Dentists who use their corporations (dentistry professional corporation (PC), hygiene or technical service corporation (H/TSC) and holding company) to generate passive investment income may see an unexpected rise in their corporate taxes due to the recent Federal Budget.
Why? Your small business deductions limit (i.e. amount of income subject to low corporate tax rates) could be reduced, meaning you will have to pay more corporate taxes on your active business income. Every $1 of investment income over $50,000 (including those of associated corporations) reduces your small business deduction limit by $5. Depending on the amount of investment income, some or all of your active business income (i.e. dental/hygiene income) could be taxed at a rate of 26.5% instead of 12.5% (for 2019 and subsequent years).
|Passive income||Small business deduction available||Corporate tax rate on business income|
|75,000||$375,000||12.5% on first $375,000, 26.5% thereafter|
|100,000||$250,000||12.5% on first $250,000, 26.5% thereafter|
|125,000||$125,000||12.5% on first $125,000, 26.5% thereafter|
|150,000 or more||$0||26.5%|
Relief – Ways to Avoid Investment Income Trap
Rather than having your corporation buy passive investments that are subject to harsh tax treatments, consider:
- Buying your own dental building. First, this protects your practice by avoiding lease issues related to a demolition clause, which permits the landlord to demolish the building leaving you without a place to practice, and a relocation clause, which permits the landlord to relocate you to another area within the plaza, mall or building that would result in major disruption and possibly cost. Second, the tax department views the purchase of your dental building, used solely for practicing dentistry, as essential in operating your dental practice and therefore this purchase would not be classified as a passive investment.
- Contributing to an Individual Pension Plan (IPP). With an IPP, your PC funds your pension plan with cheaper PC tax dollars. The PC can also claim a tax deduction for any contribution it makes to the plan. Such a pension plan may be viewed as a supersized RRSP, as the deduction limits are usually higher than an RRSP. Money grows tax free within this pension plan until withdrawal, in which case you will pay personal taxes on the withdrawn amount. There are actuarial fees which will be incurred and these are tax deductible. IPPs are less flexible than RRSPs. Contributions to RRSPs result in a personal tax deduction whereas contributions to IPPs result in a PC tax deduction.
- Buying investments which do not, rarely, or pay very little dividends. Because these types of investments reinvest their profits, which would have otherwise been paid as a dividend, they tend to grow. Since little or no dividends are paid annually, this circumvents the passive investment tax rules until the investments are sold.
- Paying out a capital dividend, where possible. The Capital Dividend Account (CDA) keeps an accumulated balance of the tax free portion of the capital gains (i.e. one half) generated by the corporation that can be paid out tax free to shareholders. Paying the capital dividends, where available, reduces passive investments and should be done as soon as possible after confirming the CDA balance with the tax department.
- Buying certain types of insurance, including universal and/or whole life insurance, skirts the passive investment tax rules as money grows tax free inside the insurance policy. These types of insurance are comprised of a death portion and an investment portion. Management fees are “built in” to the insurance premiums.
Please ensure that you evaluate the investment merits of an investment and not base your decision solely on tax issues.
This article was prepared by David Chong Yen*, CPA, CA, CFP, Louise Wong*, CPA, CA, TEP and Eugene Chu, CPA, CA of DCY Professional Corporation Chartered Professional Accountants who are tax specialists* and have been advising dentists for decades. Additional information can be obtained by phone (416) 510-8888, fax (416) 510-2699, or e-mail firstname.lastname@example.org / email@example.com / firstname.lastname@example.org . Visit our website at www.dcy.ca. This article is intended to present tax saving and planning ideas, and is not intended to replace professional advice.