Doctors and Dentists: January 1st, 2006 was the best day of your financial life

…but perhaps you didn’t know that because you are so busy – and I can’t blame you. But for you, and the rest of us, here is what happened on that auspicious day. Brain drain should have officially ended with a new law that took effect that day with respect to the tax treatment of professional corporations set up by doctors and dentists.

Stethoscope.jpgDoctors and Dentists have been able to incorporate themselves since 2001 – but not many did because unless they had a habit of saving there was no real point.  The corporate entity did not afford you any creditor protection or release you from any professional liability – all it did was provide you with the ability to pay 18% tax on corporate income up to $400,000 per year instead of paying about 45% tax on personal income.  Since most doctors and dentists spend more than what they make for the first 10 years – it didn’t really do what it was intended to: make it more attractive to stay in Canada by substantially lowering the taxes these professionals have to pay.

BUT in January of 2006 some enhancements were added that now make it, quite frankly, a NO-BRAINER to incorporate. You now have the ability to issue non-voting shares of the corporation to your spouse, children and direct parents. They do not have to be part of the business in any way – but now you can issue them dividends from the corporation and if they don’t earn any money, they can effectively get $36,000 in dividends without having to pay any tax. (*Note: I am assuming that all other persons have no other income for the example below.)

Still don’t know what the ramifications could be? Let me draw out a sample of BEFORE incorporation and AFTER:

                                Sole Proprietorship          Incorporated

Billed Earnings              $400,000                      $400,000

For the sole proprietorship, you would just claim all $400,000 on your personal tax return. With the incorporated entity you would pay yourself a salary of $198,470 (you’ll see why below). 

Salary from Corp.          $0                                $198,470

Now, we apply personal tax (using Ontario tax rates) to $400,000 and $198,470 for each case. 

Personal Tax                 ($167,807)                    ($74,277)

The next line shows the after-tax personal income so far. For the sole proprietorship, this is as far as we get really. But with the corporation we still have $201,530 inside the corporation – so bear with me for a few more lines of math. 

Personal After Tax         $232,193                      $124,193 

Next we apply the corporate tax rate of roughly 18% – this only applies to the corporation. 18% of $201,530 is $36,275. That leaves us with $165,255 inside the corporation AFTER TAX which can now be dividended out.

Corporate Tax               $0                                ($36,275)

Dividend to Spouse        $0                                $36,000 (Tax free)

Dividend to Child 1        $0                                $36,000 (Tax free)

Dividend to Child 2        $0                                $36,000 (Tax free)

For the net personal spending using an incorporated entity, we have to add up the personal after tax earnings when a salary was paid out of the corporation to all the dividends. For the sole-proprietorship, we already know the after tax amount.  

Net personal               $232,193                      $124,193+$36,000+$36,000+$36,000

As you can see, they are equal. So at this point, what ever is left in the corporation is how much you have saved in tax in this example. This is known as the retained earnings in accountant-speak:

Retained Earnings        $0                                $57,255

So in this quick and dirty example, this doctor/dentist would realize a tax savings of $57,255. In both cases, the actual amount of money that was spent by the household was the exact same at $232,193, but with the incorporation the doctor dentist was able to retain $57,255. After 10 years that’s almost $600,000 not even factoring in growth on the money. In other words, if you are a doctor or dentist, you need to incorporate. I know that for physicians, incorporation should cost you no more than $2500 from a lawyer, or if you can muddle through the process yourself with the College of Physicians and Surgeons in your own province it should run about $1500.  Annual costs to keep up your incorporation should be no more than $250. 

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Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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  • David Grant

    When you talk about $36,000 to each child and spouse, are you assuming that the spouse does not have another job? If the spouse already made $50,000/year are you saying that they can receive an additional $36,000 from the corporation tax-free?

  • Preet

    Hi David – thanks for bringing to my attention that I omitted to include the assumption I made that the spouse was "stay at home" and had no other income.

    If the spouse already made $50,000/year than there would certainly be some tax on the dividends.

    Sorry about that – I’ll amend the post to include that assumption…

    Preet