Chiropractors Professional Advantages of Incorporation – Ontario Tax Lawyer Comments
If you are a chiropractor then there are both tax and non-tax reasons for considering the corporate form of a business organization.
As a chiropractic professional, you provide professional services and you are regulated by a governing professional body known as the College of Chiropractors of Ontario. This means that if you choose to incorporate, you must incorporate as a professional corporation. A chiropractor must apply and obtain certificates of authorization from the College of Chiropractors of Ontario before they can incorporate a professional corporation. Certificates of authorization must be renewed annually.
Tax Advantages of Incorporating a Professional Corporation for a Chiropractor
Here are three potential significant tax benefits of incorporating a professional corporation for chiropractor:
- Paying salary to family members in lower tax brackets;
- Tax deferral by retaining earnings in the professional corporation;
- $800,000 capital gains exemption for the sale of a small business can only be claimed on the sale of shares of a qualifying corporation and cannot be claimed for the sale of a sole chiropractic proprietorship or a chiropractic partnership.
The remainder of this article discusses these three benefits in greater detail. This article will also discuss the liability issues as well as the disadvantages of incorporating a professional corporation.
Tax Deferral by Chiropractor
Net income of a chiropractor’s sole proprietorship or a partnership is taxed directly in the hands of the owner, according to the progressive individual tax rates determined by the taxpayer’s personal income. However, a chiropractor’s professional corporation is a separate taxpayer and entity with its own income tax rates.
A chiropractor’s corporation incorporated in Canada and which is controlled by individuals governed by the College of Chiropractors of Ontario who are also Canadian residents will normally qualify as a "Canadian-controlled private corporation". This status allows it to claim the small business deduction, which is a reduction of the normal corporate income tax rate on the first $500,000 of a corporation's annual taxable income earned from carrying on an active business in Canada.
The tax advantage which the shareholders of a chiropractic corporation with active business income enjoy is the ability to defer the payment of some income tax. A chiropractor’s corporation eligible for the small business deduction pays tax of approximately 11 – 16% on its first $500,000 of taxable income. The percentages of tax differ depending upon which province the corporation is resident in. Full taxation is deferred until after the corporation’s after -tax income and retained earning is paid out to the shareholders as dividends, as further tax will have to be paid upon the receipt of dividends from the corporation by the shareholder. The tax rate is dependent on whether the dividend is an eligible or ineligible dividend, with the range being between 19% and 40% depending on the province.
Chiropractors can take advantage of this tax deferral when incorporated by choosing to issue dividends at a later time.
The deferral can be significant and can even turn into absolute tax savings especially for a taxpayer in the top marginal tax bracket. A professional corporation can keep the after tax income as retained earnings (taxed at the lower corporate rate after the small business deduction) and then issue dividends to shareholders when the shareholders are at a lower tax bracket and paying tax at a lower rate, so that the shareholder can pay less tax personally overall.
Please take note of the discussion found below as to who can be shareholders in a professional corporation.
Electing Shareholders, Directors and Officers
In a regular corporation, you usually have the ability to have anyone you like as a shareholder, director or officer. However, in a professional corporation this is restricted to the rules set out by the governing professional body for chiropractors: the College of Chiropractors of Ontario.
For example, all of the issued and outstanding voting shares of a chiropractor’s professional corporation can only be legally and beneficially owned by a member of the same profession (chiropractor) who are certified by College of Chiropractors of Ontario. The College of Chiropractors of Ontario does not allow holding companies to control a chiropractor professional corporation. The Ontario Regulation 39/02 (the “Regulation”) made under The Regulated Health Professional Act, 1991, sets out that family members can own non-voting shares of the corporation only in the case of physicians/doctors and dental/oral surgeon medical professional corporations. The Regulation does not allow the family members of a chiropractor to hold non-voting shares of the chiropractic professional corporation. Only chiropractors registered with College of Chiropractors of Ontario can be shareholders of a chiropractic professional corporation. This forecloses the possibility to income split with family members and adult children by issuing them dividends.
The professional corporation can not carry on any business that is not the chiropractic practice but the professional corporation can carry on activities related to or ancillary to the chiropractic practice, which includes the investment of surplus funds earned by the corporation. These are not the only rules; if the professional corporation violates any of the rules set by the College of Chiropractors of Ontario, the College of Chiropractors of Ontario may revoke the authorization.
An important restriction to note is that all officers and directors of the chiropractor’s professional corporation must be shareholders of the corporation who are members of the College of Chiropractors of Ontario. It is important to check these rules prior to incorporating and designating anyone as a shareholder, officer or director of a chiropractor professional corporation.
The Canadian tax system is designed, in certain instances, to be neutral between income earned personally or through a corporation. This is called the integration of the corporate and personal taxation schemes in Canada. As a result of integration,, after the shareholder pays tax on his dividends, the total tax burden will be approximately the same amount she/he would have paid if the income was received directly.
This neutrality means that for non-active income of a chiropractor’s corporation such as investment income or capital gains, the professional corporation effectively pays tax at the same rate as an individual. Accordingly there is no material tax deferral possible on passive income.
Capital Gains Exemption
The other main tax benefit to incorporation of a chiropractor practice is the ability to claim the $800,000 capital gains exemption on a sale of the shares of the professional chiropractor practice. The complex rules provide, in effect, that to claim the exemption the shares must be of a Canadian-controlled private corporation, at least 90% of the assets of which are used in an active business carried on in Canada, or a holding company which owns such shares. Additionally, there are further rules stating the owner/shareholder must hold the shares for a period of two years prior to the sale.
Where the shares qualify, the owner/shareholder can sell them and the first $800,000 of capital gains is exempt from tax. The exemption applies to the individual owner/shareholder and not the corporation. Once an owner/shareholder has claimed $800,000 of capital gains exemption, the exemption is no longer available on a sale of other qualifying shares. When the capital gains exemption is calculated, it is reduced by the taxpayer's Cumulative Net Investment Losses (“CNIL”) balance. The CNIL balance is the amount by which the total of all investment expenses exceeds the total of all investment income for all tax years after 1987. The CNIL can be calculated by filling in CRA's form T936 for each year after 1987.
Capital Gains Purification Transactions
The capital gains exemption may only be used when certain criteria have been met.
The three criteria are:
- A full 90 percent of the professional corporation’s assets must be used in an active business at time of sale;
- Professional corporation shares must be not owned by anyone other than the individual or persons related to the individual (chiropractor, or other chiropractor partners) during the 24 months before the sale;
- During the 24-month period, at least 50 percent of the professional corporation’s assets must be used principally in an active business or to finance a connected active business.
When the corporation cannot meet the assets requirement above, the professional corporation will most likely need to remove non-qualifying assets (usually cash, retained earnings, or investments) from a chiropractor’s corporation in order to ensure that the asset mix meets the assets requirement. This process is often referred to as the “purification” of the professional corporation.
Liability protection is generally the main non-tax reason to incorporate. While a sole proprietor or partner in a general partnership has unlimited liability to creditors of the business, shareholders of a corporation have no such risk. Without the protection of limited liability most entrepreneurs would not take the risks of going into business.
In a professional corporation, the liability is different. As a chiropractor, you may be sued for malpractice. A professional corporation does not provide the same protection as a regular corporation. It actually provides no additional limitation on liability in this case. That is why it is extremely important to always keep your malpractice insurance up to date.
A professional corporation does provide some protection from creditors if you borrow money. Perhaps you have taken out a loan to finance a new office or to purchase some new equipment. A professional corporation will shield you from personal liability if you are unable to repay those loans.
While shareholders have limited liability, directors of a corporation are subject to various liabilities. These include liabilities for unremitted source deductions, unremitted PST and GST/HST and certain environmental liabilities.
Furthermore, passive directors who may not be involved in running the business may still be subject to certain of these liabilities. Passive directors should be aware of what the corporation is doing and should ensure that director's liability insurance is in place to protect them.
As a chiropractor, you will no doubt have employees working with you. They could be your receptionist, chiropractic assistant or anyone else employed in your office. It is up to you to ensure that the above is taken care of, or else the Canada Revenue Agency can assess you personally.
Private Pension Plan
Another advantage of incorporating a professional corporation is the ability to set up an Individual Pension Plan for the business owner/shareholders who are also employees of a professional corporation. It is important to begin planning for retirement early in your career by contributing to a private pension plan. A private pension plan can be registered or unregistered with the Ministry of Revenue. An employer’s contribution to the registered pension plan is not a taxable benefit for the employee whereas it is a taxable benefit if employer contributes to an unregistered pension plan for employee.
An Individual Pension Plan has many advantages over an RRSP, and it can be set up for high income earning incorporated professionals to obtain more immediate tax deductibility advantages than compared with an RRSP. An Individual Pension Plan is a registered and defined benefit pension plan Private Pension Plans have to be created by a corporate employer with the main purpose of “providing periodic payments to individuals after retirement and until death in respect of their service as employees.” Contributions to the Individual Pension Plan are tax-deductible for employer and if the corporate employer borrowed money to sponsor the contributions for the Individual Pension Plan, the interest can be deducted as well. Because it is a defined contribution plan, it generally will allow the contribution room to increase as a person ages.
There are limits to making contributions to an Individual Pension Plan, as the actual calculation of allowable contribution to an Individual Pension Plan is based on an individual’s age, employment earnings and a formula prescribed by the Canada Revenue Agency (CRA). Due to these factors, larger contributions to an Individual Pension Plan will likely be required as the individual gets older, since the expected time to retirement is shorter. Tax deductible contributions for past services can also be made. In addition, if the pension plan portfolio underperforms (meaning that if the return is less than 7.5% per annum), then the employer must contribute more to the pension plan. Earnings of the pension plan fund are not taxed while they are still in the pension plan. However, the assets of the Individual Pension Plan fund are locked in until retirement; this means that they cannot be withdrawn before retirement.
If the employee no longer works for the corporate sponsor of the employee’s Individual Pension Plan, or if the plan is terminated before the employee retires or turns 71 years old, then the plan must be transferred into a Locked-In Retirement Account or a locked-in RRSP account. No more contributions to the plan can be made and no cash can be withdrawn from it if it is transferred to a Locked-In Retirement Account or a locked-in RRSP account. Any gains that accumulate in the Locked-In Retirement Account and a locked-in RRSP account will continue to be tax-deferred. At retirement age, or when the employee turns 71 years old, the funds in the Locked-In Retirement Account or a locked-in RRSP account must be converted to a Life Income Fund (LIF), Locked-in Retirement Income Funds (LRIF), or a Registered Retirement Income Fund (RRIF), or used to purchase life annuity.
If you are an owner of a professional corporation, as an employer you will generally need to consult with an actuarial or an accountant to determine the necessary and optimal contribution for employees for a given year. An employer’s contribution to the employee’s Individual Pension Plan is not a taxable benefit for the employee. The cost of establishing and administering an Individual Pension Plan for employees is deductible for the corporate employer as an expense.
Disadvantages of Incorporation for a Chiropractor
Integration of the personal and corporate tax systems has virtually eliminated double taxation with the additions of the gross up, credit calculation and the introduction of the general rate income pool (“GRIP”). Corporate profits from active business income in excess of $500,000 per year are taxed at full corporate rates. With full integration, these amounts are no longer subject to double taxation as explained below.
Eligible and Ineligible Dividends
Eligible dividends are taxed at a reduced federal rate, where ineligible dividends are taxed at the full federal rate because these types of dividends are issued from profits earned and taxed at the small business deduction rate. Therefore there is no resulting double taxation.
For CCPC's (“Canadian Controlled Private Corporation”), an eligible dividend is a dividend that is paid out of the corporation's general rate income pool (“GRIP”). The GRIP account balance generally reflects taxable income that has not benefited from the small business deduction or any other special tax rate. This eligible dividend designation is at the discretion of the company paying the dividend. It should be noted that the GRIP balance must be sufficient for the dividend to be deemed eligible.
For non-CCPC's the situation is the opposite. All dividends will be eligible dividends unless the corporation has a low rate income pool (“LRIP”). The LRIP is generally made up of taxable income that has benefited from certain preferential tax rates. An important difference is that these non-CCPC's do not have discretion as to whether the dividend is eligible or not. The LRIP balance must be paid out first as an ineligible dividend before eligible dividends can be paid.
Other Disadvantages of Incorporation for a Chiropractor
A corporation is also subject to strict rules governing the taxation of shareholder benefits, such as shareholder loans or the use of a company car.
Finally, the transfer of the unincorporated chiropractic practice or chiropractic partnership to a corporation will be a taxable transaction unless a section 85 rollover agreement is made and the appropriate election is filed with Revenue Canada. Provided such an election is made, however, the transaction can be free of any immediate adverse tax implications.
When a proprietorship or a partnership incorporates, it is generally a good idea to consider any life insurance needs. Upon the incorporation of a chiropractic partnership, a shareholders agreement will normally be entered into, often requiring funding through life insurance. An incorporated sole proprietorship may not have any additional life insurance requirements, but in certain circumstances, such as the entrepreneur being a single parent, additional life insurance to pay for any deemed capital gains incurred on the death of the shareholder might be appropriate. A life insurance policy may be beneficial to the corporation if one of the shareholder/key personnel of the professional corporation dies and the corporation is faced with an adverse financial impact as a consequence. A life insurance policy can hedge the financial effect of the death of a key income earning chiropractor partner/shareholder for the corporation. Although life insurance premiums paid by the business for key personnel insurance protection are not deductible for tax purposes, the proceeds received as a consequence of death are tax free if they are structured as ‘exempt policies’. Alternatively, life insurance paid for an employee is deductible for the corporation if it is included as employee benefits.
Chiropractor Personal Services Business
A Personal Services Business (PSB) is essentially a corporation that provides services to an employer like an employee. As a PSB, the corporation cannot claim regular deductions that a regular corporation gets. If the corporation has at least six or more full time employees, then it is not a PSB. . For example, if you work as an in-house chiropractor for a hospital, incorporate and then enter into a contract with the hospital stating you are a professional corporation and are to be paid as such, then you are likely a PSB. The easiest way to think about it is without the corporation, would you reasonably be considered an employee of the hospital.
From the Canada Revenue Agency’s point of view, if you are running a personal services business, then you are not eligible for any of the tax advantages that come along with incorporation discussed above, such as the small business deduction, and you are not able to deduct business expenses like a regular corporation.
There will likely be no tax advantage to incorporate if you will be considered as a PSB ineligible for SBD and deduction of business expenses (for example if you are working for one hospital as a in-house chiropractor). If you are working on contract for multiple hospitals simultaneously as an independent contractor, then likely, if you incorporate, you likely will not be seen as a PSB. If you think you are operating as a personal services business, it is important to speak with a Toronto Tax Lawyer prior to incorporating so that we may assist you and you do not waste money incorporating if there is no advantage.
Canadian Tax Lawyer Assistance
If you are looking at the benefits of incorporating your professional corporation or are looking for the best method to compensate your employees or shareholders, give our Ontario tax lawyers a call. Effective income tax planning is required to ensure you and your professional medical corporation keep as much of the profits as you are entitled to.
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."