Sole Proprietorship vs corporation

The topic sole proprietorship versus corporation for medical practitioners is discussed in this article, to serve as an aid in choosing the right structure. Each alternative has its own benefits, and an analysis of both options is offered below.

Control of income timing and amount

As a sole proprietor, all income earned in the medical practice will become personal income, which will be included on your individual tax return. Individual marginal tax rates are higher than business tax rates, and so you will pay a higher amount of tax. Everything earned in the calendar year will be taxable.

A corporation is a separate legal entity; it has the ability to operate a business, and is a separate taxable entity as well. Corporations enjoy tax rates from as low as 15.5%, which is lower than the lowest combined individual marginal rate.

In addition, a corporation can control the timing of the distribution of the income it earns. This means that the income a corporation earns is not taxable right away to the individual shareholder. The corporation’s income can be distributed as a dividend, salary, or bonus at any time.

Income Splitting Through Corporate Dividends

One of the most important considerations in the debate of sole proprietorships versus corporations for medical practitioners is the benefit of income splitting. Income splitting is the ability to distribute income to spouse/children or other family members, in an effort to legally reduce taxable income. It does not make sense for one individual of the family to draw all the money because of the marginal tax rate system. To demonstrate this, consider the example below.

Taylor is a medical practitioner who owns 100% of the voting shares in her medicine professional corporation, and her adult daughter, Emma, is a non-voting shareholder. Taylor’s medicine professional corporation paid dividends in the year to Taylor and Emma in the amount of $40,000 each. Since this in their only source of income, the total personal taxes paid between them would be about $0, resulting in savings of about $19,130. For more information on income splitting, please see the article “Tax Strategies for Medical Practitioners”.

Benefits of Holding Corporation

Medical practitioners can create a holding corporation to own shares of the professional corporation.

Consider this example:

1. The medical practitioner and their family members become shareholders of the holding corporation.
2. The professional corporation then lends the holding company money at an interest rate of 2% (CRA’s prescribed rate of interest)
3. The holding corporation invests the loan money into income producing assets (stocks, bonds, real estate, etc.).
4. Dividends from the holding company’s profits are paid to family members (who are shareholders)

This strategy will accomplish the following:

• Allow the medical practitioner to split income with family members
• Give family members an opportunity to benefit from the income earned in the holding company
• Provide creditor protection to the professional corporation by transferring excess funds to the holding corporation.

Section 3.2(2) of the OBCA requires that all shares of the professional corporation be owned, directly or indirectly, by a member of the particular profession, which means that holding corporations are allowed. However, there is a specific exception by the College of Physicians and Surgeons and the Royal College of Dental Surgeons who do not allow holding corporations to own shares in the professional corporation. The College of Pharmacists allow holding corporations, as long as the holding corporation is a pharmacy professional corporation.

Limited Liability Protection

Medical practitioners’ personal assets are protected if they operate as a corporation, because a corporation is a separate legal entity. This can be crucial if clients and other persons come to you with legal action with unfounded claims. However, the limited liability status of a corporation does not protect a medical practitioner from litigation due to professional negligence, malpractice, carelessness or other torts. With a sole proprietorship, the liability is unlimited.

Ownership

Only qualified medical practitioners can become shareholders of a medical profession corporation. Its directors and officers are required to be shareholders. There is an exception to the rule that only qualified practitioners can become shareholders; physicians’ and dentists’ professional corporations are not restricted by this, as their family members and trustees can own shares as well, as long as they are non-voting shares. Family member shareholders includes parents, step-parents, children, step-children, spouse and common-law spouses.

The above is certainly not an exhaustive list of the pros and cons in the debate between sole proprietorship versus a corporation for medical practitioners, but it gives you a rough idea of what each entails. You should seek the advice of a professional accountant so a decision can be made according to your exact situation.

ABOUT THE AUTHOR

ALLAN MADAN

CPA, CA

Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.

Related Resources