Capital Gain Strip

Surplus Stripping for Medical Professionals

In recent years many medical professionals have been looking for tax efficient ways of removing funds from their professional corporations. As the federal deficit increases taxes, this type of tax planning will become more and more important. One of the strategies that is currently being utilized is the Capital Gains Strip (CGS).

WHAT IS A CAPITAL GAINS STRIP?

CGS is a structured transaction that allows you to extract funds from your corporation as a capital gain as opposed to a dividend.

The Benefits of Capital Gains Strip – Capital gains are taxed at a lower rate than dividends. The top income tax rate on a capital gain is 26.77% vs. The top tax rate on an “other than eligible” dividend which is 47.74%, thereby representing tax savings of approximately 20%.

Let’s assume that in a given year a Physician earns $400,000 (after corporate tax) and has $300,000 of retained earning which they would like to extract from their Medical Professional Corporation (MPC). The traditional method would be for the physician to declare a dividend for the $300,000 in retained earnings and a mix of salary and dividends on the $400,000 in earnings for the year. For the purpose of this analysis, we will assume that the full $700,000 is paid out of the MPC as a dividend which would leave an after-tax amount of $365,820 (tax paid – $334,180). If the physician were to instead draw the $700,000 from the corporation using a CGS they would be left with $512,610 (tax paid $187,390) which represents a
tax savings of $146,790.

It is important to note from this example that aCGS is not solely about extracting retained earnings from the corporation. Additionally, the CGS may include converting the physician’s current income for the year, which was previously paid as salary or dividends, into capital gain and benefiting from the lower tax rate as outlined.

The disadvantages of Capital Gains Strip – When including current year earnings in the CGS you are effectively saving on the tax cost when comparing to other forms of distributions from the corporation (salary and/or dividends).

However, when accumulated retained earnings are included in the CGS, you are effectively prepaying tax (generally split between two tax years) to save tax in the future.

There are also costs (legal and accounting) associated to implement this strategy which generally range between $20,000-$25,000. This of course all must be taken into consideration in the context of the value of the CGS and estimated tax savings from implementing this strategy.

DOES CAPITAL GAINS STRIP MAKE SENSE FOR YOU?

Most physicians assume that they require a significant amount of assets in their MPC that must be liquidated in order to benefit from this type of transaction, but this is actually not the case. Lets take an example of a practitioner that has assets in their MPC (portfolio or real estate) that they do not want to liquidate.

Assume that this individual is drawing $300,000 per year from their corporation, which means that they are paying the highest marginal rate of tax on a significant amount of their income. Instead of withdrawing all of the funds in the current year, they can still complete a CGS which creates a
shareholder loan from the corporation to them personally, which can be extracted from the corporation tax free at a later date. An effective use of this shareholder loan is to allocate a portion of it to the practitioner on a annual basis, which offsets their corporate salary requirements and lowers their personal salaried income, and has the effect of over many years maintaining the physicians in a lower tax bracket and therefore less tax.

The determination of whether a CGS is right for you depends on a number of factors, including but not limited to, your short
and long term financial needs, corporate investment strategy, and retirement plans.

HOW MUCH LONGER WILL THIS STRATEGY BE AVAILABLE?

Recently there have been discussions in the department of Finance to introduce legislation to prevent this type of tax planning. Fortunately, as of the time of this article, measures have not taken to eliminate this tax strategy.

HOW TO PROCEED?

At MedFocus we have a strong and successful background with CGS. Please reach out to us today and lets get you started!