Introduction to taxes and Medical Professional Corporations (MPC)
As a medical professional you receive fees for services which is generally classified as business income. In Ontario the two most common structures for medical professionals are either a sole proprietorship (unincorporated business) or a professional corporation. There are significant differences between the two which we will explore in more detail below. As a sole proprietor there is no legal distinction between you and the business. Whatever income the business makes is your income and you pay personal tax on that amount at your marginal rate. The top tax rate in Ontario is 53.53% on income over $220,000 per year which is what most unincorporated professionals end up paying.
Corporate Income Tax Rates vs Personal Income Tax Rates
In Ontario the corporate income tax rate on active income earned from a business is a flat 12.2% on the first $500,000 per year of income. Contrast that with the top personal tax rate of 53.53% on income over $220,000 and you can quickly see why there is an advantage to earning income through a corporation.
Wealth Creation through Tax Deferral
In order to take full advantage of the lower corporate tax rates, you will need to leave some of the income in the corporation. Because of the low corporate tax rates there will be significantly more funds left over to reinvest.
Let’s take an example of a medical professional earning $300,000 of income, the individual pays themselves a salary from their corporation of $200,000 and they pay personal income tax on that amount at their graduated rates. By leaving the extra $100,000 of surplus in the corporation and only paying 12.2% corporate tax on that amount instead of 53.53%, this individual would have $87,800 left over in their corporation after tax as opposed to $46,470 after tax if they had earned that income as an unincorporated sole proprietor.
This tax deferral of $41,330 per year could be put to use by investing it within the corporation to generate investment income.
Corporations can generally invest in many different types of assets, some of the more frequently used are investment portfolios (stocks and bonds), income producing real estate properties, mortgages, etc., so there is a lot of flexibility on how to allocate your corporate funds as long as they are income producing assets and not personal use property.
Let’s take the example above and assume that this individual is able to leave $100,000 of surplus each year in the corporation and earn a 5% investment return on their corporate funds. When we fast forward 20 years the incorporated business will have a net worth of $2.24M in the corporation which is almost double the amount that the unincorporated professional would have ($1.19M of net assets, a difference of over $1M). Now keep in mind that the incorporated business will still have to pay out these retained earnings to the individual as salary or dividends but if it is done slowly over many years utilizing the individuals graduated tax rates the after tax amount is still significantly higher due to the compound investment returns on the tax deferral and the utilization of low tax rates to smooth out personal income and stay in lower tax brackets.
Lower effective personal tax rates by smoothing out personal income
Corporations do not have graduated rates like individuals, the tax rate is a flat 12.2% on the first $500k of annual income and 26.5% on any income above that. By earning the income through a corporation you can control how much income you report personally by paying yourself a salary or dividend from your MPC which allows you to keep your income in a manageable tax bracket by spreading out the income and utilizing your lower tax brackets every year. Many people use their corporations to build up retirement savings and draw the money out in retirement as dividends when they have low income and pay very little personal tax on the money coming out of the corporation.
Income Splitting Opportunities
The concept of income splitting is taking income that would have been earned by a family member who is subject to a higher income tax rate and transferring it to an individual in a lower tax bracket that will pay less tax on that income. Income splitting can be done in certain situations by paying someone a reasonable salary for services provided or by paying dividends to an individual that would be considered a reasonable rate return based on their contributions. The 2017 federal budget introduced new legislation that makes income splitting more difficult so care must be taken when navigating these rules but there are still opportunities to income split in certain situations.
Should I incorporate my Medical Practice?
The million-dollar question now becomes, should I incorporate my medical practice? The answer to that question is not driven by how much you make, it should be determined by how much you make vs. how much you spend personally. If you spend all of the income that you make then you will not be any further ahead by incorporating because you will not be taking advantage of the low corporate tax rates.
If you do not use all of your income and would like to use some of your surplus funds in a tax efficient manner to defer taxes and generate investment income then you may be benefit from incorporating your medical practice.