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It’s a well known fact that Canada’s tax system is progressive, which means that the more a dentist makes, the more tax you pay. While strategic tax planning can defer tax, it can also reduce a taxpayer’s income tax liability by shifting income from the dentist to a lower income family member. There are several ways to accomplish income splitting and to multiply the capital gains exemption among family members.
For professionals who are not incorporated, the only income splitting opportunity available is the payment of salaries to family members for services that are rendered to the dental practice. It’s important that salaries paid to family members are reasonable in relation to the services that are provided.
However, if you want to more effectively income split above and beyond paying salaries to family members, the dental practice must be incorporated and family members must either own shares of the dental corporation directly or indirectly through the settlement of a family trust. There are advantages and disadvantages to each of the options.
For example, if family members own shares in the dental corporation directly, there is the risk of exposure to creditors and / or potential creditors of all family members who own shares. Good news! There is a way around this potential problem. You can create classes of shares that are entitled to receive dividends but that do not grow in value; these shares can be redeemed by the company for their nominal issue price. If each family member subscribes for a separate class of shares, full flexibility is created for paying dividends in any amount to any family member, after taking individual cash flow needs and personal taxes into consideration. However, because these nominal value shares do not increase in value, it’s not possible to multiply the capital gains exemption if / when the shares of the practice are sold.
For many years, the most common and preferred solution to having family members own shares directly has been found in the settlement of a discretionary family trust, the beneficiaries of whom are the dentist’s family members. The trustee of the trust – the dentist – has the sole ability to determine if and when any individual trust beneficiary receives income from the trust. Using the trust facilitates income splitting to take advantage of lower tax rates and allows the dentist to multiply access to the capital gains deduction.
It’s important to note that recent changes to the Family Law Act in B.C. have caused professionals to revisit the attractiveness of family trusts because the new law treats ALL assets held by a trust as an “asset of marriage” for all married beneficiaries. In other words, if a married adult trust beneficiary gets divorced, it is possible that the divorce might impact not only the amounts that the adult beneficiary receives from the trust, but it could affect the amounts that ALL beneficiaries of the trust might receive. There are still very valid reasons to use a trust. This is just another factor that needs to be taken into consideration when making the decision to set one up.
While income splitting is a great way to minimize your tax exposure, it’s not without complications. Talk to your tax advisor to learn how to apply these strategies to your tax planning.
To learn more, contact Don Murdoch at 250.763.8919 or
[email protected], or your local MNP Advisor
Related Topics:Dentists; Capital Gains
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