As I have discussed in previous articles of The Professional Advisory, the laws permit specific family members of a dentist to be non-voting shareholders of his or her dentistry professional corporation (PC). A “family member” means a dentist’s spouse, child or parent. Having such family members as non-voting shareholders of the PC can result in substantial tax savings for the family unit.
There are many potential benefits to having your PC own your dental practice, with your specified family members (non-dentists) as non-voting shareholders of your PC. Benefits include the low corporate income tax rate, the ability to sprinkle dividends among family members and the capital gains exemption on the sale of PC shares. If structured and planned properly, family members might be able to use the capital gains exemption when they sell their PC shares. However, to ensure non-dentist family members can enjoy all such benefits, it is critical to plan well in advance as such plans may require two or more years to implement properly.
Keep in mind that a PC’s business is restricted to the practice of dentistry and activities related to or ancillary to the practice of dentistry. Surplus funds can be withdrawn from the PC by dividends paid to the dentist shareholder or non-dentist family member shareholders. Or such funds can remain in the PC and invested by the PC.
Creating the proper share structure for your PC with non-voting shares is a critical step and your tax and legal advisors will assist you in that process. Consider in particular whether the PC non-voting shares to be issued to your family members participate in the annual profits only (Dividend Only Shares) and/or in the PC’s growth and residual value (Equity Shares).
Dividend Only Shares typically have the right to a variable dividend in an amount determined in each year by you, the dentist, in your sole discretion. For maximum flexibility each family member should have a different class of shares. That way in each year you can declare different dividend amounts on each class, depending on the needs of each family member shareholder. For example, your parent may need assistance with living expenses, while your spouse needs nothing at all that year.
Dividend Only Shares typically are redeemable by the PC at any time, meaning the PC can repurchase and cancel the shares. The shareholder’s consent is typically not required for such redemption of shares.
Minor children (under age 18) cannot own shares in their own name. Shares for your minor child must be issued to a trustee on the child’s behalf. Current tax laws discourage paying dividends to shares held in trust for minor children. Typically no dividends are paid on the minor child’s shares. When the child reaches 18, the shares are transferred directly into the child’s name.
A shareholders agreement (Agreement) is essential if family members receive (i) Equity Shares or (ii) Dividend Only Shares that are not redeemable by the PC. A shareholders agreement is a private contract between the shareholders. Your dental practice is your livelihood. It is critical that you, the dentist, and not your family members, have absolute control of your PC at all times.
At some point in your career you will likely sell your practice by asset sale or a sale of all the PC shares. The dentist must be assured that all the PC shares or assets will be sold, whether or not the other shareholders (your family members) wish to sell or agree on the sale price or sale structure. The Agreement should provide that the dentist has the right to ‘drag along’ the other shareholders on the sale of the practice.
Consider other events such as death of a family member or divorce or separation from your spouse. The Agreement should specify what happens to the family member’s shares. For example, the shares might be redeemed by the PC or purchased by the dentist. The Agreement should deal with how those shares are going to be valued and the terms of payment.
The dentist must remain in control of the PC regardless of changing circumstances. A properly drafted Agreement will ensure this. The ideal time to complete the Agreement is at the beginning of the process when the non-voting shares are being issued to family members.
The rules permitting family members to own shares of your PC present significant tax planning opportunities and potentially substantial tax savings for you and your family. However, the laws are complex. Proceed carefully and with the benefit of professional advisors who are very familiar with such structures and who regularly advise dentists on such matters. PA
David Rosenthal is a senior lawyer with Spiegel Rosenthal Professional Corporation whose practice is devoted to corporate, commercial and business law, with special emphasis on advising dentists. He can be reached at (416) 865-0736 or e-mail to firstname.lastname@example.org.