Passive investment income earned by a professional corporation is not considered active business income, and does not qualify for the small business deduction. Therefore, there is a tax incentive to structure your personal and corporate holdings to minimize overall tax paid.
Asset Mix
The same guidelines apply to corporate-owned investments as for personal investments - focus your interest earning assets within your registered accounts, and capital gains and dividend earning assets in your non registered accounts. Why? Interest income attracts the highest rate of tax while dividend and capital gains are taxed more favourably. Investment income earned in registered accounts accumulates on a tax-deferred basis regardless of the type of income. This means that your overall tax payable will generally be lower if your non-registered accounts hold investments whose earnings are tax-advantaged such as equity type investments.
Keep in mind that tax preference is only one aspect of wealth management. Your investment portfolio must be consistent with your risk tolerance and objectives. Furthermore, caution must be exercised when reducing diversification in an effort to minimize tax. Otherwise, an inappropriate increase in risk can easily be the result.
Individual Pension Plans
An individual pension plan (IPP) is a registered defined benefit pension plan funded by corporate assets for your benefit (in your capacity as an employee of the corporation). Because the formula to calculate contributions is based on age and plan performance in addition to salary, contributions to an IPP could be from 20% to 60% higher than maximum RRSP contribution limits. In general, incorporated physicians likely to benefit the most from an IPP are over 45 years of age, have past service they can buy back, earn income in excess of the small business limit and are comfortable with the actuarial fees associated with an IPP. Your MD advisor can analyze your situation and refer you to a qualified actuary for a no-fee quote.
Corporate-owned Universal Life Insurance
How can you decide if you should consider a universal life insurance policy?
- Do you have corporate assets you likely won't need for retirement income purposes?
- Are you interested in tax sheltering the earnings on more of your assets?
- Do you want to increase the after-tax value of your estate?
A universal life insurance policy is paid for out of after-tax dollars, but earnings within the policy are tax-sheltered. Also, the death benefit of the policy will be paid tax-free to your professional corporation as beneficiary. The excess of the death benefit over the policy's adjusted cost basis will be added to your company's capital dividend account and can be paid tax-free to your estate or heirs (as shareholders). Using cheaper after-tax corporate dollars to fund the policy makes this an affordable way to transfer funds tax-efficiently to the next generation. Talk to your MD advisor today about how MD Life Plan can help you achieve your goals.
Wind Up
While it is possible to sell the shares of a professional corporation to another professional, this can be difficult with a medical practice, where there is unlikely to be a buyer. This means that most professional corporations may need to be wound-up at some point, although there is no need to wind it up upon retirement - you can continue to pay yourself and any shareholders dividends as long as there are assets in your corporation. Your primary concern here will likely be minimizing the taxes payable on distributions from the corporation; your MD advisor and your tax consultant can help you time the withdrawals to achieve this goal.
Winding up your corporation includes:
- Liquidating and paying out the remaining assets
- Filing a final corporate tax return
- Having your lawyer legally dissolve the corporation
Until such time as you wind-up your corporation, assuming you plan on winding it up in your lifetime, you should consider a professional executor or co-executor. Your corporation does not automatically wind-up upon your death, and a good estate plan including a well drafted Will, managed by a knowledgeable executor, can mitigate the risk of double taxation. Your MD advisor can refer you to an MD Private Trust Estate and Trust consultant to review and update your estate plan.
Retirement Income Strategies
In retirement, you'll want to meet your lifestyle needs while paying the least amount of tax possible. That means considering your corporate assets as well as those held personally and planning the type and timing of withdrawals.
- Generally speaking, you'll want to plan on using your personal non-registered assets first to provide an income; the principal is not taxable but a withdrawal may trigger a taxable capital gain or loss.
- Next, draw from your corporation's non-registered assets. While dividend distributions are taxable at a shareholder level they receive more favourable tax treatment due to dividend tax credits. Liquidating assets within the corporation may also trigger capital gains or losses.
- Finally, draw from your registered assets. Withdrawals will be fully taxable at your marginal rate.
In all instances you'll want to discuss the source and timing of withdrawals with your tax consultant. Financial planning doesn't end with retirement, and your MD advisor can help implement strategies to turn your assets into income tax-efficiently.
