One of the biggest advantages to having a corporation is that it gives you access to the small business deduction. This is a mechanism that effectively allows Canadian-controlled private corporations to pay a reduced federal rate on the first $500,000 of active business income.
For pharmacists who have chosen to incorporate their relief business, this provides an opportunity to reduce their federal tax to 9% for the money they choose to leave in their corporation. It’s important to note that it isn’t a permanent tax savings, because when you eventually pay it out as dividends, you’d pay person taxes. But that deferral is important, giving you a larger amount to invest in the meantime. There is also a provincial rate that stacks on top of this, which varies by province. Money you pay yourself as salary, of course, will be taxed at your personal tax rate, but for income you earn that exceeds your personal expenses, there can be a big difference by taking advantage of the small business deduction.
One of the biggest considerations for pharmacists who are considering incorporation is to ensure that you are also on side with the CRA's test for personal services businesses. This is a complicated topic worthy of its own article (read it here), but in short, failing this test could make your corporation ineligible for the small business deduction, which means you pay a 33% federal rate rather than 9%.
For a lot of pharmacists $500,000 per year is more than they typically bill anyway so they effectively get all their corporate income under the threshold.
But if you're running a large operation or own multiple pharmacy locations yourself, it's possible you could exceed this limit. Anything above that $500,000 limit is subject to the 15% general federal rate.
One important nuance to keep in mind with the small business deduction is that it's only applicable to active business income. This is critically important from a planning perspective because one of the major reasons pharmacists use a corporation is so that they can invest their retained earnings inside of it. Doing this can be a smart strategy to implement, but you need to pay very close attention to whether those investments generate passive income. If your corporation earns more than $50,000 of adjusted aggregate investment income, you start to get a reduction in your small business deduction amount. This income could be in the form of interest, rent, foreign income, portfolio dividends and the taxable half of realized capital gains. For this reason, understanding the type of assets that you own, how they generate income, and having a plan for when to realize your capital gains is important. If your adjusted aggregate investment income exceeds $150,000 in any given year, you’ll lose your entire federal small business deduction the following year (this includes income earned in associated corporations, such as a holding company). For the provincial portion, the phase-out rule applies differently in different provinces.
Another thing to keep in mind is that the $500,000 limit is treated as a cumulative amount across associated corporations. For pharmacists who own multiple pharmacies and run each one through a separate corporation and have another corporation for their relief business and maybe a holdco or two, don't expect that you get $500,000 for each.
Overall, the small business deduction is a powerful tool that you can use strategically to mitigate your tax burden. Understanding the rules and structuring your plan around them is critical to making sure that you stay on side with the CRA's strict rules and leverage the full advantage of this tool.
- Small Business Deduction: Allows your business to pay less tax on its first $500,000 of income.
- Only active business income counts: Passive income earned through investments can cause you to be charged more tax.
- Make sure your work is in line with CRA rules: The Canada Revenue Agency can decide your work is that of an employee rather than a business and you could lose your small business deduction.
Related Pharmacist Resources: Avoiding Personal Services Business Classification Deciding Whether to Incorporate: important considerations for pharmacists deciding on their structure.