Salary or Dividends for an Incorporated Physician
Dr. Patel, 52, is an Ontario physician incorporated as a professional corporation. The corporation has $800,000 in retained earnings invested in a balanced portfolio and no debt. Patel's personal marginal tax rate is 53.53%; the Ontario small business corporate rate is 12.2%. Patel needs $200,000 for a home renovation and wants to know whether to take salary, eligible dividends, or a combination. Patel's spouse, Nina, has no role in the medical practice and earns $45,000 as a librarian. Their two children are 19 and 22 and in university. The corporation owns a $150,000 unrealized capital gain on shares of a public company and has $300,000 of available RRSP contribution room. Patel has no individual pension plan. The corporation's year-end is December 31. Patel also wants to begin funding a retirement plan inside the corporation and asks whether an IPP is better than an RRSP.
1. Compare salary and eligible dividends for Patel's $200,000 renovation need, including integration and TOSI.
Read the worked answer
Salary. The corporation deducts the salary, so it avoids corporate tax on that amount. Patel includes it in income at graduated rates, with the top marginal rate applying to the upper portion. Salary creates RRSP contribution room and CPP contributions, but it also triggers payroll costs and withholding. Because Patel has $300,000 of RRSP room, salary has value beyond the current-year tax cost.
Eligible dividend. The corporation pays tax first, then pays a dividend from after-tax funds. The dividend is grossed up by 38% and Patel claims the dividend tax credit. At high income, integration is designed to produce a similar after-tax result to salary, but it is imperfect. Dividends do not create RRSP room and may trigger the alternative minimum tax in some years.
TOSI. Dividends paid to Nina or the children would likely be split income taxed at the top rate because Nina does not work in the practice and the children are not engaged in the business. Patel's own dividends are not caught by TOSI. Paying Nina a salary would require genuine services and a reasonable amount; otherwise the deduction is vulnerable.
Practical answer: Use a mix. Take enough salary to use RRSP room and cover personal cash needs, and take eligible dividends for the balance. Do not pay dividends to Nina or the children without a TOSI analysis. Model the exact after-tax cost because the answer depends on the corporation's tax pool and Patel's other income.
2. Evaluate whether an IPP or RRSP is the better retirement vehicle for the corporation's surplus cash.
Read the worked answer
An individual pension plan (IPP) is a defined-benefit registered pension plan for the business owner. Contributions are deductible to the corporation and are generally larger than RRSP limits for an owner with high earnings and long service. Assets are creditor-protected and locked in until retirement. However, an IPP requires actuarial administration, has higher fees, is less flexible, and may require funding past service. It also cannot be used as freely as an RRSP for pre-retirement withdrawals.
An RRSP is more flexible, but contributions require earned income or a spousal contribution, and Patel already has $300,000 of room. If the corporation retains $800,000 of surplus cash, an IPP can accelerate tax-deferred retirement savings inside the corporation. A reasonable approach is to establish an IPP for the ongoing retirement funding and use RRSP room to diversify and preserve flexibility. The decision should be modeled with an actuary because IPP contribution limits depend on age, earnings history, and past service.
3. What tax issues arise from the $150,000 unrealized gain on public company shares if sold to fund the renovation?
Read the worked answer
If the corporation sells the public company shares, 50% of the gain is included in income, so $75,000 is taxable. The corporation pays tax at the investment-income rate, and the after-tax proceeds can then be paid to Patel as a taxable dividend. The lifetime capital gains exemption is not available because the shares are not qualified small business corporation shares. The corporation should consider whether it has capital losses to offset the gain, whether the sale can be staged over two taxation years, and whether the renovation can be funded from cash flow or a corporate loan instead. Do not let the tax tail wag the investment dog: if the shares are no longer suitable, diversification may still be appropriate, but the after-tax cost should be quantified before selling.