Professional Corporations (PC) for Physicians: Navigating the Latest CRA Rules on "Income Splitting"

For decades, incorporating a medical practice has been a cornerstone of tax planning for Canadian physicians. Professional Corporations (PCs) offer significant advantages, including tax deferral, access to the Small Business Deduction, and enhanced flexibility for retirement and estate planning. However, the landscape for PCs, particularly concerning "income splitting" with family members, has undergone significant changes with the introduction of the Tax on Split Income (TOSI) rules.

At SG Tax And Accounting Advisory, we specialize in guiding physicians through the complexities of corporate tax planning. We understand that staying compliant while maximizing your financial benefits is paramount. This article will delve into the advantages of professional corporations for physicians, explain the latest CRA rules on income splitting (TOSI), and provide strategies to navigate these regulations effectively.

The Enduring Benefits of a Professional Corporation for Physicians

Despite recent tax changes, incorporating your medical practice continues to offer substantial benefits:

1. 01Tax Deferral: By leaving after-tax profits within the corporation, you defer personal income tax until funds are withdrawn. This allows for greater capital accumulation and investment within the corporation.

1. 01Small Business Deduction (SBD): Your PC can qualify for the SBD, allowing the first \$500,000 of active business income to be taxed at a significantly lower corporate rate (e.g., around 12.2% in Ontario, compared to personal rates that can exceed 50%).

1. 01Income Sprinkling (with TOSI considerations): While restricted, opportunities for income sprinkling with genuinely contributing family members may still exist, subject to TOSI rules.

1. 01Estate Planning: PCs facilitate smoother intergenerational wealth transfer and estate planning, allowing for strategies like estate freezes.

1. 01Creditor Protection: Incorporation provides a layer of legal separation between your personal assets and the liabilities of your practice.

1. 01Investment Opportunities: Surplus corporate funds can be invested, growing on a tax-deferred basis within the corporation.

Understanding the Tax on Split Income (TOSI) Rules

Introduced in 2018, the Tax on Split Income (TOSI) rules were designed to prevent the "sprinkling" of income to family members who do not meaningfully contribute to the business, thereby taxing that income at the highest marginal personal tax rate. For physicians, this significantly impacted traditional income splitting strategies.

Who is Affected?

TOSI applies to "split income" received by an "individual" from a "related business." This typically includes dividends, interest, and capital gains received by family members (e.g., spouse, children) from a physician's PC.

The "Reasonableness Test" and Exclusions

To avoid TOSI, the income received by a family member must be considered "reasonable" in relation to their contribution to the business. The CRA provides several exclusions from TOSI, including:

• Excluded Business: If the individual is actively engaged in the business on a regular, continuous, and substantial basis (generally averaging 20 hours per week) in the year or any five prior years.

• Excluded Shares: For individuals aged 25 or older, if they own 10% or more of the votes and value of the corporation, and the corporation earns less than 90% of its income from providing services (like a medical practice), and is not a professional corporation.

• Age 65 Exclusion: Income received by an individual aged 65 or older from a related business, provided their spouse is also 65 or older and actively engaged in the business.

• Arm's Length Exclusion: Income received from a business where the individual deals at arm's length with the corporation.

For physicians, the "Excluded Business" exclusion is often the most relevant. This means if your spouse or adult children genuinely contribute to the medical practice (e.g., as a practice manager, receptionist, or bookkeeper) for at least 20 hours a week, their compensation may be considered reasonable and not subject to TOSI.

Navigating TOSI: Strategies for Physicians

While TOSI has curtailed aggressive income splitting, legitimate opportunities still exist for tax-efficient planning:

1. 01Reasonable Salary for Family Members: Pay a reasonable salary to family members who genuinely contribute to the practice. Ensure their duties, hours, and compensation are well-documented and justifiable to the CRA.

1. 01Spousal Loans: A spouse can lend money to the physician's PC, and the interest paid on this loan can be deductible to the corporation and taxable to the spouse. This can be an effective income splitting strategy if structured correctly.

1. 01Individual Pension Plans (IPPs): As discussed in "IPPs vs. RRSPs," an IPP can be established for the physician, allowing for significantly higher tax-deductible contributions than an RRSP, funded by the corporation.

1. 01Corporate-Owned Life Insurance: This remains a powerful tool for tax-deferred growth and tax-efficient wealth transfer, providing liquidity for estate taxes without triggering TOSI.

1. 01Estate Freezes: An estate freeze can still be implemented to cap the physician's capital gains and pass future growth to the next generation, often through a family trust. While dividends from the trust to adult children may be subject to TOSI, the capital gains exemption multiplication remains a significant benefit.

The Importance of Expert Advice

The rules surrounding professional corporations and income splitting are complex and constantly evolving. Misinterpreting or misapplying these rules can lead to significant tax penalties, interest, and reassessments from the CRA.

At SG Tax And Accounting Advisory, we work closely with physicians to:

• Review Your Corporate Structure: Ensure your PC is optimally structured for your current practice and future goals.

• Assess Income Splitting Strategies: Evaluate the reasonableness of compensation paid to family members and ensure compliance with TOSI rules.

• Develop Comprehensive Tax Plans: Integrate your PC with your personal financial planning, including retirement and estate strategies.

• Stay Updated: Keep you informed of the latest tax legislation and CRA interpretations that impact your medical practice.

By partnering with us, you can navigate the complexities of professional corporations with confidence, ensuring your practice remains tax-efficient and your wealth is protected for the long term.