Doctors! Should you incorporate?
When Adam came in to my office I could see the sweat forming on his forehead. He was finishing residency soon and his wife Amanda was 20 weeks pregnant and they were getting ready to enter a new life chapter. He was no longer going to be a student but now a main breadwinner and a father. After talking about the upcoming baby and me showing some photos of my two kids we got in to how life will be changing when he ends residency and starts his staff position. Having maxed out his RBC line of credit ($250,000) he wants to start planning for the future.
Adam looked at me and asked the same question I have heard many times. “Should I incorporate? The other doctors say I should.” I told him the same thing I always say…. “It depends”.
For doctors and other professionals there are generally two key tax reasons to incorporate - income splitting and the opportunity to defer taxes. A common reason for others to incorporate is to make it easier to self-finance business growth and to reduce liability risk, but given the coverage provided by CMPA, liability risk may not be a strong reason to incorporate as long as your premiums are being paid.
When I spoke to Adam about incorporation he looked lost. Medical school is great at teaching medicine but lacking when it comes to taxes. So I explained the two key reasons from a tax point of view to him.
Imagine Adam has a 3 Liter bottle of Coca-Cola and two cups. One cup is empty the other is partially full already. He has two options. Option one is to pour the entire bottle in to his cup, and if he does this he will lose about 1.16L (about 38%) to the sink (taxes). However, option two is to pour the Coca-Cola in to both cups, if he does this he will only lose 1.03L (about 34.5%) to the sink (taxes).
In Adam’s case income splitting would save him about $13,000 on a $300,000 income. This savings is because of the significant discrepancy between his income and his wife’s income of $40,000.
OK… you got it? So if you have a partner (or maybe even a parent in some provinces) who you can split income with, great! If you do not, the decision may not be as clear. So you may wish to learn about tax deferral instead.
Let’s assume that both Adam and his wife, Amanda, are earning the same. The Coca-Cola is pouring out but they each start with not much room in their cups, so they risk a significant amount of the bottle going down the drain. So instead, Amanda says, why don’t we just not pour out the bottle. Aha! This is tax deferral. There is no overflow to go to taxes. The remaining bottle of Coca-Cola is available for your use going forward when your cups are not as full. Now imagine that the Coca-Cola can increase at a rate of 5% a year. Well, that is the advantage. You can have about 2L in your hands (as in the tax splitting scenario) growing at 5% a year or you have 3L in the bottle growing at 5% a year, guess which will get to 4L first?
Now tax deferral works if Adam can leave his money in the company. If he cannot, as he has a kid on the way and $250,000 debt eating at him, it may lead him to waiting to incorporate until a few years from now.
Here are some other areas where incorporation can be advantageous:
- Life Insurance
- Estate planning
- Protecting you from liabilities
- Building your wealth and investing in various investments
- Purchasing properties (maybe even your home)
- Simplifying your personal tax return
- Better reporting on your business performance
If you want to take advantage of tax deferral or income splitting, incorporation may make sense for you, but sometimes it does not, and this depends on your situation and your goals. In the case of Adam and Amanda, it makes sense for Adam as they will save $13,000 in tax! For you there will most likely be a point where it does make sense, it just may not be now.
If you want to incorporate or want a more detailed discussion, we would be happy to speak to you one-on-one by phone or in person at either our Vancouver or Edmonton office. We also have a team of advisors (lawyers, insurance advisors and financial planners) who regularly work with doctors on incorporation related matters.
Do you want a free 20-minute tax strategy discussion? Send me an email at firstname.lastname@example.org.
(Please note that all names were fictional, and tax calculations are based on a simplified calculation)