Financial Benefits of Incorporation for Early Career Physicians: Shane’s Journey
Three years into his practice as a nephrologist, Shane’s accountant pointed out that most of his other physician clients were incorporated and he should do so as well. The explanation was a blur of figures and jargon which this brilliant kidney specialist was embarrassed to admit did not make much sense to him. He asked if we could review the proposal.
I am deeply interested in this topic as I spent five years in the early 90s persuading my radiology colleagues to dissolve our partnership and adopt a new strategy which would permit incorporation despite advice from some senior tax firms that this could not be done. The credit for this initiative belongs to an accountant who pointed out the flaws in that line of reasoning. We became the first radiologists in Canada to incorporate in the mid-nineties. Subsequently, our federal friends have removed many of the benefits of incorporation such as paying dividends to minor children; why they chose to pick on professionals simply trying to provide for their retirement (doctors like dentists and lawyers do not have pensions and must create their own) while others like teachers and civil servants enjoy fully indexed and often publicly-funded pension plans remains a mystery.
At the present time, there are still some benefits to incorporation and they are not difficult to understand. I believe the best analogy is to consider incorporation as a saving plan or enhanced RSP. This concept makes it clear that if you are spending all your income for items such as debt repayment, taxes, a mortgage, RSP and a TFSA, then incorporation is not for you which is true of almost every doctor who has been in practice for less than seven years. If you incorporate while still spending all your income, you are simply paying higher accounting and legal fees for zero benefit.
With a corporation, you may be eligible for a “small business deduction” which lowers your tax rate as long as the funds stay in your corporation and are invested. On the other hand, if the funds in your corporation are required to flow to you to pay the obligations noted above, taxes are applied as the funds leave your company and there is no benefit to having set up the corporation. Shane had done an excellent job paying off student loans, but in the meantime had purchased a house with a substantial mortgage. He was fully contributing to his RSP, but still had room to catch up on TFSA contributions. As a consequence, every dollar he earned was spent.
We made some projections and calculated that it would take Shane at least another five years to sufficiently reduce his mortgage, catch up on TFSA contribution room and stay fully invested in his RSPs, before he might have sufficient surplus funds to save in a corporation that would justify the legal and accounting costs to go through that process. He contacted his accountant and politely declined the advice to incorporate, but will review the matter in another five years or so.
KEY CONCEPTS:
Just because everyone else has adopted a plan does not make it a good idea.
As mentioned many times, there are no financial concepts that a knowledgeable person cannot clearly explain to an attentive ten-year-old so if you do not understand, someone is doing a poor job with their explanations.
Incorporation is best thought of as a second RSP useful for those not spending all available income which is rarely true for those in practice for less than seven years.
Canadian tax laws are among the most complex in the world, so any future decision about incorporation should take into account any new regulations which have not tended to be favourable for independent professionals.
Real-Life Insights for Retired Physicians
Shane's experience provides practical insights into financial planning strategies for retired physicians:
Benefits of Incorporation: Understand the tax advantages and financial implications of incorporating your practice.
Timing Considerations: Evaluate the optimal time to incorporate based on personal financial goals and commitments.
Financial Discipline: Maintain a balanced approach to managing personal and corporate finances to maximize savings and minimize tax liabilities.
Long-Term Investment Planning: Strategize for long-term financial security, considering retirement savings vehicles like RSPs, RIFs, and TFSAs.
Tax Efficiency Strategies: Plan withdrawals and income distributions to optimize tax efficiency and preserve wealth for retirement and legacy planning.
Adapting to Regulatory Changes: Stay informed about evolving tax laws and regulations that impact financial decisions for independent professionals.
Incorporating a medical practice can offer significant financial advantages for early career physicians like Shane, despite the complexities involved. By understanding the benefits such as tax savings and enhanced retirement planning, physicians can make informed decisions about incorporation. Shane's experience underscores the importance of balancing financial commitments, seeking clear financial advice, and timing the decision to incorporate wisely. Ultimately, strategic incorporation can serve as a powerful tool for long-term financial stability, efficient tax management, and legacy building, helping physicians secure their financial future and retirement.