Perhaps the biggest reason for a professional to incorporate is to reduce and defer income taxes. For an Ontario resident, the top marginal tax rate for an individual is 46.41% where as a Canadian controlled private corporation carrying on an active business pays tax of 16.5% on the first $500,000 of active business income. As a result there is the possibility of deferring close to 30% of the tax liability if structured correctly.
In addition to the deferral of tax certain professional corporations can issue certain non-voting shares to family members and pay them dividends which, depending on the circumstances, can save additional taxes. Here are some other points to consider before deciding if forming a professional corporation is right for you.
Typically, forming a corporation can be a good way to protect yourself from certain liabilities. The ability to limit liability however in a professional corporation is restricted. For example, professional liability such as malpractice is not limited and the professional remains personally liable, however liabilities related to ordinary creditors may be limited.
Another difference professional corporations have from ordinary corporations is that the business undertaken by the professional corporation is restricted to only the business of practicing the profession. One thing professional corporations are able to do however is invest surplus funds which allows the professional corporation to earn investment income on funds not distributed to the professional or the shareholders which includes the deferred tax liabilities resulting from the difference in tax rates between individuals and active business income earned by a Canadian controlled private corporation as discussed above.
Professional corporations have restrictions around naming. All professional corporations must include the words “Professional Corporation” or “Société Professionel”. Each professional body may have additional restrictions about what the professional corporation can be named. Thus it is important to confirm with your professional body to ensure that the name you wish to call your corporation complies with these restrictions.
It is important to remember that the professional corporation is a distinct entity and separate from the professional. One of the implications of this difference is that one has to be very careful when it comes to removing funds from the corporation. One possible method is to pay a salary to yourself and to your employees. Employees can include family members however special attention must be given to ensure that the salaries paid to family members are reasonable in the circumstances. It is recommended that you discuss family salaries with your tax accountant.
Another possibility for extracting funds is through the payment of dividends. As certain professional corporations are able to have family members as shareholders it may be possible to pay them dividends. In certain circumstances the payment of dividends to family members may be inadvisable due to attribution. To find out if paying dividends is right for your professional corporation contact your Chartered Professional Accountant.
A third method of extraction is through the repayment of a shareholder loan. For a number of reasons shareholders may lend funds to the professional corporation, for example to purchase more equipment or as part of the consideration received for the assets transferred into the corporation at the time of forming the corporation. Having the professional corporation lend money to the shareholder is not a recommended method for extracting funds.
Before determining the most appropriate method or methods for extracting funds from the corporation it is recommended that you speak to your accountant.
Immediately before the assets of the business are transferred to the corporation there is a deemed year end for the unincorporated business and deemed disposition of the assets of the business. As a result the unincorporated business will not be able to take capital cost allowance (depreciation) as there will no longer be any assets in this business.
Generally the professional corporation will be able to select a year end date that falls within 53 weeks of the date of incorporation. A number of corporations select a December 31st year end however there are advantages to having a year end different to December 31st. Year ends in the middle of the calendar year can be beneficial when it comes to determining the appropriate mix and amount to be paid in salaries and dividends to the professional prior to December 31st. As a result it may be easier to determine the optimal mix of salary and dividends prior to December 31st resulting in more effective tax planning. It is recommended that you work with your small business accountant to determine the most effective compensation mix.
Angus Shuttleworth CPA Professional Corporation.