Tax planning seems complicated, because it often is.  There is no way around some of these complexities, and many dentists who try to take the “easy” approach end  up  discovering  that  it’s  actually  the  hard  way.  However,   we   have   developed   what   we   call   the  “DENTIST”  Approach  to  Tax  Planning,  because we  think  that  breaking  the  important  issues  down into  the  following  categories  can  be  helpful.    This article highlights what we have identified as the most important tax issues dentists face, and in subsequent articles  we  will  look  in  greater  detail  at  each  one.

D eductions
E xemption for the first $750,000 of lifetime capital gains
N on-arm’s length transactions
T iming of income and expenses
I ncome splitting
S avings plans
T ype of income

DEDUCTIONS are  amounts  subtracted  from  your  total billings  in  order  to  arrive  at  your  taxable  profit,  or deducted from your personal income in order to arrive at your taxable income.  Deductions are almost always better than “tax credits”, since every deduction you can claim  means  a  tax  savings  calculated  at  the  highest marginal tax rate you are paying.  For example, if you are in the top 46.4 per cent bracket, every extra dollar of RRSP contribution you make saves you 46.4 cents of  tax.    For  most  professional  corporations  (PC), every  extra  dollar  of  business  expense  saves  the  PC 15.5 cents of tax, since a PC’s tax rates are generallyl ower than for a self-employed individual.  Once your taxes  are  calculated,  based  on  your  personal  taxable income after deductions, then the system allows you to claim certain “credits” against that tax, but usually the tax saved is only about 20 per cent of the credit,so if you claim the Children’s Arts Amount of $500 for  example,  your  actual  tax  saved  is  about  $100.  Identifying  deductions  you  can  claim,  for  yourself or in your PC, is an important part of reducing your total tax bill. The goal is to maximize deductions.  We will illustrate how to do this in subsequent articles.

EXEMPTION for  the  first  $750,000*  of  capital  gains arising  from  the  sale  of  qualifying  small  business shares (PC shares) is a major part of many dentists’ tax planning.  Great care must be taken in order to ensure that the dentist’s PC qualifies for the exemption.  If it  does  not,  there  are  sometimes  steps  that  can  be taken to make it qualify.  You can sometimes structure your  business  so  that  family  members  can  also  use
their  lifetime  exemptions  thereby  multiplying  the $750,000 Capital Gains Exemption (CGE). However, it generally takes a time span of several years for these plans to be successful, so forward planning is essential.

NON-arm’s  length  transactions  such  as  salaries  or dividends  paid  to  family  members,  or  investment assets transferred to family members, often look like easy  ways  to  reduce  the  family’s  tax  bill,  but  there are many traps for the unwary when trying to move income or assets among family members.  These traps known  as “attribution  rules”  will  be  addressed  in  a subsequent article.

TIMING of INCOME and expenses can save a great deal of money over the years.  Even if a revenue item must be taken into income, for example, if you can defer this for one year, you have delayed the tax on that income for a year, and thus have the tax amount available to invest for a year before you need to pay it to the Canada Revenue Agency (CRA).  The same principle works for  deductions.    For  example,  if  you  buy  equipment and put it into use, or incur a business expense in your PC such as the purchase of supplies at the end of one tax year rather than the beginning of the next, you get a tax saving earlier, and have saved that amount available to invest twelve months earlier than you would otherwise.

INCOME SPLITTING The  real  tax  bill  for  most  people  is not  what  you  pay  individually,  but  the  total  tax  you pay as a household.  If you can find permissible ways to  transfer  income  from  a  high  tax  bracket  dentist to  a  lower  tax  bracket  spouse,  child  or  parent,  then the  same  total  income  will  result  in  a  lower  total household tax bill.  “Income Splitting” is intended to develop structures so that income can be transferred among family members in ways which are allowed by the CRA. Be careful to avoid tax traps arising from the  attribution  rules  referred  to  in  the  ”Non-arm’s length transactions” section above.

SAVINGS PLANS  Many  plans  are  available  to  help  you defer  taxes,  income  split,  and  fund  your  retirement. These plans include, but are not limited to: registered retirement savings plans, registered education savings plans, registered disability savings plans, individual pension plans, and retirement compensation arrangements.  It is  important  to  understand  how  each  of  these  plans works to help you achieve your goals and to maximize the tax savings available.

TYPE of INCOME  is  very  important  in  determining your total tax bill, since some types of income such as dividends are often taxed at lower tax rates than other types,  such  as  interest  or  salaries.    Interest  or  salary payments by PCs also have very different tax results for your PC.  Therefore, it is just as important to focus on  the  type  of  income  you  take,  as  it  is  to  focus  on how much income.  There is an optimum mixture of dividends and salaries which minimizes taxes.

We will be preparing further articles which will deal with  these  topics  separately,  given  how  important careful tax planning is for all dentists.  Tax planning may not be “easy”, but it will become more straight forward once you start to use the DENTIST Approach to Tax Planning.

*The 2013 Federal Budget proposes to raise the lifetime CGE to $800,000 (from $750,000) effective 2014, and thereafter the exemption will be indexed.