Could a personal corporation work for you?

If you are a lawyer, accountant, engineer, architect or other professional, did you know you may be able to save thousands of dollars in taxes? Instead of running a practice as a sole proprietorship or partnership, you could consider incorporating it. Taking advantage of this option will convey tax and estate planning benefits available only to owners of a private incorporated business.

How it works

A professional corporation is like any other corporation; however, it is subject to certain rules, generally outlined by the governing body. Legal set-up fees and annual filing for the corporation's tax returns with the relevant payroll and capital taxes must be remitted. As a private corporation, active business income is subject to a low tax rate (currently on the first $300,000), so the annual tax savings may offset the costs of incorporation and additional annual accounting fees.

A key reason for a person to incorporate a business is to limit personal liability. A corporation is a legal entity separate from its shareholders. However, in the case of certain professional corporations, other than those established by architects and engineers, individuals cannot limit their personal liability for negligence or malpractice. Liabilities that may be limited include financing obligations, leases, non-guaranteed bank loans and non-professional contingencies where the professional has not personally guaranteed the loan.

Advantages of incorporating

Some benefits gained by incorporating are:

1. Personal income planning - Professionals may choose between taking income or dividends, subject to a lower tax rate, thus maximizing their after tax income while retaining the ability to contribute to an RSP.
2. Access to the small business deduction - This is the lower tax rate on the first threshold of active business income generated by the corporation's business activities - currently 18.6 per cent on the first $300,000 of income, compared to a personal tax rate of approximately 46.3 per cent on the same amount of income.
3. Tax deferral - Income that is kept within the corporation after taxes have been paid at the low rate may be paid at a later date in the form of dividends, which is more tax effective.
4. Income splitting - Many professional associations permit non professionals to own non-voting shares of the corporation, allowing after-tax profits to be distributed to other members of the family, such as to the spouse and children.
5. Family trusts - Where minors will be shareholders, professionals can establish a family trust to hold those shares, until the child reaches the age of majority to avoid the "kiddy tax".
6. Capital gains exemption - This is available on the disposition of shares in a qualified small business. Currently, shares that are "qualified small business shares" will be exempt from tax on the first $500,000 of capital gains.
7. Probate planning - Many jurisdictions allow for a second will to distribute assets outside the estate, avoiding the probate process.
8. Estate freezes - These would now be available to the professional as the business matures and increases in value. The freeze would allow for the use of the capital gains exemption as well as the creation of a new class of shares that may be purchased by family members, creating a new layer of tax advantages, such as income splitting and access to additional capital gains exemptions.
9. Buy-sell options - These now become available to the incorporated professional so that the most tax-effective way to disposing of shares on death or retirement can be designed.
10. Retirement and pension planning - Shareholders/employees of a corporation can establish a pension plan, funded by their corporation on a tax-deductible basis that may outperform a personal RSP due to the larger capital infusions that pension arrangements generally allow. These arrangements include individual pension plans and retirement compensation arrangements.
11. Corporate paid expenses - Some expenses, such as life insurance premiums, can be cost effective for the shareholder. Corporations may purchase, pay for and own life insurance policies on the life of the professional and the insurance benefit, when paid, will create a tax free dividend to the estate or family of the deceased, at a much lower after-tax premium cost than if purchased personally. In addition, the investment component of a universal life insurance policy will create a tax shelter for excess earnings retained in the company where they would normally be subject to tax at a 49.8 per cent rate and may be used to create tax- preferred or tax-free income for the professional.

Incorporating not only results in a more efficient cash flow, but also creates tremendous tax advantages for you and your family, now and in the future. If you have not considered the benefits of incorporating, call our office for an appointment.