WHEN TO INCORPORATE
MD PRACTICE | RUNNING A PRACTICE SERIES
LAST UPDATED: May 20, 2021
LAST UPDATED: May 20, 2021
You need to know two things to determine if and when you should incorporate:
If your personal expenses are high and you are left with minimal to no leftover cash after taxes, there is no benefit to incorporation. The corporation is a vehicle for investment, but if you have no cash to invest, the benefits of the corporation are minimized.
Also, when you finish residency, most individuals will be left with a certain degree of debt. This debt can only be paid off with after-tax income. If you have a high debt load, you may wish to delay incorporation and pay down this debt. If you are more comfortable paying down the debt slower, you can instead incorporate and invest the remaining funds.
- Your income after personal expenses
- Your tolerance to hold onto debt
If your personal expenses are high and you are left with minimal to no leftover cash after taxes, there is no benefit to incorporation. The corporation is a vehicle for investment, but if you have no cash to invest, the benefits of the corporation are minimized.
Also, when you finish residency, most individuals will be left with a certain degree of debt. This debt can only be paid off with after-tax income. If you have a high debt load, you may wish to delay incorporation and pay down this debt. If you are more comfortable paying down the debt slower, you can instead incorporate and invest the remaining funds.
FEDERAL AND PROVINCIAL TAX RATES IN CANADA
If you are a sole proprietor and do not incorporate, your gross income is taxed at the individual rate.
In 2021, the Canadian federal tax rates are:
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In 2021, the Canadian provincial tax rates are (Ontario as an example):
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Your taxable income is your gross income minus any business expenses you write off and RRSP contributions.
SMALL BUSINESS DEDUCTION LIMIT
If you incorporate, you are taxed at corporate tax rates. However, there are two different corporate tax rates you need to be aware of: the usual corporate tax rate and the small business deduction (SBD) tax rate.
As a medical corporation, you are eligible for the SBD rate. This means that the first $500,000 earned in your corporation (amount varies by province) will be taxed at the SBD rate, and any further incremental income is taxed at the usual rate. In 2021, the corporate tax rates are (Ontario as an example):
The SBD tax rate applies on the first $500,000 of earned income, but this amount begins to decrease when
The business limit of $500,000 is reduced to zero and eliminated when taxable capital reaches $15 million dollars or aggregate investment income reaches $150,000.
As a medical corporation, you are eligible for the SBD rate. This means that the first $500,000 earned in your corporation (amount varies by province) will be taxed at the SBD rate, and any further incremental income is taxed at the usual rate. In 2021, the corporate tax rates are (Ontario as an example):
- SBD Rate: Federal 9% and Provincial 3.2% (12.2%) on the first $500,000, plus
- Usual Rate: Federal 15% and Provincial 11.5% (total 26.5%) on the amount over $500,000
The SBD tax rate applies on the first $500,000 of earned income, but this amount begins to decrease when
- Taxable capital >$10 million dollars, or
- Aggregate investment income >$50,000
The business limit of $500,000 is reduced to zero and eliminated when taxable capital reaches $15 million dollars or aggregate investment income reaches $150,000.
Equation = $500,000 x 0.225% x (taxable capital - $10 million) / 11,250
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Equation = 5 x (aggregate investment income - $50,000)
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AN EXAMPLE
Let's assume your gross income is $400,000 for the tax year and you write off $120,000 (30%) in business expenses. Then, your taxable income is $280,000. We'll keep things simple and ignore items such as RRSP contributions and capital gains.
Federal:
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Provincial (Ontario):
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Sole Proprietor: Grand total is $100,583 for an effective tax rate of 35.9%
Corporation: Grand total is $34,160 at a tax rate of 12.2%
To determine how much you have remaining left to invest after you remove taxes and personal expenses (let's make our annual personal expenses $150,000):
Corporation: Grand total is $34,160 at a tax rate of 12.2%
To determine how much you have remaining left to invest after you remove taxes and personal expenses (let's make our annual personal expenses $150,000):
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Sole Proprietor |
Corporation |
Corporate Income |
N/A |
$280,000 |
Less Salary (Becomes Personal Income) |
N/A |
- $225,000 |
Corporate Taxable Income |
N/A |
$55,000 |
Less Corporate Tax (12.2%) |
N/A |
$48,290 |
Personal Income |
$280,000 |
$225,000 |
Less Personal Tax. (35.9% vs 33.4%) |
$179,480 |
$150,000 |
Less Personal Expense ($150,000) |
$29,480 |
$0 |
If you use a sole proprietor model, you will be left with $29,480 at the end of the year. If you use a corporate model, you will be left with $48,290.
WHAT IT TAKES TO INCORPORATE
You will need a lawyer and the running cost is approximately $5,000 per year
WHY WOULD YOU INCORPORATE?
Incorporation allows you to protect your new earnings from taxes. You can then decide what to do with this money. Options include:
- Pay yourself your salary
- Invest in the stock market and grow your investment
- Keep as an emergency fund that you can loan back to yourself