| | | |
 | Planning
for the Incorporation of Dentists in Ontario
by
David Chong Yen (Ontario Dentist Magazine, April 2001) |
| |
 | |
The
May 2, 2000 Ontario Budget proposed that regulated professionals, including dentists,
should be given the option to incorporate. In short, this means dentists will
be permitted to incorporate their dental practice, which would then be referred
to as a professional corporation. The legislation also states that non-dentists,
including spouses, children and parents, will not be permitted to own shares of
the corporation.
The Ontario government is expected to provide more specifics
in due course. At the time of this article's writing, legislation permitting the
incorporation of dental practices had been given Royal Assent, but it still needs
to be proclaimed as law before coming into effect. In the meantime, the following
tax planning issues should be considered, in anticipation of the approved legislation
allowing dentists to incorporate. But before you take any action, consult a tax
professional to determine if you can, in fact, save and defer taxes by incorporating
your particular dental practice. Also, consult your lawyer to determine the legal
ramifications.
Selling a Professional Business to a Corporation
A valuation may need to be done of the dental practice, since the dentist would
sell their dental practice to the newly-formed corporation. Consider an independent
appraiser of dental practices for this task. The valuation is just one of several
steps needed determine the price at which the dental practice will be sold to
the corporation. It is generally possible to defer any taxes arising on the sale
of the dental practice to the corporation by consulting a tax professional.
Dividend / Salary Mix
Salaries are paid to employees of the corporation
for services they have rendered. Employees of the corporation include the dentist,
but dividends are only paid to shareholders of the corporation. In light of this,
paying the optimum amount of dividends and salaries is important in order to minimize
overall taxes. Factors surrounding the optimal mix of salaries and dividends are
as follows: - Tax
rates applicable to dividends are different from those that apply to salaries.
The top tax rate for salaries is higher than the top tax rate for dividends;
- Salaries
are considered "earned" income, and as such, increase your RRSP contribution
limit. Dividends are not considered earned income and so do not count towards
your RRSP contribution limit;
- RRSP
contributions are currently limited to 18 per cent of earned income, to a maximum
of $13,500 per year;
- Salaries
represent tax-deductible expenses to the professional corporation;
- Dividends
are not considered a tax-deductible expense to the professional corporation, and;
- The
professional corporation, if it derives virtually all of its income from dentistry,
will be considered an active business, with the first $200,000 of its income taxed
at a low rate, approximately 20 per cent. The professional corporation may also
derive some of its income from investments. However, this investment income will
be taxed at a rate of approximately 50 per cent.
Other
Issue to Consider
The dentist, who owns shares of the corporation or company,
is entitled to dividends, provided the corporation has retained earnings (in other
words, profits from the current or previous years, which have not been paid out
to share-holders). These dividends do not count towards income on which RRSP contribution
limits are based, since earned income is a requirement for the RRSP limit calculation.
Because of the above factors, a salary of $75,000 should be paid in order
to maximize your RRSP contribution, provided your corporation is profitable enough
to do so. Consider leaving any money not required for personal expenses in the
corporation. If you follow that advice, a tax deferral will be achieved, as the
company would pay only a 20 per cent tax rate, versus a higher rate if the dentist
receives the income directly. The corporation can then invest the surplus money,
although such investment income will likely be taxed at a higher tax rate of approximately
50 per cent.
In general, the corporation's tax rate will likely be 20
per cent on the first $200,000 of income subject to taxes. Furthermore, the dentist
who incorporates will likely be entitled to a $500,000 capital gains exemption
with respect to shares of the professional corporation (in other words, the first
$500,000 capital gains, which arise when the corporation shares are sold, will
be tax free, subject to certain restrictions).
Many dentists are currently
independent contractors. Where dentists are permitted to incorporate, they will
become employees (and not independent contractors) of the corporation they own.
Furthermore, where the dentist owns more than 40 per cent of the professional
corporation, no employment insurance is payable on the salaries paid to the dentist.
However, where this test is not met, then employment insurance will be payable
on the salaries paid to the dentist.
Are Hygiene, Technical Service
Corporations Still Needed?
Hygiene or technical service corporations were
created to operate the hygiene or technical service component of a dental practice.
A non-dentist, including a family trust, may own either corporation. It bears
repeating that a dentist's spouse or children who are not members of the regulated
profession would not be allowed to own shares of the newly-formed professional
corporation.
Therefore, if there are individuals with whom income splitting
can be achieved, and these individuals are not dentists, then a hygiene or technical
service corporation will still continue to yield tax savings. In such cases, non-professionals
will directly or indirectly own the non-professional (hygiene) portion of the
business. The dentist will own shares of the dental corporation, which in turn,
owns the dental business. Therefore, depending on the circumstances, a hygiene
or technical service corporation may be used in combination with a professional
corporation.
Impact on Stub Period Income
Many dentists are
paying additional taxes as a result of reporting a non-December year-end as at
December 31, 1995. Since then, the government has taxed dentists on the income
deferred over a 10-year period, from 1995 onward. Where the professional sells
the business to the corporation, he or she will be deemed to cease operating this
business. Instead, the corporation (a separate legal body from the dentist) would
then take over.
When a dentist ceases to operate his or her business,
the remaining reserve (in other words, the untaxed portion of the income deferred)
will be recognized as income. However, with proper planning some of this can be
deferred to the year following incorporation. This could create a larger tax bill
than anticipated in the initial year. Seek a tax professional before incorporating.
Use of a Holding Company
A holding company is created to own shares
of another company. This is often done to protect one company' assets from creditors,
or to separate the operating asset of one company from the investment assets -
including cash - of another company. Generally speaking, it is permissible to
pay dividends from one company to another on a tax-free basis. Unfortunately,
it is unlikely that the new legislation will permit the use of holding companies
to own professional corporations.
| |
