your accountant should be able to provide you with a list. Take the time to make sure all the steps get done – be proactive.
- You will have estimated your personal income needs in your feasibility study, now you need to determine the right mix of salary, dividends or a combination of both. There is no right answer on how you should be remunerated and there are many other considerations that need to be looked at to determine what is best for you. Consider what you need, then sources of income outside of the practice, then what you and your family need to take.
Each one of these items is a topic onto itself. There is no “one size fits all” and each of you has to do your own homework. But in our experience we see a lot of opportunities that are being missed and not discussed. Incorporation is not a function of age or income level; it is when it makes sense for each individual. Take the time to talk to your accountant and ask the question each year; “Is incorporation right for me?”
Bottom Line: This article explains how to decide whether or not you should incorporate your optometry practice.
Lloyd Wright is a Partner and the National Leader for BDO’s Professional Services practice. Anita Hollands is a Senior Tax Manager and an integral part of the BDO health care team.