Tax planning for dentists seems complicated, because it often is. There is no way around some of these complexities, and many dentists who try to take the “easy” approach end up discovering that it’s actually the hard way. However, we have developed what we call the “DENTIST” Approach to Tax Planning, because we think that breaking the important issues down into the following categories can be helpful. This article highlights what we have identified as the most important tax issues dentists face, and in subsequent articles we will look in greater detail at each one.
DeductionsExemption for the first $750,000 of lifetime capital gainsNon-arm’s length transactionsTiming of income and expensesIncome splittingSavings plansType of income
Deductions are amounts subtracted from your total billings in order to arrive at your taxable profit, or deducted from your personal income in order to arrive at your taxable income. Deductions are almost always better than “tax credits”, since every deduction you can claim means a tax savings calculated at the highest marginal tax rate you are paying. For example, if you are in the top 46.4 per cent bracket, every extra dollar of RRSP contribution you make saves you 46.4 cents of tax. For most professional corporations (PC), every extra dollar of business expense saves the PC 15.5 cents of tax, since a PC’s tax rates are generally lower than for a self-employed individual. Once your taxes are calculated, based on your personal taxable income after deductions, then the system allows you to claim certain “credits” against that tax, but usually the tax saved is only about 20 per cent of the credit, so if you claim the Children’s Arts Amount of $500 for example, your actual tax saved is about $100. Identifying deductions you can claim, for yourself or in your PC, is an important part of reducing your total tax bill. The goal is to maximize deductions. We will illustrate how to do this in subsequent articles.
Exemption for the first $750,000* of capital gains arising from the sale of qualifying small business shares (PC shares) is a major part of many dentists’ tax planning. Great care must be taken in order to ensure that the dentist’s PC qualifies for the exemption. If it does not, there are sometimes steps that can be taken to make it qualify. You can sometimes structure your business so that family members can also use their lifetime exemptions thereby multiplying the $750,000 Capital Gains Exemption (CGE). However, it generally takes a time span of several years for these plans to be successful, so forward planning is essential.
Non-arm’s length transactions such as salaries or dividends paid to family members, or investment assets transferred to family members, often look like easy ways to reduce the family’s tax bill, but there are many traps for the unwary when trying to move income or assets among family members. These traps known as “attribution rules” will be addressed in a subsequent article.
Timing of income and expenses can save a great deal of money over the years. Even if a revenue item must be taken into income, for example, if you can defer this for one year, you have delayed the tax on that income for a year, and thus have the tax amount available to invest for a year before you need to pay it to the Canada Revenue Agency (CRA). The same principle works for deductions. For example, if you buy equipment and put it into use, or incur a business expense in your PC such as the purchase of supplies at the end of one tax year rather than the beginning of the next, you get a tax saving earlier, and have saved that amount available to invest twelve months earlier than you would otherwise.
Income splitting The real tax bill for most people is not what you pay individually, but the total tax you pay as a household. If you can find permissible ways to transfer income from a high tax bracket dentist to a lower tax bracket spouse, child or parent, then the same total income will result in a lower total household tax bill. “Income Splitting” is intended to develop structures so that income can be transferred among family members in ways which are allowed by the CRA. Be careful to avoid tax traps arising from the attribution rules referred to in the ”Non-arm’s length transactions” section above.
Savings plans Many plans are available to help you defer taxes, income split, and fund your retirement. These plans include, but are not limited to: registered retirement savings plans, registered education savings plans, registered disability savings plans, individual pension plans, and retirement compensation arrangements. It is important to understand how each of these plans works to help you achieve your goals and to maximize the tax savings available.
Type of income is very important in determining your total tax bill, since some types of income such as dividends are often taxed at lower tax rates than other types, such as interest or salaries. Interest or salary payments by PCs also have very different tax results for your PC. Therefore, it is just as important to focus on the type of income you take, as it is to focus on how much income. There is an optimum mixture of dividends and salaries which minimizes taxes.
We will be preparing further articles which will deal with these topics separately, given how important careful tax planning is for all dentists. Tax planning may not be “easy”, but it will become more straight forward once you start to use the DENTIST Approach to Tax Planning. PA
*The 2013 Federal Budget proposes to raise the lifetime CGE to $800,000 (from $750,000) effective 2014, and thereafter the exemption will be indexed.