When I started this Blog of Ice and FIRE, I likened the medical climate in Canada to the seasons of the fantasy world in Game of Thrones. There are long bountiful Summers that can last years, followed by long dark Winters when armies of the undead march down to pillage the Southern Kingdoms. The Winter usually starts with appearance of the creepy White Walkers and their zombies, followed later by their necromancer leader, The Night-King.
We have been heading into one of those Winters where our governments have spent beyond their means and need to try to cut costs where they can. Professionals are easy targets since we are prominent high income earners, are relatively small in number, and we won’t stop fulfilling our duties – even when under attack. So, there are potential savings and revenue with limited repercussions to voters and therefore politicians.
We had some harbingers of Winter with White Walker Wynne in Ontario unilaterally imposing a 4.5% across the board clawback of physician fees. Ontario doctors have been without a negotiated contract for years now.
Those clawbacks come off of our monthly payments like an income tax installment. Wynne also created higher income tax rates on those earning six figure salaries – like we have seen in many provinces.
In 2016, the Federal government made yet another new higher marginal tax rate – pushing the top combined rate to over 50% east of Saskatchewan and up to 54% in many places. Added onto the 5% fee clawback (Ontario Doctor Tax), that is now almost a 60% top marginal tax rate on medical practice in Ontario. Punishing. This would certainly motivate physicians to leave money in their professional corporations rather than pay it out and have over half of it confiscated.
Alas, our hard earned money was still not safe within our professional corps. This past summer, the Night-King Mourneau was sighted and announced further plans to attack Canadian Controlled Private Companies (CCPCs) and a broad swath of small businesses. Unwittingly, he drew in difficult political targets like farmers, fishers, and the Mom and Pop small businesses that are the backbone of our economy into his attack.
People across Canada’s small business community banded together to fight back. A seemingly unstoppable breech of The Wall by the armies of the Night-King and White Walkers met resistance.
When all seemed lost, there were some strong blows struck back against the shuffling army intent on consuming the life force from Canadian small businesses. We have awaited the outcome of the battle for a several months.
Now, the Night-King has arrived South of the Wall and today delivered his 2018 Federal Budget.
The full budget document can be found here. I will hit the highlights below.
Income Splitting Via Dividends From Professional Corporations
Measures to limit income splitting using CCPCs were announced in December. I outlined the proposed rules in Let’s Keep the Sprinkler Running. I have also done a big series of posts on other ways to income split in the Financial Planning section and with demonstrations in the Sim Lab area of the site.
Passive Investments In Professional Corporations and CCPCs
There will not be grandfathering of old investments and new investments facing new punitive tax rules as originally planned.
The changes will take effect for 2019 and onwards.
Instead, they are taking an approach of decreasing the amount of business income that the lower small business tax rate applies to as the amount of passive investment income increases. Starting at $50K of passive investment income in a year, the threshold for the Federal small business rate will decrease by $5 for every $1 of passive income and disappear by $150K/yr of passive income.
So, essentially CCPCs that earn larger passive investment incomes will start paying the higher corporate tax rate at lower active income thresholds. Capital gains from active investments will be excluded. Passive investment capital gains would count. However, it is only the taxable half of the capital gain that counts with the 50% excluded half not counting. With that, using capital gains oriented passive investments that don’t pay interest or dividends could effectively double the passive investment income that you could receive. I provide a detailed explanation of what counts as passive investment income here.
Paying out dividends and Refundable Dividend Tax On Hand (RDTOH)
The RDTOH account is a notional account from which you can essentially give a tax-free dividend to yourself when you pay-out regular dividends from your CCPC. The idea is that passive income in a CCPC is taxed at a higher rate than an individual would pay. So, when the money is passed on to the individual, the difference in those tax rates is refunded. That way the amount of tax paid on the dividend overall would be the same whether paid to the individual directly or through a CCPC.
Currently, it is possible if you have a corporation making over $500K to pay the General Corp Tax rate on some earned income and give lower taxed eligible dividends from that portion of income. At the same time it was possible to have that eligible dividend dispersal to trigger the ability to a give tax-free dividend from the Refundable Dividend Tax On Hand (RDTOH) account of the CCPC resulting in an overall lower tax-rate on the dividend.
They will close that gap and make two notional accounts in a corporation – an eligible RDTOH and a non-eligible RDTOH account. You will only get that RDTOH from the investment income taxed at the higher small business passive investment income rate if paying out the higher taxed non-eligible dividends from the CCPC.
I know, it all sounds like Klingon speak to me. I translate the Klingon-sounding RDTOH changes into plain english (with diagrams) here.
Good News – this is much better for most than the original proposal
There are many ways that a practicing physician or other high income professional could avoid pushing themselves into the higher general corporate tax rate. In general, it does mean the end of simply having a CCPC and paying yourself with dividends whilst building up a large investment portfolio within the corp. However, it will likely mean that we need to utilize salaries, RRSPs, and possibly taxable accounts to make a more complex financial plan for our retirement saving and wealth building.
More Good News
I have been making connections with some financial and tax planning experts who specialize in physicians and other high income earners. While I believe that physicians should teach physicians about finances, adding the input and quality control of experts to what we are producing on this site will be great.
There are lots of nuances and potential strategies to maneuver within the new small business tax rules that we will explore further in the coming weeks on this blog.
We have just about finished exploring all of the ways that you can still income split (I still have a few more posts coming) and after that we will be exploring how to optimize passive investment and active business income across the professional career span and how to build a tax optimized investment portfolio. Stay tuned…