Year-end tax planning for incorporated professionals

Most of the tax decisions that matter for a professional corporation have to be made while the year is still open. Once December 31 has passed, the return is largely a matter of recording what happened. The planning conversation belongs in October or November, and this is what it usually covers.

Start with what the corporation earned

Before anything else, the books need to be current to the end of the most recent month. Not roughly current. Reconciled. A planning conversation built on a ledger that is three months behind produces decisions that have to be undone in April.

From a reconciled ledger we can estimate taxable income for the year, what the corporation has already paid in instalments, and what the personal picture looks like for the owner and any family shareholders. Everything below depends on those three numbers.

Salary, dividends, or both

An incorporated professional can be paid a salary, receive dividends, or take a combination. The Canadian tax system is designed so that, over the corporation and the individual together, the total tax on each route ends up roughly similar. In practice the differences are real and worth deciding deliberately.

Salary is a deductible expense to the corporation. It creates RRSP contribution room for the following year, at 18 percent of earned income up to the annual limit, and it requires both the employer and employee share of Canada Pension Plan contributions. Salary also requires payroll: source deductions remitted through the year and a T4 in February.

Dividends are paid from after-tax corporate income. They do not create RRSP room and do not attract CPP. They are simpler to administer. Whether the dividend is eligible or non-eligible depends on the rate of corporate tax that was paid on the income being distributed.

The right answer depends on the owner's other income, how much they want in RRSP room, whether they value the CPP entitlement, and how much cash they actually need to take out. It is a calculation, not a rule of thumb, and it should be run each year.

The small business deduction

Active business income up to the federal limit of $500,000 is taxed at the small business rate. Above that limit, the general corporate rate applies. Two things can reduce the limit for a professional corporation.

The first is passive investment income. Where the corporation, together with any associated corporations, earned more than $50,000 of adjusted aggregate investment income in the previous year, the small business limit is reduced by $5 for every $1 over that amount. At $150,000 of investment income the limit is gone entirely. A corporation holding a sizeable investment portfolio needs to know where it stands before year-end.

The second is association. Corporations controlled by the same person or group share one small business limit between them. If you own a professional corporation and a holding company or a second operating company, the limit is allocated, not duplicated.

Timing

A few items are worth moving across the year-end line, in either direction.

A bonus can be accrued in the current year and deducted by the corporation, provided it is actually paid within 180 days of the year-end. That lets the corporation take the deduction now while the individual reports the income in the year it is received.

Capital purchases such as equipment or a vehicle are deducted over time through capital cost allowance rather than in full when bought. The rules on how much can be claimed in the first year have changed several times in recent years, so a planned purchase should be checked against the current schedule before it is brought forward for tax reasons alone.

Personally, RRSP contributions for a year can be made up to 60 days after December 31, so the deadline is in late February or early March. The tax-free savings account limit, by contrast, is an annual amount that does not depend on the calendar in the same way.

Family shareholders

Paying a spouse or adult child a salary for work they actually perform is deductible, provided the amount is reasonable for the work done. Paying them dividends is subject to the tax on split income rules, which will tax the dividend at the top marginal rate unless one of the exclusions applies. Those exclusions depend on age, hours worked and the type of business, and they need to be checked before a dividend is declared, not after.

What to bring to the meeting

The corporation's books to the end of the latest month. Last year's corporate and personal returns. A list of anything that has changed: a new associate, a new lease, a large purchase planned, a change in family circumstances. And a sense of how much cash you need to take out between now and spring.

With that, an hour in the autumn is usually enough to settle the year. Without it, the same decisions get made in April, when most of them can no longer be changed.

This article describes general rules as they stood at the time of writing and is not advice for any particular situation. Limits and rates change. Confirm the current figures before acting on them.