If you’re a lawyer, accountant, healthcare provider, or any professional who has set up a corporation to provide services back to your firm, the budget has changed the rules on accessing the small business tax exemption. Pierre Letourneau, High Net Worth Planner at TD Wealth discusses how that could affect your tax strategies.
ORIGINALLY PUBLISHED MAY 2016
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If you're a lawyer, accountant, doctor or dentist, or any other professional who has set up a professional corporation to provide services back to your firm, listen up because the Budget has changed the rules.
And they could affect you.
Pierre Letourneau, high net worth planner at TD Weatlh-- he joins me to explain some of the changes.
Pierre, thanks for joining us.
Thanks for having me.
OK, let's start off with just the basics.
Who do these changes affect?
So these changes could affect professionals such as lawyers, accountants, doctors, or dentists that have structured or put structures in place that use professional corporations to gain access to the small business deduction.
And the small business deduction is a preferential tax rate that's available to Canadian private corporations on $500,000 of active business income.
OK so this is the key here.
They had a deduction of $500,000, which is important when you're running the business.
And this structure was set up so that-- these individuals had set up a structure that would allow them each to benefit from that.
Exactly, exactly.
What are the changes now?
So the changes are-- so these structures were put in place mostly law firms or accounting firms where the partners of the firm would set up a professional corporation that would provide services to the partnership.
And by having the corporation provide services instead of being a direct member of the partnership, then each corporation-- each partners-- would be able to gain access to the small business deduction.
And so the changes would make it so that all of these individuals, all of these partners would now have to share in the $500,000.
So for example, if we had a partnership with five partners, with these structures they were each able to get $500,000 of the small business deduction.
And now they would have to split it.
So it would be $100,000 each.
That's significant.
That's significant, yes.
So what would that mean in terms of someone-- if, at the end the day when they're paying tax, what kind of impact does that have on them having that pro-rated $100,000 versus that half a million before?
So it would vary from province to province depending on the tax rate.
So if we take Ontario as an example, the small business tax rate is 15%.
And the general corporate tax rate is 27.03%.
So we've got a difference of approximately 12%.
So if we're looking at a situation where the professional has lost the ability to use the full small business deduction, then that could be a difference in around or up to $60,000 of extra taxes that need to be paid.
And this is significant.
This is something that, of course, the government ran on and where it has said they were going to do.
But the legislation is not out yet, correct?
Yes.
So we have to wait and actually see the details of how it's actually going to manifest itself.
So, you know, I guess this is one benefit of the professional corporation.
But is there still benefits?
There still are other benefits, yes.
There are other tax benefits-- for example, income splitting.
So a professional corporation could allow a professional to split income with other family members like a spouse, a common-law partner, or adult children by paying dividends to these individuals.
So if they have a lower or don't have other sources of income, then the professional corporation could allow them to get some income.
And being taxed at a lower rate, this reduces the overall family tax burden.
Another example of a benefit is if the professional is looking to sell their business later on.
The professional corporation could allow them to gain access to the capital gains exemption, which would reduce the taxes on the sale of the business.
And, finally, another example of a benefit is creditor protection.
So the professional corporation could offer protection against creditors on personal assets because the professional corporation is a separate legal entity on its own.
So it provides some protection for the professional.
So the structure's still invaluable.
Just one of the benefits is just not going to be there anymore.
Exactly.
So bottom line, if someone was setting up this structure purely to get that small business deduction, they may not want to do that anymore.
Yes.
The structure might not make sense.
So it's probably important for that individual to speak with their tax advisor to see if the structure still makes sense for them.
And if the other benefits do apply, then it might be worthwhile to keep the structure.
But if not, there are additional costs to having a corporation.
So that corporation-- it might not be necessary to incur those additional costs.
Pierre, great to have you here.
Thanks so much.
Thank you.
Pierre Letourneau, he's a high worth planner at TD Wealth.
And a reminder, please talk to your advisor, lawyer, or accountant to figure out what works best for you.
And they could affect you.
Pierre Letourneau, high net worth planner at TD Weatlh-- he joins me to explain some of the changes.
Pierre, thanks for joining us.
Thanks for having me.
OK, let's start off with just the basics.
Who do these changes affect?
So these changes could affect professionals such as lawyers, accountants, doctors, or dentists that have structured or put structures in place that use professional corporations to gain access to the small business deduction.
And the small business deduction is a preferential tax rate that's available to Canadian private corporations on $500,000 of active business income.
OK so this is the key here.
They had a deduction of $500,000, which is important when you're running the business.
And this structure was set up so that-- these individuals had set up a structure that would allow them each to benefit from that.
Exactly, exactly.
What are the changes now?
So the changes are-- so these structures were put in place mostly law firms or accounting firms where the partners of the firm would set up a professional corporation that would provide services to the partnership.
And by having the corporation provide services instead of being a direct member of the partnership, then each corporation-- each partners-- would be able to gain access to the small business deduction.
And so the changes would make it so that all of these individuals, all of these partners would now have to share in the $500,000.
So for example, if we had a partnership with five partners, with these structures they were each able to get $500,000 of the small business deduction.
And now they would have to split it.
So it would be $100,000 each.
That's significant.
That's significant, yes.
So what would that mean in terms of someone-- if, at the end the day when they're paying tax, what kind of impact does that have on them having that pro-rated $100,000 versus that half a million before?
So it would vary from province to province depending on the tax rate.
So if we take Ontario as an example, the small business tax rate is 15%.
And the general corporate tax rate is 27.03%.
So we've got a difference of approximately 12%.
So if we're looking at a situation where the professional has lost the ability to use the full small business deduction, then that could be a difference in around or up to $60,000 of extra taxes that need to be paid.
And this is significant.
This is something that, of course, the government ran on and where it has said they were going to do.
But the legislation is not out yet, correct?
Yes.
So we have to wait and actually see the details of how it's actually going to manifest itself.
So, you know, I guess this is one benefit of the professional corporation.
But is there still benefits?
There still are other benefits, yes.
There are other tax benefits-- for example, income splitting.
So a professional corporation could allow a professional to split income with other family members like a spouse, a common-law partner, or adult children by paying dividends to these individuals.
So if they have a lower or don't have other sources of income, then the professional corporation could allow them to get some income.
And being taxed at a lower rate, this reduces the overall family tax burden.
Another example of a benefit is if the professional is looking to sell their business later on.
The professional corporation could allow them to gain access to the capital gains exemption, which would reduce the taxes on the sale of the business.
And, finally, another example of a benefit is creditor protection.
So the professional corporation could offer protection against creditors on personal assets because the professional corporation is a separate legal entity on its own.
So it provides some protection for the professional.
So the structure's still invaluable.
Just one of the benefits is just not going to be there anymore.
Exactly.
So bottom line, if someone was setting up this structure purely to get that small business deduction, they may not want to do that anymore.
Yes.
The structure might not make sense.
So it's probably important for that individual to speak with their tax advisor to see if the structure still makes sense for them.
And if the other benefits do apply, then it might be worthwhile to keep the structure.
But if not, there are additional costs to having a corporation.
So that corporation-- it might not be necessary to incur those additional costs.
Pierre, great to have you here.
Thanks so much.
Thank you.
Pierre Letourneau, he's a high worth planner at TD Wealth.
And a reminder, please talk to your advisor, lawyer, or accountant to figure out what works best for you.