Introduction
For self-employed physicians in Canada, incorporation can offer several financial and tax advantages, but it also comes with complexities that must be carefully evaluated. Many doctors consider incorporating to reduce taxes, retain earnings, and invest through their Medical
Professional Corporation (MPC), but there are several misconceptions about the benefits and challenges of incorporation.
This article breaks down common myths about incorporation, helping physicians make an informed decision about whether incorporating their medical practice is the right move.
1. Tax Advantages and Passive Investment Income: Does an MPC Work Like an RRSP or TFSA?
Misconception: Retaining savings in a corporation provides tax advantages similar to RRSPs and TFSAs.
Reality: While corporations allow tax deferral, passive investment income is taxed at high rates annually.
One of the biggest misunderstandings is that keeping earnings inside a corporation offers tax-free or tax-deferred benefits similar to RRSPs and TFSAs.
- Active business income retained in an MPC is tax-deferred, meaning taxes are paid only when the income is withdrawn.
- However, passive investment income (dividends, interest, capital gains) is taxed annually at high corporate tax rates, making it less tax-efficient than personal registered accounts like RRSPs or TFSAs.
- Physicians must carefully compare the long-term benefits of investing corporately vs. personally to ensure tax efficiency.
2. The Small Business Deduction (SBD) and Passive Investment Income
Misconception: Passive investment income has no impact on corporate tax advantages.
Reality: Earning too much passive income can reduce or eliminate the Small Business Deduction.
The Small Business Deduction (SBD) allows MPCs to pay a lower tax rate on the first $500,000 of active business income, but this benefit is phased out if passive investment income exceeds $50,000 per year.
- For every dollar of passive income above $50,000, the amount of active income eligible for the SBD decreases.
- If passive income reaches $150,000 or more, the corporation loses access to the SBD entirely, resulting in higher taxes on active business income.
- This hidden tax impact makes it crucial for physicians to manage corporate investments strategically.
3. Taxation of Passive Income Within a Corporation
Misconception: Passive investment income inside a corporation is taxed at lower rates.
Reality: Passive income is taxed at rates comparable to top personal tax brackets.
The Canadian tax system ensures that investment income is taxed at similar rates, whether earned personally or corporately.
- Passive investment income inside an MPC is taxed at a rate comparable to the top personal tax rate.
- Tax integration rules prevent corporate tax shelters for passive income, meaning the tax advantage of corporate investing is limited.
- Physicians must ensure that corporate investment strategies align with their long-term financial plans to avoid unnecessary tax burdens.
4. Costs and Administrative Responsibilities of Incorporation
Misconception: Incorporation is simple and has minimal costs.
Reality: Incorporating a medical practice comes with ongoing administrative and financial responsibilities.
While incorporation offers tax deferral and financial flexibility, it also comes with legal and compliance costs:
- Filing separate corporate tax returns each year.
- Maintaining corporate records and annual meetings.
- Engaging legal and accounting professionals for compliance and reporting.
- Managing corporate investments within tax-efficient limits.
Physicians must weigh whether the financial benefits of incorporation outweigh the administrative costs based on their income and financial goals.
5. Income Splitting and Tax Efficiency
Misconception: Incorporation allows for simple income splitting and long-term tax reduction.
Reality: Income splitting is restricted by Tax on Split Income (TOSI) rules.
Many doctors assume incorporation allows them to split income with family members to reduce overall taxes. However:
- The TOSI (Tax on Split Income) rules limit the ability to distribute corporate earnings to family members in lower tax brackets.
- Without proper tax planning, withdrawing funds from an MPC could lead to higher taxes rather than lower them.
- Tax-efficient income withdrawal strategies must be implemented to ensure incorporation remains beneficial.
Incorporation still provides tax deferral opportunities, but physicians must be mindful of withdrawal strategies to minimize tax liabilities.
6. Provincial Regulations and Incorporation Benefits
Misconception: All physicians benefit equally from incorporation.
Reality: Incorporation rules and benefits vary by province.
Each province has different regulations regarding incorporation, affecting:
- Income-splitting options (some provinces have stricter rules).
- Share structure flexibility (certain provinces restrict share issuance to non-family members).
- Provincial tax rates on corporate earnings.
Physicians must consider provincial tax laws before incorporating, ensuring they maximize tax savings based on their location.
7. Limited Liability Protection: What Does Incorporation Really Cover?
Misconception: Incorporation protects physicians from professional liability.
Reality: Incorporation does not shield doctors from malpractice claims.
Many physicians believe incorporating their practice will limit personal liability, but:
- Incorporation provides protection for business liabilities, but not for professional misconduct or malpractice claims.
- Physicians remain personally liable for professional actions, meaning they must maintain malpractice insurance regardless of incorporation.
- Incorporation may still offer financial security benefits by separating personal assets from business assets.
Understanding the true liability protections of an MPC helps doctors make informed decisions about incorporating.
8. Why Personalized Tax Planning Matters
Misconception: General tax information is enough to decide on incorporation.
Reality: Incorporation decisions should be based on personalized financial planning.
Every physician’s financial situation is unique. Making the wrong choice about incorporation can lead to unnecessary tax liabilities, lost deductions, or administrative burdens.
A tax professional can help:
- Assess your financial situation and tax bracket.
- Determine if incorporation aligns with your long-term wealth-building goals.
- Develop a tax-efficient strategy for investing and withdrawing income from an MPC.
- Ensure compliance with CRA and provincial regulations.
Physicians should consult a tax expert to make an informed decision about incorporating their practice.
Conclusion
Incorporation can be a valuable tool for tax efficiency and financial growth, but it is not a one-size-fits-all solution. Physicians must understand the true benefits and limitations of an MPC, particularly in areas such as:
- Passive investment income taxation
- Small Business Deduction (SBD) eligibility
- Income splitting and TOSI rules
- Administrative costs and compliance requirements
Before incorporating, physicians should seek professional tax guidance to ensure their financial strategy aligns with their career goals.
Tax Partners specializes in helping medical professionals navigate tax-efficient incorporation strategies. Contact us today for expert advice on whether incorporation is right for your practice.
This article is written for educational purposes.
Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at info@taxpartners.ca, or by visiting our website at www.taxpartners.ca.
Tax Partners has been operational since 1981 and is recognized as one of the leading tax and accounting firms in North America. Contact us today for a FREE initial consultation appointment.