Navigating the intricate world of financial planning can be a challenge for dentists. This article provides a brief overview of the financial structures that dentists can leverage to protect their assets, reduce tax liabilities, and efficiently transfer wealth to future generations.
Dentistry Professional Corporation (DPC)
Establishing a DPC entails transitioning from an individual to a corporation/company. You, the dentist, continue providing dental services but through a corporate structure. The DPC now owns the practice and assumes responsibility for its liabilities, offering protection from business creditors, except in instances of malpractice. Note that this option is available to associate dentists; it is not solely for clinic owners.
Advantages of DPCs
Lower Taxes: Corporate income enjoys a significantly lower tax rate of approx. 12% on the first $500,000 of income, compared to approx. 50% in many provinces if the $500,000 was earned personally. This vast difference enables retained income in the corporation to grow faster due to lower tax burdens. For instance, a DPC earning $350,000 would pay about $42,000 in taxes, compared to nearly $150,000 for an individual dentist. This difference, invested over time, can lead to substantial wealth accumulation.
Tax Planning Opportunities: Suppose you’re at a stage where your income fluctuates year-on-year, such as parental leave; a DPC can provide a way to “smooth out” your taxes over the years by sheltering income inside the DPC in “high” income years and withdrawing from the DPC in “low” income years.
Disadvantages of DPCs
Elevated Administrative Costs: DPCs entail accounting and legal expenses, including setting up the corporation, annual financial statements, and corporate tax returns.
Financial Complexity: A DPC can add complexity to your personal financial matters, which might complicate securing personal loans or mortgages.
Financial Indicators for Opening a DPC: Consider establishing a DPC when your earnings consistently exceed your living expenses and savings plans. The primary goal of incorporating is to retain surplus funds in the corporation, taxed at a lower rate.
Holding Corporations
Holding corporations, similar to DPCs, are legal entities. They are essentially the same as a DPC but do not carry out any business activities. Instead, they are used to control other companies, manage investments, protect assets, and plan for taxes.
Advantages of Holding Corporations
Income Splitting: Holding Corporations enable income distribution among family shareholders, helping minimize overall family taxation. For instance, by adding your spouse as a shareholder, you can effectively split your income, potentially reducing the family’s tax liability by keeping the income in lower tax brackets. Note that there are strict rules around income splitting, namely tax on split income (TOSI), and decisions to split income must be confirmed with your tax advisors.
The disadvantages of Holding Corporations are the same as DPCs.
Financial Indicators for Opening a Holding Company
Dentists should consider establishing a holding corporation if their practice is profitable, they possess substantial assets needing protection, or they wish to utilize advanced tax planning strategies and income splitting. It’s also worthwhile when you own shares in a dental clinic or other businesses, facilitating the consolidation of various investments under one roof for better management.
Family Trusts
Family trusts are legal entities that allow trustees (often parents or grandparents) to hold and manage assets for the benefit of beneficiaries (often children or grandchildren).
Advantages of Family Trusts
Income Splitting: Family trusts facilitate income splitting by distributing income among beneficiaries in lower tax brackets. For example, suppose you’re a high-income dentist. A trust allows you to distribute your income to your spouse or children legally, reducing the overall family tax liability. But again, this strategy must fall within the confines of the TOSI rules.
Multiplying the Capital Gains Exemption: Family trusts can allow for multiplication of the Lifetime Capital Gains Exemption (LCGE), which provides tax-free gains on qualified small business corporation shares. For example, if a dentist’s practice is held in a trust, upon selling, the capital gains could be allocated among beneficiaries, each potentially utilizing their LCGE to shield profits from taxes.
Implementing a Prescribed Rate Loan: A trust can lend funds to a lower-income family member at the CRA’s prescribed interest rate. The family member can invest these funds, and any income generated above the interest rate can be taxed in their hands, effectively reducing the family’s overall tax burden. Attribution rules may apply in these circumstances, so a tax advisor should be consulted prior to making any loans.
Estate Freeze Strategy: This involves transferring future growth of the practice to a family trust while retaining control over the current assets. This strategy “freezes” the value of your assets for tax purposes, allowing future growth to accrue to the next generation, potentially reducing your estate’s tax liability.
Wealth Transfer Planning: Family trusts facilitate the smooth transition of assets across generations, allowing trustees to control when and how beneficiaries receive their inheritance. For instance, the trust can stipulate funds for a grandchild’s college education, ensuring resources are used as intended.
Asset Protection: Trusts insulate assets from potential creditors, matrimonial disputes, and lawsuits. For example, if your child faces financial difficulties, the assets in the trust remain protected.
Protecting a Child: A trust allows parents to provide for a minor or a child with special needs, ensuring they have the necessary resources even if parents cannot care for them directly.
Disadvantages of Family Trusts
The 21-Year Rule: This rule stipulates that a trust is deemed to dispose of and reacquire its capital property every 21 years, potentially triggering capital gains tax. This requires careful planning to avoid unintended tax consequences.
Significant Administrative Requirements: Trusts necessitate annual tax returns, meticulous recordkeeping, and periodic trustee meetings, requiring considerable time and administrative effort. Mismanagement of trusts, such as incorrect distributions or missing tax filings, can lead to severe tax penalties.
Complexity and Costs: Establishing and maintaining a trust can be complex and expensive. It involves legal and accounting fees for setup, ongoing management, and tax filings. Also, the intricacies of trust laws and taxation necessitate the guidance of experienced professionals, adding to the overall cost.
Conclusion
In conclusion, financial planning for dentists extends far beyond basic income management. The strategic use of DPCs, Holding Corporations, and Family Trusts can deliver significant tax advantages, enhance asset protection, and facilitate efficient wealth distribution. Each structure involves unique considerations. Hence, partnering with a financial advisor who understands the specific needs of dentists can help you make informed decisions, ensuring your financial health for generations to come.
About the Author:
Gurtej Varn, BA, CFP®, CLU® is Canada’s leading Wealth Advisor for Dentists. Named Canada’s top wealth professional under 40 for 2023, Gurtej is also the host of “The Dollars & Doctors Show” and the founder of White Coat Financial Inc., a full-service private wealth advisory firm for Dentists.
