Tax Strategies for Professionals
December 1, 2012
By By Kelly Kolke, CA Grant Thornton LLP
Let’s face it. Canadian professionals pay a lot of tax, which is why individuals and members of partnerships of all sizes are always looking for ways to reduce their annual tax burden. Below are a few tax strategies that engineers can use...
Let’s face it. Canadian professionals pay a lot of tax, which is why individuals and members of partnerships of all sizes are always looking for ways to reduce their annual tax burden. Below are a few tax strategies that engineers can use to keep more of what they’ve earned.
• Defer income taxes through a professional corporation. The first tax planning objective is to reduce or defer current income taxes on professional income. In many cases, the most effective approach is to create a professional corporation where assets of the practice are transferred to the corporation, and you essentially become a shareholder and employee of your own company. Incorporation lets you take advantage of the Small Business Deduction, which allows for a reduced tax rate on professional income earned by the corporation (and not withdrawn as salary) up to a specific yearly limit. In turn, the professional corporation (or holding company) can invest the cash retained from the tax deferral back into the practice or in other investments rather than hand it over to the Canada Revenue Agency.
Professional incorporation is a great option for individual professionals who don’t need most of the money generated by their practice to fund their current lifestyle, or for professionals who have the ability to split income with other family members who are taxed at lower personal income tax rates. However, if the amount of income retained in the corporation is too low, or if there are no income splitting opportunities, the tax savings may not justify the extra work.
• Partnerships and income splitting. What about engineers working in a partnership? Traditional tax structures aren’t very efficient, and partners often can’t access the same tax benefits available to individuals who incorporate because all partners in the firm must split the Small Business Deduction annual limit. But the fact is, the tax planning benefits of professional incorporation are also generally available to partners of both large and small partnerships through the introduction of a multiple professional corporation structure in a partnership. This arrangement can also have other benefits, like making it easier to attract high-performing professionals. It can also offer increased flexibility for retirement and increased liability protection.
But you not only want to defer tax — you also will want to look at ways to actually save tax, such as by income splitting with adult family members who have lower marginal tax rates. Most professionals in Canada are allowed to have family members as shareholders of a professional corporation, either directly or indirectly (through a family trust), which facilitates income splitting with family members in the form of dividends. Individual practitioners and partners in professional firms who have set up a professional corporation are generally able to take advantage of this option.
• Management Services Limited Partnerships. If you are already in an existing partnership, you can also take advantage of income splitting through the creation of something called a Management Services Limited Partnership (MSLP) which provides administrative and support services to the partnership. Family members of partners — such as spouses or family trusts — can invest as limited partners and earn income at lower tax rates.
Although any existing partnership could benefit from the implementation of an MSLP structure, it is best suited to larger professional partnerships where the transferable administrative and support services can generate enough income for splitting with family members and justifies the costs of establishing and maintaining this structure.
The introduction of a family trust in either a professional corporation or an MSLP structure can also be an excellent way to achieve income splitting with adult family members who have a lower marginal income tax rate. The family trust holds shares in the professional corporation or partnership units of the MSLP and the family members are beneficiaries of the trust. The use of a family trust provides the flexibility to allocate income to beneficiaries on a discretionary basis to maximize income splitting opportunities each year.
Each professional, of course, needs to fully understand the risks and benefits of any new tax scenario in relation to their individual needs and goals. Firms who make their shareholders or partners aware of the range of wealth retention strategies available will have an advantage in retaining good people. And you might be able to hit the links earlier than you’d planned!cce
Kelly Kolke is a Chartered Accountant and partner with Grant Thornton LLP in Nova Scotia. E-mail Kelly.email@example.com