Saving in my Professional Corporation – It’s a Great Idea!

Q1 | March 2022

Topic: Tax Planning

Brad Weber  CPA, CA, CFP, CIM

March 2, 2022

Image used with permission: iStock/relif


Print & Share

Print

Saving in my Professional Corporation – It’s a Great Idea!

Q1 | March 2022

The ability for professionals in Canada to incorporate their practice has existed for some time. Doctors, dentists, lawyers, accountants, and other qualifying professionals have realized various benefits from their ability to incorporate. The rules governing how a professional corporation operates do change over time, and the last significant changes were introduced in 2018.

Even though the rule changes have been in place for several years now, there still seems to be some uncertainty around their impact. One area of confusion is the effect of investment income on the small business deduction. When I sit down with some of my professional clients, they know that earning passive income in their corporation affects them. But they are unsure how and wonder if they should even be saving in their corporation and how much.

The Small Business Deduction

To help clarify the confusion around the passive income rules, I need to highlight a few points about professional corporations. First, what is the small business deduction? In simplest terms, the first $500,000 of income a corporation earns benefits from a lower tax rate. In Ontario, that tax rate is 12.2%1. You can compare this to the general corporate tax rate of 26.5%1. That lower tax rate results in more after-tax dollars available in your corporation to either invest back into the business or save for the future.

The Tax Deferral Opportunity

The second item to highlight is the tax deferral benefit. People have written whole articles on just this topic. So, to keep it brief, the tax deferral benefit makes saving in your professional corporation more favourable. Suppose you were earning $100,000 of income personally, and you were paying taxes at the top rate in Ontario of 53.53%. That would leave you with $46,470 after-tax, and we’ll assume this is surplus income that you will save. If you earned the same income in a professional corporation, the tax rate would be 12.2%, and you’ll have $87,800 after-tax to save. This difference between the two saving amounts is due to the lower corporate tax rate, but it represents deferred taxes. When you move this money out of the corporation, you’ll have to pay those deferred taxes. But until then, you keep access to that money to invest and grow it. This can allow you to build up more savings through a professional corporation than you would personally, although with a large deferred tax bill attached to it.

The rules around passive investment income in a corporation reduce the tax deferral benefit over time. Passive income means investment income, such as interest, dividends, and capital gains. Once this passive investment income reaches $50,000 in a year, your small business deduction begins to be reduced. For every $1 of investment income earned over $50,000, your small business deduction is reduced by $5. Once investment income reaches $150,000, your small business deduction is eliminated. For example, if your professional corporation earns $100,000 of investment income, your small business deduction is reduced from $500,000 down to $250,000.

For example, if we use 5% as an average rate for return, the small business deduction could start being reduced once a corporation has accumulated $1,000,000 of investment savings. At around $3,000,000 in investments, it could be eliminated. Keep in mind these are just estimates – to give you an idea of the size of investments needed before the reductions begin. It’s the actual investment income that matters, not the size of the assets. And that income could change year over year so that these asset ranges could be higher or lower depending on your circumstances.

The Tax Deferral Opportunity Without the Small Business Deduction

How does that affect your decision about saving in your professional corporation? When you have access to the small business deduction, you can defer taxes at the rate of 41.33%2 in Ontario. But without that deduction, the tax deferral benefit in Ontario is still 27.03%2. That’s still a decent amount of tax to be able to defer. If the small business deduction never existed, it would still be a good idea to use your professional corporation as a place to save for your retirement. Even with a large amount of passive investment income in your corporation, you are still benefiting from tax deferral by continuing to save.

The exact rules are more complicated than I’ve outlined here. There are other elements of how a professional corporation works that I haven’t touched on, such as access to the lifetime capital gains exemption or the impact of making donations through the corporation. But a professional corporation can be a valuable tool for professionals, and you want to make sure it is integrated into your overall wealth plan to maximize its benefits.

1 Across all provinces the small business rate varies from 9% to 12.2% and the general corporate tax rate varies from 23% to 31%.

2 Across all provinces the tax deferral benefit from the small business deduction range from 37% to 42.5% and at the general corporate tax rate from 20.37% to 27.03%.

More Like This...

See another CRM2 blog post that may be of interest to you.

CRM2: The Nexus Approach to our CRM2 Reports

Topic:
CRM2
Excerpt:
With changing securities regulations coming into effect, investment firms are now required to provide individual investors with specific additional in

More Like This...

See another Foundations & Endowments blog post that may be of interest to you.

Charitable Giving Made Easier

Topic:
Foundations & Endowments
Excerpt:
Giving to charities and supporting our community are important to us at Nexus. We donate a portion of our management fees back to the charities and

More Like This...

See another Human Interest blog post that may be of interest to you.

To Insure Promptitude

Topic:
Human Interest
Excerpt:
Historically, tips were a monetary translation of either “thank you” or “sorry”.

More Like This...

See another Inside Nexus blog post that may be of interest to you.

Understanding Pride: A Timeless Celebration

Topic:
Inside Nexus
Excerpt:
In today’s world, the concept of Pride has become a celebration embraced by people of all ages and backgrounds.

More Like This...

See another Investments blog post that may be of interest to you.

Snakes and Ladders

Topic:
Investments
Excerpt:
…. as the newest member of the Nexus investment team, I would like to introduce myself.

More Like This...

See another Pearls of Wisdom blog post that may be of interest to you.

The Joy of Doing Nothing Together!

Topic:
Pearls of Wisdom
Excerpt:
Life seems to be a never-ending balancing act, doesn't it?

More Like This...

See another Tax Planning blog post that may be of interest to you.

You May Have a Trust and Not Even Know It

Topic:
Tax Planning
Excerpt:
There is a significant change this tax season as additional reporting requirements have been introduced for trusts and bare trusts.

More Like This...

See another Wealth Planning blog post that may be of interest to you.

The Case for An Annual Family Roundtable

Topic:
Wealth Planning
Excerpt:
Not long after I joined Nexus, Bill Berghuis imparted some good advice that has stuck with me

On a Side Note…

See another CRM2 Nexus Notes Quarterly article that may be of interest to you.

No posts found.

On a Side Note…

See another Foundations & Endowments Nexus Notes Quarterly article that may be of interest to you.

Charitable Giving Made Easier

Topic:
Foundations & Endowments
Excerpt:
Giving to charities and supporting our community are important to us at Nexus. We donate a portion of our management fees back to the charities and

On a Side Note…

See another Human Interest Nexus Notes Quarterly article that may be of interest to you.

Worth a Thousand Words… J24

Topic:
Human Interest
Excerpt:
A little humour makes the world a better place.

On a Side Note…

See another Inside Nexus Nexus Notes Quarterly article that may be of interest to you.

Understanding Pride: A Timeless Celebration

Topic:
Inside Nexus
Excerpt:
In today’s world, the concept of Pride has become a celebration embraced by people of all ages and backgrounds.

On a Side Note…

See another Investments Nexus Notes Quarterly article that may be of interest to you.

Snakes and Ladders

Topic:
Investments
Excerpt:
…. as the newest member of the Nexus investment team, I would like to introduce myself.

On a Side Note…

See another Pearls of Wisdom Nexus Notes Quarterly article that may be of interest to you.

Pearls of Wisdom

Topic:
Pearls of Wisdom
Excerpt:
Reading is one of the principal occupations in our profession..

On a Side Note…

See another Tax Planning Nexus Notes Quarterly article that may be of interest to you.

You May Have a Trust and Not Even Know It

Topic:
Tax Planning
Excerpt:
There is a significant change this tax season as additional reporting requirements have been introduced for trusts and bare trusts.

On a Side Note…

See another Wealth Planning Nexus Notes Quarterly article that may be of interest to you.

The Case for An Annual Family Roundtable

Topic:
Wealth Planning
Excerpt:
Not long after I joined Nexus, Bill Berghuis imparted some good advice that has stuck with me