What is professional incorporation?
A professional corporation is a business structure in which a regulated professional such as a doctor, lawyer or veterinarian incorporates their practice, making the person and the corporation separate entities for tax purposes. The corporation then pays a salary or dividends to the professional practitioner. Professional incorporation does not protect the owner/practitioner from professional liability (such as negligence or malpractice), but it does offer some financial protection and a number of important income tax benefits over operating as a sole proprietorship or partnership.
The rules for which professionals can incorporate vary among provinces and territories, so check with your accountant. Professional corporations are also subject to rules in addition to those that apply to corporations in general.
Benefits of incorporation
The biggest income tax benefit is that the corporate tax rate is significantly lower than the personal tax rate. If your practice earns more than you need for living expenses, excess cash can stay within the corporation. Depending on where in Canada you work, up to the first $500,000 of the corporation’s income is taxed at a relatively low rate – about 15% for combined federal and provincial/territorial tax. That’s a lot lower than the personal tax rate of near 50% for income at that level.
As well, when it’s time to retire, you may be able to sell your professional corporation and take advantage of the lifetime capital gains exemption. If your practice is not incorporated, this exemption is not available.
In some jurisdictions, another advantage of incorporating is income splitting (but note that share ownership by non-professionals is restricted in some provinces). If your family members own shares in your professional corporation, you can split income by paying dividends to them for taxation in their hands. You can, of course, also split income by hiring family members to work in your practice.
It may be an advantage in your profession, based on your usual business cycle, to have a year-end other than the calendar year-end. Professional corporations are permitted to choose their year-end, whereas proprietorships must use a calendar year-end.
Setting up the corporation
In most provinces, a professional corporation may carry on business only in relation to the practise of your profession – investing cannot be a major part of your operations, for example. Because of restrictions on share ownership, work with your advisors on careful succession planning in relation to your professional corporation – your options are more limited than for a regular corporation. The governing body of your profession may have requirements in addition to government regulations.
As for whether it’s better to take a salary or dividends from your corporation, each has advantages. Dividends can have a lower tax cost because of the dividend tax credit, but a salary allows you to make salary-based CPP, IPP and RRSP contributions.
Consult your advisors
Because different rules apply to professional corporations in different jurisdictions, consult your accountant and business/legal advisors to ensure your professional corporation is set up to best advantage. Your advisors can also help you determine whether professional incorporation is appropriate for you in terms of generating the many potential benefits, and they can ensure you are on top of the ongoing filing and other requirements of incorporation.