The last few years have been a period of significant financial changes for doctors across Canada.
“We’ve seen fee cuts to Ontario physicians, partnership rules change and now passive income restrictions and the loss of income splitting,” says Donna Ho-Faloon, a partner with Ottawa accounting firm GGFL. “There are a lot of upset doctors out there, many of whom are more actively involved in discussing tax planning with us.”
Changes to the federal Income Tax Act that took effect in 2018 constitute the most radical of those changes.
Specifically, physicians – especially younger doctors and those about to become doctors – are being forced to re-examine how they should structure their finances.
There’s a fundamental question physicians should be asking themselves: Does it still make sense to incorporate their medical practice?
The question is particularly relevant because the new federal measures will affect two important areas: A physician’s ability to income “sprinkle” – reducing income tax by paying dividends to low or no-income family members – and sheltering passive income earned on investments held by the professional corporation and unrelated to the medical practice. (In contrast, active income is revenue derived directly from the physician’s practice.)
It all comes down to timing, says Ho-Faloon.
“It makes sense to incorporate if a physician is in a position to leave income in the corporation and save for the long term,” she says. “Then they will still have the benefit of tax deferral. So determining when to incorporate is more crucial now.
“If a physician has high student debt, or personal lines of credit, they have to use after-tax income to pay off those debts,” adds Ho-Faloon. “It is important to have a plan for debt repayment from the beginning so they can be in a position to start saving. That is when they will have the advantage of incorporating.”
Under the new rules, family members not active in the practice will be taxed at the top marginal rate on dividend payments.
These new rules have effectively eliminated the benefit of income splitting through dividend payments to family member shareholders, with the exception of the spouse.
There is no longer any advantage to having children, or the physician’s parents, as shareholders because of requirements that they contribute. However, if children or a spouse are working for the practice, they can be paid a reasonable salary and do not have to be shareholders.
Tax deferral opportunities
On the positive side, a well-timed incorporation for a physician’s practice still makes sense because it continues to offer tax deferral opportunities.
Currently, incorporated physicians can benefit from a reduced tax rate on the first $500,000 of active business income, unless the physician is associated with a partnership group.
Beginning in 2019, the small business limit of $500,000 will be reduced when the annual investment income of the prior year for the professional corporation and associated corporations exceeds $50,000. The small business limit will be reduced to nil when annual investment income reaches $150,000. Even with the changes outlined above, incorporation continues to benefit physicians and is an effective tax planning tool.
It’s complicated, concedes GGFL partner Ho-Faloon.
She suggests thinking of incorporation as another form of saving for retirement when money can be invested in the corporation for the long term.
Figuring out the new financial intricacies is understandably a big headache for most busy physicians, so making an appointment with an accountant for a tax checkup is highly recommended.