Many business owners decide to incorporate, as they grow, to take advantage of the numerous benefits of incorporation. What fewer business owners are aware of is that if members of certain professions decide to incorporate in order to render their professional services, they are often required to do so as professional corporations.
These professional corporations differ in a few major ways from regular provincially incorporated corporations, which are discussed below. Some eligible professions would include accountants, architects, dentists, doctors, engineers, lawyers, pharmacists, social workers, and veterinarians.
What is the difference between a professional corporation and a non-professional corporation?
Professional corporations differ from non-professional corporations in a number of ways.
One key distinction is that professionals of professional corporations are often subject to legislation that governs their specific profession. For example, social workers in Ontario are regulated by the Social Work and Social Service Work Act, and veterinarians by the Veterinarians Act. This effectively means that in addition to being governed by the Business Corporations Act, a professional corporation is also subject to the laws of these profession governing acts.
A second distinction is in the classifications of shareholders either type of corporation can have. For instance, a business owner of a non-professional corporation can elect anyone as a shareholder. On the other hand, for many professional corporations, only licensed individuals of the same regulated profession may be shareholders. There are, however, some professions that will allow immediate family members to hold shares in the professional corporation subject to certain conditions. To illustrate, doctors in Ontario can issue shares to immediate family members, provided that these shares are designated as non-voting shares.
Another notable difference has to do with liability. Shareholders in a non-professional corporation are only at risk of losing what they invested in the company, meaning that, except for a few exceptions, their personal assets are protected. Part VII of Ontario’s Business Corporations Act (the “Act”) Section 92 (1) states:
“The shareholders of a corporation are not, as shareholders, liable for any act, default, obligation or liability of the corporation except under subsections 34(5), 108(5) and 130(5) and section 243.”
As for professional corporations, however, the same cannot be said. For instance, if a doctor providing services through a professional corporation were to be sued for malpractice, the doctor may be personally held liable. Section 3.4(1) in the Act states this clearly:
“Subsection 92(1) shall not be construed as limiting the professional liability of a shareholder of a professional corporation under an Act governing the profession for acts of the shareholder or acts of employees or agents of the corporation.”
What are the benefits then of starting a professional corporation?
Despite not offering the same limit on liability as a non-professional corporation, professional corporations still carry numerous advantages. Below is a list of some of the benefits:
- Income Splitting
- Reduced Tax Rates
- Special Funds
- Improved Record Keeping
Income splitting is the act of transferring income between immediate family members. The purpose is to bring down the overall tax burden that the family member making the highest income would otherwise have to face. Furthermore, in bringing income levels down to a lower tax bracket, a family may be able to take advantage of a host of deductions and credits. This is not available for all professional corporations.
Income splitting through a corporation can prove to be very beneficial over the long term. Here, we will provide a simple example that focuses solely on regulated professionals.
Imagine Dr. Anderson, a physician, made $200,000 though her professional corporation. She can then decide the salary she would like to be issued from the professional corporation. In addition, since her profession allows it, she can distribute dividends to her husband, who holds non-voting shares in the professional corporation (and who, for this scenario, had a tough year as a writer and did not generate an adequate income).
The $200,000 in earnings that Dr. Anderson made through her incorporated practice are being taxed at the corporate rate, which is below 20%. Without her corporation, the $200,000 would be taxed at the personal rate, which hovers around 50%.
Third, the dividends issued to her husband are taxed at the lower “capital gains” rate, and not at the level of “personal income tax.” In other words, through professional corporations, families can all help each other out through the strategic distribution of income. This is why the government considers this maneuver as a form of income splitting.
Reduced Tax Rate
On the first $500,000 of business income, professional corporations in Ontario have the advantage of being taxed at the reduced corporate rate of 19.5%. This is known as the “small business deduction.” As already stated above, corporate tax rates are significantly lower, and thus, preferable to personal tax rates.
Deducting the expense of a bonus is another advantage that professional corporations have. Bonuses can be deducted by a professional corporation, so long as the bonus was paid out within the fiscal year.
On top of making deductions from bonuses, a professional that operates a corporation can also deduct the costs of attending over two business conventions annually. The only requirement is that the conventions are related to his or her actual practice. Compare this to non-professional corporations, which are limited to making cost deductions on only two business conventions.
Professional corporations come with the added benefit of giving regulated professionals the chance to set up special funds and financial plans for themselves and their workers. For instance, a professional corporation can own its own group and life insurance policies. This would give the owner of the professional corporation the ability to pay premiums out of pre-tax income (which, in turn, lowers the corporation’s overall taxable income).
Professional corporations also give professionals in their later stages in life the opportunity to set up individual pension plans similar to the specialized ones that public service workers have. Such a pension plan could provide more tax deferred savings than under a Registered Retirement Savings Plan (i.e. RRSP). This is because the individual pension plans of incorporated professionals have higher contribution limits than regular RRSPs, allowing for a greater accumulation of retirement savings. Also, not only can the employer of the professional corporation deduct contributions, but the pension benefits are also protected from creditors.
Improved Record Keeping
A professional corporation requires a separate bank account, a special letterhead, unique business cards, corporate financial statements, and annual tax return filings, to name a few. And while these requirements may seem rather onerous, the fact is that professional corporations encourage better bookkeeping overall, as they make it much more difficult to mix up personal financial records with those of business.
These are but a few of the benefits to be gained from managing and controlling your own professional corporation. To be sure, there are limitations, and for some, disadvantages to running a professional corporation. These points will be discussed in a future post.
For further information regarding professional corporations contact Erudite Law LLP at firstname.lastname@example.org or 905-471-6161.
— B. Brillantes, Student Intern at Erudite Law LLP