Income vs. Dividends from Your Medical Corporation: Understanding the Financial Impact
VANESSA ASKS ABOUT INCOME VERSUS DIVIDENDS FROM HER CORPORATION
In practice for about ten years, Vanessa set up her corporation three years ago after her debts were under control and she was able to fully contribute to her RSP and TFSA accounts. Her accountant also stressed the importance of catching up on any unused contribution room in both of those funds before taking on the extra legal and accounting costs associated with incorporation. However, the financial concepts are still new to her and she is not certain that she understands the benefits of paying herself with income or dividends. She is also worried about the proposed new capital gains inclusion rate.
This is a frequent question and the answer depends on your objectives and needs. In the simplest of terms, an income from a corporation should be high enough to ensure you can make maximal RSP contributions and not any higher. Additional funds that you may require can then be paid from your corporation as lower taxed dividends based on your needs which likely vary from one year to the next. A scenario where all income earned by your corporation is paid out as a combination of income and dividends suggests poor planning as corporations are expressly designed for the owner to save funds in that entity as an “additional saving beyond RSP/TFSA”. Most professionals like doctors and lawyers and dentists treat their corporations as a second RSP since they are not usually eligible for the public sector sometimes indexed pensions enjoyed by teachers and politicians. Those latter individuals have relentlessly attacked corporations with the recent new capital gains inclusion rate applying to the first dollar of any corporation capital gain without the 250K exemption for personally held assets.
In Vanessa case, her partner had a much smaller RSP so an additional objective was to use her corporation to pay her partner an income they could justify to increase her partner’s RSP room as in ideal circumstances each partner should have nearly equal RSP funds. When the RSP funds are of similar size, the two can each draw similar amounts in retirement and therefore pay equivalent taxes on those withdrawals which is usually much more desirable than very different tax levels. Once the appropriate income levels are determined to ensure RSP contribution room, that number is usually fixed each year and the income taken as dividends from her corporation is variable depending on needs.
The proposed new 67% capital gains inclusion rate is bad news if adopted as it does apply to the first dollar of any corporate capital gain. The only way to avoid this punitive tax is to never sell your corporate assets that have capital gains or more realistically, hope that the current thoughtless politicians are voted out and their replacements drop the ill-advised plan.
Real-Life Insights for Early Career Physicians Understanding the nuances of income and dividends from a corporation is crucial for early career physicians:
Strategic Financial Planning: Optimize RRSP and TFSA contributions before expanding incorporation benefits.
Variable Dividend Strategy: Adjust dividend payouts based on financial needs while securing RSP room.
Tax Considerations: Stay informed about potential tax reforms impacting corporate assets to adapt financial strategies proactively.
Navigating income versus dividends from a corporation requires careful consideration of financial objectives and tax implications. Vanessa's journey underscores the importance of strategic planning in maximizing corporate benefits while adapting to regulatory changes. For Career-Start Claire and other early-career professionals, this insight offers a practical approach to financial management and long-term wealth accumulation.