In some ways, the 2016 Federal Budget will change tax planning strategies for dentists. During the campaign leading up to the election last fall, Prime Minister Trudeau said in a CBC interview, “A large percentage of small businesses are actually just ways for wealthier Canadians to save on their taxes, and we want to reward people who are actually creating jobs and contributing in concrete ways.” This led to speculation the government would target professional corporations, specifically those employing three or fewer employees. Many dentists and other medical professionals could have been affected under those conditions, but fortunately it did not turn out to be as bad.
Thankfully, the budget did not include these changes so the basics remain the same. Dentists can still incorporate regardless of the number of employees, and the corporate tax rate remains unchanged. This is good news for all incorporated dentists (owner operators and associates), and it leaves the ‘salary vs. dividend’ planning strategy intact. But some of the more advanced planning strategies, like hygiene corporations and corporations for dental partnerships, will no longer offer the same attractive tax advantages. Let’s take a closer look at the main issues impacting dentists.
For 2016, the combined federal & provincial tax rate for small business corporations in Ontario will remain at 15% for profits.
For investment income, the rates will be 25.1% on capital gains and 50.2% for interest (under $500,000) and other income (such as rent). In spite of these rates, it often makes more sense to invest inside the company rather than personally.
The tax benefits of setting up a Hygiene or Technical Services Corporation have effectively been eliminated. In the past, both companies could utilize the lower tax rate of 15% on profits up to $500,000, provided the companies were not “associated”. To avoid association, each company would be owned by different individuals; for example, the dentist would own the Professional Corporation and the spouse would own the Hygiene Corporation.
Going forward, the $500,000 lower tax limit must be shared between the Professional Corporation and the Hygiene Corporation where the shareholders are not dealing at arm’s length (e.g. spouse, parent, child or sibling). The result is that combined profits exceeding the $500,000 will be subject to a higher tax rate at 26.5% instead of 15%.
This does not mean Hygiene Corporations should immediately be discontinued, as there may be some benefits, costs or other factors to consider, including two separate lifetime capital gain exemptions exceeding $800,000 upon eventual sale.
The changes to the association rules noted above will also apply to dental partnerships and situations where a “mothership” corporation has been utilized. This can occur when there is common ownership between the Profession Corporation and the partnership/”mothership” corporation.
Under the proposed changes, the new rules deem the Professional Corporation and the partnership to be associated, therefore, they must share the $500,000 lower tax rate. Again, these structures should not be immediately discontinued as there may be some benefits, costs or other factors to reconsider.
Some business owners, including dentists, utilize a separate holding company to own the property or unit in which they operate their practice. In these situations, the net rental income will continue to benefit from the lower 15% tax rate provided both corporations have elected to be “associated”. Just like the scenarios above for hygiene corporations or partnerships, both companies would need to share the $500,000 lower tax rate. This can occur in situations where one spouse owns the Professional Corporation and the other spouse owns the holding company.
The process of obtaining a “Life Insurance Valuation” and subsequently transferring the policy into a corporation in exchange for withdrawing the higher value tax-free has been eliminated. For example, prior to the budget a $1 million life insurance policy with no cash value could be assessed by an actuary to have a fair market value of say $300,000. Once the policy ownership was transferred to the company, the shareholder could withdraw $300,000 cash or investments tax-free. As a result of the changes, the $300,000 tax-free amount will no longer be allowed for transactions done before or after the budget.
In the event a dental practice decides to sell assets i.e. “goodwill” instead of selling shares of their corporation, the immediate tax impact may be greater by as much as 12%. In other words, the new provisions will cause a portion of the proceeds to be taxable immediately whereas the same proceeds would only be taxable upon withdrawal from the company. Dentists who are contemplating their exit strategy would be well-advised to determine if a share sale is possible or consider a “crystallization” of goodwill.
The budget proposes to eliminate tax-deferred switches of shares of one mutual fund for shares of another mutual within a corporate class structure. This has traditionally been one of the “selling features” of these funds, especially for taxable investment accounts. (As an aside, TMFD Financial was never a fan of these corporate class structures, hence, our clients are unaffected by these changes.)
The new government does not intend to proceed with a measure introduced in the previous budget which would have allowed an exemption from capital gains tax for the donation of real estate or shares of a private company. The donation of publicly traded shares will continue to benefit from the capital gains exemption.
Accepting the rules of the new budget is like going on a date with a chaperone—you can still go out and have fun, but you can’t get wild and crazy.
We must acknowledge that tax rules in Canada are constantly changing, and it’s important to work with a team who is in touch with how the changes impact dentists. If you have questions about the budget and how the changes might impact you, please contact our TMFD Financial office at 1-844-311-8633 or email us at firstname.lastname@example.org.
Chris Molloy,B.A.Sc., CFP, is Senior VP, Advisory Services at TMFD Financial. Chris has over 20 years of experience at TMFD Financial as a Financial Advisor working in the Ontario area. Chris specializes in tax, estate and investment planning for the dental profession.
For a complimentary initial consultation with our team, we can be reached at email@example.com or by toll-free at 1-844-311-8633.