In 2001, many provincial governments changed their incorporation laws to include professionals. Since then, lawyers have been eligible to incorporate their legal practices in Ontario.
There are advantages and disadvantages to incorporating a practice — these must be weighted against each other to determine if incorporation is a beneficial option. This article presents the primary advantages and disadvantages of incorporating your practice.
If you are thinking of incorporation, you will want to first discuss your specific situation with a tax accountant before making a final decision.
1. Deferral of income tax: Under tax legislation, a corporation is a legal entity and separate taxpayer. Because corporate taxes are — depending on your province of residence — approximately 30 per cent lower than personal income tax rates, retaining money inside of a corporation as corporate surplus can be an advantageous way to defer income taxes and build wealth. A corporate surplus is referred to as tax-deferred funds because at some point they have to be withdrawn from the corporation and will be taxed at personal income tax rates. However, the long-term, tax-deferral, compounding effect can be powerful.
2. Individual pension plans: An individual pension plan is a registered defined-benefit pension plan funded by corporate assets with the goal of providing income post-career. In a lawyer’s mid-40s, IPP contribution rates are higher than registered retirement savings plan (RRSP) contribution rates, and carry the benefit of allowing additional one-time contributions to an incorporated lawyer’s retirement plan. In addition, IPPs are creditor proof.
3. Health and welfare plans: A health and welfare plan — also commonly referred to as a health and welfare trust — is a corporate arrangement through which an employer can provide employees reimbursements for medical and/or dental expenses. The coverage includes the incorporated lawyer and speaks to medical expenses that are not commonly covered by provincial or group insurance plans. As this is a tax-free benefit, a HWP has the effect of making medical and dental expenses tax deductible; contributions are a tax deduction for the corporation.
1. Increased costs and administration: Professional corporations are required to complete their own tax return, thus resulting in additional accounting fees. Setting up an IPP will incur initial and ongoing actuarial expenses. Make sure you understand and discuss all fees with your advisers before proceeding.
2. Reduced small business deduction: If you practise in a partnership structure, you may have to share the small business deduction benefits among the partners. This could significantly reduce the tax benefits of incorporating. Redrafting partnership agreements can be expensive and divisive within a partnership.
3. Inability to income split with family members: While other professionals like doctors and dentists may pay immediate family members dividends from their corporation, lawyers may not. It is stipulated that the beneficiary family members of a lawyer must be lawyers themselves to receive dividends paid from the legal corporation. This is a significant disadvantage to the owner of an incorporated legal firm, as paying dividends to family members results in an immediate pure tax saving, rather than just a deferral.
If incorporation is right for you, it could potentially save you a significant amount of income tax. If it is not, then it could end up costing you thousands of dollars every year. Please obtain advice from your tax accountant before incorporating your legal practice.
Alan Acton is a financial adviser in Ottawa and can be reached at email@example.com. The opinions expressed are those of Alan Acton and not necessarily those of Raymond James Ltd. Statistics, data, and other information are from sources believed to be reliable but their accuracy cannot be guaranteed. This document has been prepared to assist individuals with financial concepts and is for informational purposes only.