As a professional, you encounter many wealth management issues on a regular basis. One such issue that is frequently overlooked, however, is tax planning. For most professionals, a strategic tax plan can translate into many opportunities to minimize taxes and maximize wealth.
Tax planning is a process. As with any process, there are steps to be taken. An effective tax planning strategy begins with a comprehensive overview of your financial circumstances and goals. Once implemented, it requires regular review to ensure it continues to meet those goals. Long-term advance planning is essential -- "parachute" planning is simply not good enough.
Your complete tax plan should meet five objectives:
1. Save Taxes Now
Maximizing deductions and paying of non-deductible expenses
Obviously, you don't want to pay any more tax than is absolutely necessary. It may be possible to restructure your loans to ensure that they are deductible for tax purposes. Some of your other expenditures may also be deductible from your taxable income, including health expenses, some automobile expenses and a portion of home office expenses. And while some other expenses incurred for business purposes may not be tax-deductible (e.g. life insurance premiums, 50% of meals), it may be much more economical to pay those expenses with corporate dollars rather than personal dollars.
The Benefits of Incorporating
If you have not yet incorporated, a Professional Corporation may prove to be very useful. Many professionals are turning to Professional Corporations as a means of tax deferral. As a corporation, you can take advantage of the small business deduction allowing net income below $400,000 that is earned and retained in your Professional Corporation to be taxed at approximately 19%* (21% in Quebec), rather than the potential 47%* (48% in Quebec) if earned outside a corporation. This deferral can amount to significant tax savings.
A Professional Corporation may also permit the integration of other useful strategies such as:
Individual Pension Plan (IPP)
An IPP is a pension plan that is designed to be a replacement for your RRSP. It may permit annual contributions by a Professional Corporation to the pension plan that are substantially in excess of normal RRSP limits. In turn, a larger pool of funds will be available on retirement.
Retirement Compensation Arrangement (RCA)
An RCA can reduce overall taxation by allowing your corporation to make tax-deductible contributions to a "retirement fund." A refundable 50% tax is paid. With proper planning, the tax that you will pay on the amounts eventually withdrawn will be less than what you would normally have paid.
Private Health Service Plan (PHSP)
A PHSP is an arrangement that will pay your and your family's medical expenses with deductible pre-tax dollars. A PHSP is meant to be in addition to your regular health insurance. All medical expenses paid by the PHSP will be deductible by your Professional Corporation with no income inclusion to you. As well, with a Professional Corporation, you don't need a third party payer and the associated fee of 10% to 20%.
Income Splitting
Although family members and family trusts may not hold shares in a lawyer's Professional Corporation in Ontario, it remains possible to develop an income splitting strategy through the use of loans to family members by the Professional Corporation. This objective can be accomplished through the use of management service entities and other creative techniques.
2. Ensure an Efficient Disposition or Utilization of Assets
It is important to ensure that any disposition, or sale, of your professional practice is done efficiently. It may be possible to dispose of your practice and take advantage of the $750,000** capital gains exemption. Generally, a Professional Corporation will meet the necessary requirements for this exemption, if care is taken to ensure they are met.
3. Provide a Useful Structure for a Surviving Spouse
On the death of a spouse, the surviving spouse's income will likely increase, which may cause substantial taxation at the top marginal rates and perhaps reduce one's Old Age Security. Testamentary trusts for the benefit of the surviving spouse and family may allow income to be taxed at lower rates.
4. Reduce Tax on the Death of the Last Spouse
There are many ways to minimize the tax payable on death for company shares and other capital property (i.e. cottage) that have increased in value. This may reduce significantly the ultimate tax liability on these assets for your children or grandchildren.
5. Provide an Efficient Structure for the Ultimate Heirs
The tax situation of your ultimate heirs must be considered. Testamentary trusts may be appropriate to permit the income resulting from an inheritance that has been received as a result of your death to be taxed in an efficient manner. This could result in potential savings of $10,000 per year, per trust. Furthermore, in situations where one of your heirs is or becomes dependent by reason of physical or mental impairment, special issues must be addressed to ensure that government benefits are not compromised, and other tax advantages are obtained. Finally, consider any future inheritance you expect to receive from your parents or other family members. It may be possible to structure their wills to provide for one or more testamentary trusts, creating an efficient structure to benefit you and your family on an ongoing basis.
Professionals face many unique tax planning issues. The discussion above is just a starting point for a complete strategy. That strategy may include the use of a Professional Corporation. A Collins Barrow advisor can help you understand these issues and implement the strategies that are right for you.
Guy Desmarais is a Partner in Collins Barrow’s Sudbury-Nipissing Member Firm. He can be reached at gudesmarais@collinsbarrow.com or (705) 560-2056.
* Tax rates cited are applicable to Ontario
** Although it is not yet law, the $500,000 capital gains exemption is slated to go up $750,000.