Paying one’s bill later never hurts when the people you owe do not charge any interest or penalties for doing so. How can you defer paying your taxes? Incorporating your dental practice (dental and/or hygiene/technical) or your associateship would be a way to defer your tax bill assuming you do not need all the cash.
For example, Dr. David, a sole proprietor, earns an annual profit (revenues less expenses) of $300,000. His personal tax bill would be about $123,000 (including Canada Pension Plan premium and health premium). If he incorporates his practice, and takes a salary of $130,000, his overall tax bill (i.e., personal and professional corporations) would be $71,000. A tax deferral (paying your taxes later) of $52,000 is obtained ($123,000 – 71,000). If one incorporates, one only has about $87,000 after paying personal taxes on the salary of $130,000. However, if this is all one needs personally, why should more taxes be paid than required?
Using the same example, if Dr. David takes a dividend of $101,000, $87,000 is retained after paying personal taxes of $14,000. The total corporate taxes would be $46,500 on $300,000 profit. This way, one has deferred taxes of $62,500 ($123,000 – 46,500 – 14,000).
The charts below (based on certain assumptions) summarize the tax savings from the tax deferred over a 10, 20 and 30 year period. Return is assumed at 3 per cent per annum.
Net Income before Salaries – $300,000
|10 Years||20 Years||30 Years|
|Savings from Tax Deferral||$15,155||$26,135||$39,011|
Net Income before Salaries – $500,000
|10 Years||20 Years||30 Years|
|Savings from Tax Deferral||$32,984||$56,882||$84,907|
Hence, by deferring income taxes, Dr. David actually saves taxes of about $33,000, $57,000 and $85,000 in the above example assuming Dr. David gets a three per cent return on the savings deferred.
You and your family members take sufficient salaries/dividends to maintain your personal standard of living and leave the remaining corporate dollars inside the professional /hygiene/technical corporation. The dollars could be used to acquire a dental building or any other investments (e.g., GIC, mutual funds and stocks).
The downside of accumulating too much cash, investments or other passive assets in your professional corporation include:
- Capital gains exemption – One of the reasons to incorporate is the opportunity to utilize the $750,000 lifetime Capital Gains Exemption to shelter the profit from the sale of the PC shares. A PC which has accumulated cash/investments could disqualify the PC shares from being eligible for the Capital Gains Exemption. Plan ahead before your sale. Planning should be at least two and a half years prior to the target selling date.
- Corporate tax rate – In general, a PC’s first $500,000 profit (revenues less expenses) is taxed at rate of 15.5%. The low tax rate of 15.5% only applies to profit generated from your dental business (i.e., it does not apply to the investment income – including interest – on your professional corporation’s GIC’s and term deposits). The investment income earned by your PC is subjected to a tax rate of close to 46.42%. Any capital gains realized on stock trading are taxed at 23.21% (i.e., 50% of 46.42%).
- Dividends to yourself – If your spouse or children under 18 years old are shareholders of the PC, you may have to receive a minimum dividend in order to avoid any negative tax consequences. Tax drones call this “corporate attribution”.
In addition to the tax deferral, you also enjoy some tax savings by setting up a PC even if you have to remove all funds for personal living expenses. Let us use the same example. If David sets up a PC and takes out $130,000 salary and the rest in dividends, his overall taxes (including corporate and personal) would be $117,000; hence an annual tax saving of $6,000. Your tax savings would be more ($12,905) if you take all as dividend. With the dividend only strategy, you would forego RRSP contributions and CPP retirement benefits.
The salary and dividend mix depends on:
- maximizing your RRSP contribution
- contributing to the CPP
- setting up a RCA/IPP
- income splitting with your family members
- deducting child care expenses if you are the lower income spouse
Talk to your advisor on the mix that works best for you.