The federal government has confirmed changes to tax rules that will restrict income splitting using private corporations. The changes, effective January 1, 2018, would expand the TOSI rules. The TOSI rules will generally apply to income from private business arrangements, such as dividends or interest paid from a professional Corporation.
Where the TOSI applies, the income is subject to the top marginal tax rate in the hands of the individual, and personal tax credits (with the exception of the dividend tax credit and foreign tax credit) are denied with respect to the amounts.
The TOSI measures include clear “bright-line” tests or safe harbours to automatically exclude individual family members. The exclusions are as follows:
- The individual is over the age of 65.
- The individual is over the age of 18, and he or she worked for the business for an average of 20 hours per week, in the present year, or in 5 non-cumulative preceding years.
- The individual is over the age of 25 and owns more than 10% of the votes and value of the shares of corporation directly (not through a trust) and the business is not in the provision of services, and the corporation is not a professional corporation.
- Individuals who receive capital gains from qualified small business corporation shares if they would not be subject to the highest marginal tax rate on the gains under existing rules.
Individuals aged 25 or over who do not meet any of the exclusions described above would be subject to a reasonableness test to determine how much income, if any, would be subject to the highest marginal tax rate.
As a practicing Dentist, Family Doctor and Lawyer, it may come as a surprise that the Canada Revenue Agency will be taking close to half of your hard earned money. Did you know the marginal tax rate for income over $150,000 is about 47.97% and increases to 53.53% for income over $220,000?
Here are guidance and tax saving strategies for Dentists, Family Doctors and Lawyers:
First, set up a professional corporation.
There are three potential significant tax benefits of incorporating a professional corporation for a Dentist, Family Doctor and Lawyer:
- Issuing salary or dividends to family members in lower tax brackets;
- A tax deferral is possible by retaining earnings in the professional corporation;
- The $800,000 capital gains exemption available for sale of a small business can only be claimed on the sale of shares of a qualifying corporation and not for the sale of a sole proprietorship or a partnership.
In Ontario, the combined federal + Ontario tax rate on the first $500,000 of active business income earned by a professional corporation is only 13.5% for 2018 and 12.5% for 2019. The average tax rate to earn the same amount of income personally is about 45%. The professional corporation provides a 30% deferral of tax leaving you with more cash to reinvest in your practice. Personal tax will be payable when funds are extracted from the professional corporation.
Secondly, pay reasonable salaries to family members in a lower tax bracket
If a family member performs administrative duties for the practice, you can pay him or her a salary as long as it is reasonable (i.e. comparable to what you would pay anyone else to perform the same duties). If your family member is in a lower tax bracket, this would result in an overall tax savings.
If you would like to take advantage of these tax planning opportunities for your practice, contact us today.