Reproduced with permission, Oral Health Office, September 2015
As April 30th approaches, tax pain begins to rear its ugly head. Much like delaying a root canal, there’s only so long you can wait until you have to tackle the problem. Most tax pain stems from failing to plan. For every tax problem there is a solution, you just have to have enough time to implement it. By asking yourself “What can I do now to save on taxes in the future?”, you are ready to take steps towards tax relief.
Let’s review three tax planning concepts and a few overlooked tax breaks:
Three Tax Planning Concepts:
- Income Splitting
- Asset ownership and accessing tax-free money
- Claiming the Lifetime Capital Gain Exemption (LCGE)
Income splitting is an effective way of saving taxes by dividing income into as many “hands” as possible. One individual earning $100,000 will pay much higher taxes than two individuals each earning $50,000. Consider Dr. Kiran Jaswal family’s situation. Her husband earns $60,000 a year as an engineer, while Kiran earns $200,000 associating at various practices. Their current tax situation is as follows:
|No income splitting||Income||2015 Taxes (excluding CPP & EI)||Take-home|
Let’s see what their tax situation could be if they were to implement income splitting:
|No income splitting||Income||2015 Taxes (excluding CPP & EI)||Take-home|
The tax savings in this case could be $7,000. Consider what an extra $7,000 annually for your family would mean. Not just in terms of dollars, but also time. To earn $7,000 after tax, Kiran would have to earn nearly $13,500 more in pre-tax income. That is almost an entire month of work spent in the clinic away from her family.
The question now is how do you implement income splitting? Here are some examples:
- Paying your spouse a reasonable salary for doing work at the practice
- Having the higher income spouse pay for all the household expenses while the lower income spouse invests their savings. Investment income will be taxed at lower rates in the lower income spouse’s hands.
- You can lend your lower income spouse money with an interest rate of 1% (CRA’s prescribed rate for January 1 to March 31, 2015). If your spouse invests the money and earns a 4% return, the family achieves tax savings on the 3% net return. The interest must be paid by your spouse by January 30th of the following year. Interest received must be reported on your income tax return while your spouse would be able to deduct the interest expense.
If you have a Dentistry Professional Corporation (PC), consider applying these income splitting techniques:
- Paying dividends to lower income family members who are shareholders of your PC. This can include the dentist’s mom, dad, spouse/common-law and children over 18. An individual with no other income can receive dividends of $40,000 and pay less than $1,000 in taxes.
- Multiplying the LCGE by having other family members own an equity stake of your PC. The LCGE shelters you from taxes on $813,600 (2015) of capital gains from the sale of your qualified PC dental practice shares. If your practice is worth more than $813,600, you can split the proceeds with other equity shareholders and use their available LCGE to further shelter your family from taxes. The primary risk with this strategy is that in the event of a divorce, a relationship breakdown or wayward children, the money received from selling your shares could be at risk.
Similar techniques with a Hygiene/Technical Service Corporation may also apply.
Asset ownership and accessing tax-free money
There’s no free lunch when it comes to getting money out of the PC. Salaries and dividends both result in personal taxes. However, certain assets you hold personally could result in tax-free money in your pocket. For example, if you personally own a Universal or Whole Life Insurance policy, you could receive money tax free from your PC. By transferring your Universal or Whole Life policy which you own personally to your PC, you can receive tax-free money equivalent to the fair value of the policy at the time of the transfer. The premiums will continue to be non-deductible for tax purposes but can be funded with cheap after-tax dollars in the PC. For this maneuver to work, you need to change the owner and beneficiary of the insurance policy to your PC and have your insurance professional obtain the value of the policy immediately prior to the transfer. Note that this maneuver could affect your ability to claim the lifetime capital gains exemption and trigger additional taxes to remove it when you sell the shares of your PC in the future.
Claiming the LCGE
The biggest tax break a dentist will get in their career is the LCGE. Many dentists wait until the sale of their PC shares to claim the LCGE. However, there is a way you can claim the LCGE earlier and while you still own the practice.
Why would you do this?
- Secure your LCGE now in the event the government eliminates the tax break in the future.
- If your PC has excess cash and investments, you could be in for a large unexpected tax bill when it comes time to sell your PC shares. Claiming the LCGE now, allows you to use your PC to accumulate excess cash and investments without worrying about jeopardizing your ability to claim the LCGE.
You will trigger a capital gain by reporting a “notional sale” and freezing your existing shares at their current value. To offset the capital gain, you will claim the LCGE. When it comes time to sell your shares to a 3rd party, you will pay taxes on the difference between the selling price and the frozen value assuming the frozen value has been sheltered by the LCGE. Consult with your accountant about the pros and cons of this maneuver.
Planning for taxes ahead of due dates serves a second purpose, it prevents you from missing out on tax breaks. Here are few overlooked tax breaks:
Overlooked Tax Breaks:
- Donations: If you are doing any home renovations, consider contacting Habitat for Humanity and asking them to remove your old kitchen cabinets or other used fixtures. This won’t cost you a penny, but they will provide you with a donation receipt for the value of the items they receive. The same applies to any used dental equipment that is still in good working order.
Instead of donating cash to a charity, donate investments which have appreciated in value. For example, if your own Apple Shares and donate them to charity, you will get a donation receipt for the value of the shares at the time they were donated and won’t be taxed on the increase/appreciation since you owned them. The charity still gets the same dollar value; but you get a bigger tax break.
Don’t forget to group your donations with your spouse on a single return. You get a bigger tax break after the first $200 of donations. This might mean saving up and claiming donations periodically instead of every year.
- Meals/Entertainment: Most dentists believe that only 50% of meals and entertainment incurred in connection with your dental practice are tax deductible. The exception to this rule is where you invite all of your staff to the event. In this case, up to 6 staff meals per year are 100% tax deductible. Parties held during Christmas and other religious holidays come to mind.
- Child Care Expenses: Paying your parents or child 18 and older who are in a low tax bracket to babysit your children 16 and younger can result in tax savings for the family. Under the proposed limits, child care expenses of up to $8,000 per child under the age of 7 and $5,000 per child who is 7-16 years old can be claimed. The recipient of this income, including your parents, will report the income. However, for most individuals earning a total income of about $11,000, virtually no taxes are payable.
Taxes are here to stay. To minimize your tax pain, get a head start on planning. You should be looking ahead to next year’s tax deadline, not this year’s. There are many tax tools available at your disposal; use each and every one of them as a step along your tax savings journey.
This article was prepared by David Chong Yen, CPA, CA, CFP, Louise Wong, CPA, CA, TEP and Eugene Chu, CPA, CA, MAcc of DCY Professional Corporation Chartered Accountants who 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.