As an incorporated professional, your tax planning is a year-round process. Here are three tax strategies to help make your professional corporation tax-efficient:
Remove funds from your corporation in the most tax-efficient manner:
Since you are both an employee and a shareholder of your professional corporation, you can take funds as salary, dividends, or a combination of both, as discussed in our previous article “Withdrawing Funds from Your Professional Corporation” article.
When declaring a dividend to you, consider the following:
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- dividends paid from your professional corporation will typically be “non-eligible” dividends, on which you will pay personal tax at a higher rate than other types of dividends. This higher rate reflects the fact that non-eligible dividends are paid from corporate income that has already received the benefit of a reduced tax rate through your corporation. This would include the first $500,000 of net income eligible for the Small Business Deduction rate of 12.2 percent (combined federal/Ontario tax rate).
- review if there is a balance in your corporation’s “General-Rate Income Pool” which would allow it to pay eligible dividends to the extent of that balance. The General-Rate Income Poolbalance tracks taxable income that has not benefited from any special tax rate, such as net income greater than $500,000. It is important to ensure that your corporation does not pay an eligible dividend greater than its General-Rate Income Pool balance, otherwise it is subject to a penalty.
- there may be a balance in its Refundable Dividend Tax On Hand pools which would generate a refund of previously paid corporate tax when it declares a taxable dividend to you. It may be possible to declare dividends where the company receives a tax refund that more than offsets the personal tax on dividends.
- Your corporation may have a balance in its “Capital Dividend Account” which would allow it to pay a tax-free capital dividend to the extent of that balance. The Capital Dividend Account represents the total of tax-free amounts received by your corporation, such as the non-taxable portion of capital gains from the sale of corporate assets or investments, proceeds of a life insurance policy whose beneficiary is your corporation, and capital dividends received by your corporation from other private corporations.
Protect Your Small Business Deduction:
The small business deduction reduces the corporate tax rate on the first $500,000 of your active net income from 26.5 percent to 12.2 percent (combined federal/Ontario tax rate). However, if your professional corporation earns more than $50,000 of investment income, the $500,000 small business deduction is reduced by $5 for every $1 of investment income above this $50,000 threshold. Therefore, your Small Business Deduction is eliminated once your professional corporation earns $150,000 of investment income in a taxation year.
If your corporation has $1 million in investments earning a 5 percent return, it will reach the $50,000 threshold. If this level of investment income is limiting the amount of income taxed at the 12.2 percent tax rate, you could then consider strategies to limit additional investment income. These may include:
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- having your corporation insure you under a life insurance policy with a tax-exempt saving component (such as a universal life or whole life policy).
- deferring, until a future taxation year, the disposition of investments that would trigger additional taxable capital gains.
- establishing an Individual Pension Plan.
- accelerating withdrawal of investments by declaring dividends.
Beware of the Tax on Split Income (“TOSI”)
As a result of the Tax on Split Income (“TOSI”) rules, introduced in 2018, your professional corporation’s ability to pay dividends to members of your family in a tax effective manner has become extremely restricted.
The TOSI rules generally require family members (except spouses aged 65 and older), that are receiving dividend payments, to be actively engaged in your professional corporation; otherwise, the dividends may be taxed at the highest marginal personal tax rate.
However, the TOSI rules do not apply to salaries. Your corporation can deduct salaries paid to family members if they are “reasonable”. Salary is reasonable if sufficient services have been provided and the amount paid is similar to a comparable market rate. To support the salary, consider establishing an employment contract and retaining documentation, such as time logs, to support their work activities and the reasonableness of their salary.
Do you need help with your 2023 corporate tax planning? The experienced team of professionals at Ernst and Company CPA is available for personalized assistance. Please contact us today.
