Should you incorporate?

Like many other topics, incorporation is one of those perennial subjects of importance for advisors and their clients.

And here’s why: If professional clients have reached a point in their career where they have excess cash flow, it’s a nice reward (and a great message to deliver) that if they’re able to incorporate—and it makes sense—they can significantly reduce their taxes (upwards of 30%) on up to $500,000 of income. The benefits

This “congratulations, you’ve made it” moment also carries with it a lot of interesting benefits: Expenses like life insurance can be paid with preferential corporate after-tax dollars as opposed to more costly personal after-tax dollars. Corporate tax rates are now as low as 11% in certain provinces, whereas individual tax rates can be in excess of 46%.

Different share classes may allow professional clients to split income with family members or aid in estate planning where the profession allows.

While kiddie taxes prevent clients from paying dividends to their underage children, some shares owned by children (or a family trust) can be used to fund post-secondary education and other lifestyle expenses of adult children, at a time when they have little or no taxable income.

In some professions, a corporation can give the professional, and possibly his or her family members, access to the $750,000 capital-gains exemption when the time comes to sell the business. This can mean over $100,000 in tax savings per shareholder.

Excluding family members as shareholders can sometimes be a big mistake, as it signifies a missed opportunity to help split income and spread out tax liabilities.

Clients often don’t want family members as shareholders because they fear the impact a family breakdown might have on the business. But without shareholder or prenuptial agreements, and often even with these documents, an estranged spouse, for example, likely has access to and claim on the business assets anyway.

Incorporation’s not for everyone

Of course, even without these concerns, the incorporation route is not for everyone. Professions are often governed by different rules, depending on the province the professional works in. And if a client spends every dollar earned, there’s a much smaller benefit to professional incorporation.

Sometimes, clients pay higher tax rates on things like investment income earned inside their professional corporation than if they’d earned it personally, especially if their professionals — lawyers, accountants, investment advisors — aren’t working together.

In estate planning, too, a client’s estate can end up owing more taxes than necessary if the executor doesn’t deal with the professional corporation in a timely way. There should be a flag and instructions to this effect in the client’s will. Shareholders’ agreements should also address the situation and be consistent with the client’s will.

Clients who are usually good candidates for incorporation are typically in their 40s and 50s. Before that, even if they’re earning good money, they tend to be at the stage where they’re spending most of it or paying down debt. Many are starting families, which eat up a lot of disposable income, and are buying houses and vehicles.

But once clients reach their 40s and 50s, spending often begins to taper off, debts have been paid and they actually begin to build up reserves with excess cash flow each year. This is usually when they start looking seriously at investment and tax-saving opportunities.

Newer lawyers, accountants, doctors and other professionals might also think about incorporation once they’ve been admitted to a professional practice as a partner, particularly if other professionals in the practice are already incorporated. A team effort

Many incorporated clients ask if they should draw a salary, repay shareholder loans or take income as dividends. This is where external advisors need to work together for the client’s best interests, taking into account income splitting, RRSP and CPP contributions, and reduction of family taxes.

At this point, it’s worth examining if a client’s profession allows incorporation, and if family members can participate as shareholders. Advisors should always research the profession and province before suggesting incorporation.

It’s also a good idea to work with the client’s tax advisors to research the latest CRA administrative policies and court decisions when providing complex wealth- and estate-planning strategies.