ith all the challenges we were faced with in 2020, it also brought us some opportunities to learn on how to grow our dental practices, cash flow management and tax planning ideas that you may not have thought of during the pre-covid era.
This is an opportunity to refine some areas of your practices, remind ourselves of some forgotten opportunities and explore some new ideas for your practices. Here are 12 cash flow and tax tips that you may want to consider in boosting your cash flows for 2021!
1. Create a Health Spending Account
If you run and operate a Dentistry Professional Corporation (DPC), you may want to consider creating a personal Health Spending Account (HSA). An HSA is a bank account whose deposits are spent exclusively on health-care expenses.
By having an HSA, you may convert health-care expenses into 100 percent business deductions and a non-taxable benefit for yourself. In contrast to traditional medical and dental plans, any unused funds remain in the account for your future needs.
For example, if an incorporated dentist in Ontario who earns $100,000 of net income incurs a $10,000 medical expense, the dentist would have to withdraw approximately $20,000 in pre-tax income from the DPC to pay this bill.
By using a Health Spending Account, the company would pay only $10,000 plus the administration fee of approximately 10%; an amount that is fully tax deductible from the DPC and a non-taxable personal benefit.
The overall cash flow savings would be approximately $9,000. Although the medical tax credit of approximately $1,525 if these expenses were paid personally would be offset by the approximately $1,400 in corporate tax savings, the dentist has more cash flow in the corporation for operating and investment purposes.
2. Accelerated Depreciation Can Save You $9,150
CRA has enhanced some of its depreciated rates for dentists interested in replacing equipment or purchasing new equipment. Machinery and equipment currently qualify for a temporary accelerated CCA rate of 50% calculated on a declining-balance basis under class 53. It qualifies if you acquired the property after 2015 and before 2026 for use in Canada primarily in the manufacturing or processing of goods for sale or lease.
These assets would otherwise be included in class 43 and qualify for a CCA rate of 30%.
If you acquire property after November 20, 2018, and it becomes available for use before 2028, it will be eligible for an enhanced first-year allowance. The enhanced allowance will initially provide a 100% deduction, with a phase-out for property that becomes available for use after 2023.
For example, a piece of equipment that costs $100,000, would normally be allowed for a depreciation or capital cost allowance of $25,000 (half year rule of 25%). The new proposed rules allow for a 100% depreciation, an increase of $75,000 or a tax savings in Ontario of $9,150 (at a 12.2% corporate tax rate assuming the small business tax rate).
3. Corporate Life Insurance Can Save You $21,950 Annually
This is an excellent tool to consider for your practice. In most instances, the practice is a single dentist and in the event of death, the practice will no longer be able to continue.
Therefore, it is a good idea to think long term and protect the business that is dependent on the professional. The life insurance has many tax benefits as well.
The value of the life insurance plan grows tax free since a portion of the insurance premiums are invested in securities in the policy. Corporate Life insurance allows you to pay for premiums through the corporation without using after tax personal dollars. Although the premiums are not deductible, you can use the corporate funds to pay for the premiums.
For example, if the life insurance were in the name of the dentist held personally, for premiums of $25,000, the professional would require approximately $50,000 in order to pay for the premiums. This results in an additional cash outflow of $25,000! By having corporate life insurance, the $25,000 premiums would be added back to taxable income at 12.2% in Ontario ($3,050 in additional taxes).
Your net savings are the additional $25,000 saved in personal taxes less the additional corporate taxes of $3,050 (at the small business tax rate of 12.2%) for an annual savings of $21,950!
4. Family Members on Payroll
Many dentists have the benefit of receiving assistance from family members for technology, bookkeeping, banking, and other administrative tasks.
Assuming the family members are at a much lower tax bracket and if the dentist is at the highest tax bracket in Ontario (53%), there are significant savings to be achieved.
It is critical to document the job description of the family member and to ensure that hours of work are also tracked in the event of a CRA audit or review.
For example, if a $50,000 salary that the dentist would normally include in his or her income is moved to a family member who previously would not report that income, then there is a significant tax savings to be achieved. If the family member is at the 25% tax bracket, the difference in the taxes of 28% is estimated at $14,000 on a $50,000 salary.
Please seek a professional to ensure that the Tax on Split Income Rules (TOSI) are not impacted by these decisions.
5. Individual Pension Plan (IPP)
As dentists strive to contribute towards their retirement, there are many strategies that allow them to grow their nest egg. Whether it is an RRSP, TFSA or for employees in the private or public companies, they may have a defined benefit pension plan.
One planning tool often missed is an Individual Pension Plan (IPP). It is a trust, sponsored and funded by your DPC, which provides a steady pre-determined income stream to you at retirement. The difference is that this is set up specifically for you. An IPP allows a DPC to contribute funds for a specified employee, to be used by the employee on retirement.
The contributions are tax deductible to the corporation and grow inside the IPP on a tax-deferred basis.
The professional must be earning pension eligible T4-employment income to qualify for IPP contributions. The IPP income taken out at retirement is taxed as income. It is most suitable for dentists over age 40 and earning a high T4 income salary (T4 income) greater than $150,000.
An IPP may allow for additional deductible contributions for past service, to provide additional income if you retire before age 65.
An IPP is similar to an RRSP, but the contributions are tax deductible to the corporation and is funded by the corporation. The actuarial fees as well as the annual IPP fees are also deductible. For example, an annual IPP contribution of $30,000 provides a tax benefit of $3,660 for DPC’s paying the small business tax rate.
This does not include the 1 time ‘catch up’ of past service adjustments that provide a lump sum contribution to the IPP and in turn a significant up front tax saving!
6. Automobile Expense Tracking
When using your automobile for business and professional purposes, dentists are allowed to claim these costs as deductions. Often forgotten is that your regular route of home to the clinic are not deductions.
However, if you are driving and make stops along the way for business reasons (seminar, banking, purchase of supplies etc.), these expenses are deductible. Furthermore, for dentists working at multiple clinics and hospitals, they can choose a ‘base’ location and then each additional location is part of the ‘deductions’ available. Here are items that can be claimed:
- license and registration fees
- fuel and oil costs
- money borrowed to buy a motor vehicle
- maintenance and repairs
- leasing costs
It is also important to keep a logbook which is what the Canada Revenue Agency (CRA) recommends. This allows for the tracking of business kilometres which provides supporting documentation in the event of a CRA audit.
7. Expense Tracking
Many dentists have staff meetings or parties throughout the year. These are sometimes recorded as meals and entertainment which are only 50% tax deductible.
These can be allocated to office expenses allowing for the full 100% deduction.
A simple reclassification of these expenses into the correct expense category will result in an additional 50% of the tax deductions. The value of these is a 12.2% for every additional dollar of expense missed out on.
Employees may be given two non-cash gifts which total $500 tax-free. As an employer, you would not have to withhold any CPP, EI or income taxes from this gift. Sometimes, these are recorded by bookkeepers as personal items and not as deductions for staff gifts.
8. Home Office
As approximately 40-45% of Canadians worked from home for a portion of 2020, CRA has introduced a modified home office expense deduction for 2020.
If you worked from home for at least 50% of the time for at least 4 consecutive weeks, you could be eligible for a deduction.
Here is a summary of the methods:
- Temporary Flat Method
- Deduction of $2/day, up to a maximum of $400.
- To calculate workdays, individuals must use days that they worked full-time or part-time hours from home, but not days off, vacation days, sick leave days or other days of absence.
- Multiple people working from the same home can each make this claim.
- The taxpayer must have worked at least 50% of the time from home over a period of at least 4 consecutive weeks during 2020 or you only use your workspace to earn income and you use it regularly for meetings with clients, customers, or patients.
- Detailed Method
- Obtain a simplified T2200S form from your employer (form T2200S is a simplified version of the T2200 form)
- Individuals must have supporting documents in the event of a CRA review
- Employee can claim specific eligible expenses
- Eligible expenses include electricity, heating, water, maintenance, and rent, but not mortgage interest, property taxes or home insurance (unless a commission employee)
- employee’s deduction for the allowable expenses is limited to the employment use of the workspace
- eligible employees can also include a deduction for office supplies (e.g., postage, stationary, ink cartridges) and other expenses (e.g., the employment use of a cell phone, long distance calls for employment purposes)
- Employees cannot claim any expenses that were or will be reimbursed by their employer
- The taxpayer must have worked at least 50% of the time from home over a period of at least 4 consecutive weeks during 2020 or you only use your workspace to earn income and you use it regularly for meetings with clients, customers, or patients
9. Paying Dividends versus Salaries
Dental professionals can use family members to find an optimal mix of salary versus dividends. As a dentist, if you have a DPC, you can enable the payment of income to family members.
Family members may be eligible to receive dividends provided they work 20 or more hours per week on behalf of the practice throughout the year. A family member could earn $35,000 in dividends from a DPC and pay less than $1,000 in personal taxes, assuming they have no other income.
This is in comparison to the dentist who reports the full amount of the dividend or salary income and pays approximately $15,000 in tax on that amount.
For compensation to the dental professionals, if they would prefer to invest in their DPC and do not prefer to contribute to RRSPs or are not interested in the CPP benefits or contributions and do not have childcare expenses, then a dividend only compensation strategy may be the optimal strategy.
Salaries allow individuals to contribute to RRSPs as well as the CPP. Depending on the future planning requirements of the dentist, the dividend versus salary strategy can vary.
The often-suggested recommendation is to maximize drawings up until the CPP limit of $61,600 (in 2021) or the RRSP limit of $27, 830.
As discussed previously, income splitting also comes into play as an advantage for choosing salaries over dividends. This also will allow high earning practices to be brought below the $500K tax bracket (~14% tax saving at the corporate level for every dollar earned above $500K).
Although the combined tax amount of choosing either salaries or dividends are very similar, the decision to choose on or the other or a combination of salaries or dividends depends on a few factors.
Some of these include how diligent you are at managing your cash both personally and within your corporation, your perspective on RRSPs and CPP and if you would like to maintain most of your cash within your corporation or holding company.
If personal income varies from month to month, my suggestion is to choose dividends. This will avoid monthly payroll remittances which could have result in penalties for missing a payroll remittances (10% of required remittances) if you are not disciplined in making the remittances on a monthly basis.
Dividends only require tax instalments to be made and interest penalties of 5% annually, if they are missed. The downside of dividends is that if a tax plan is not prepared with expected installment payments, it could lead to tax surprises, especially if dental professionals have not been disciplined in drawings made from your DPC and paying the required personal tax instalments
10. Employee vs. Contractors
As dentists continue to grow their practices, the question always arises as to whether a new hire is treated as an employee or an independent contractor. The cash flow savings of hiring some as a contractor include saving the CPP, employment insurance, vacation pay and termination or severance costs at the end of the relationship.
If an individual is working on a long-term basis there are some questions to consider:
- Is the role of the individual a key component of the dental practice (for example does the dentist provide the business card or does the individual’s name and contact information appear in the client’s phone directory?
- Does the client provide the tools for the individual to complete his/her job?
- Can the individual complete the work according to his/her timelines or are they governed by the hours of work of the client (control test)?
- Who takes on the risk of the work being performed (for example risk of profit or loss)?
If CRA conducts an audit, it could deem the individual subcontractor or independent contractor to be an employee. If this is the case, CRA can go back up to three years and hit the corporation with interest and possibly penalties for the payroll remittances deemed to be remitted on a monthly basis
5. Integration – is the worker’s job an integral part of your dental business?
11. Borrowing Funds from DPC (Shareholders Drawings)
As per the income tax act and rules from CRA, if you borrowed money from your DPC, this loan must be repaid within one year after the fiscal year end in which the loan was made.
For example, if your DPC has a year end of Sept 30, 2021 and you borrowed money from your PC on Aug 31, 2021, the loan must be repaid to your DPC by Sept 30, 2022. If the loan is not repaid within these timelines, it will be treated as income in the year of drawing.
The only exception to this rule (applicable only for employees) is where the loan was used to buy a car for business use or the purchase of a principal residence. For the dentist, one thing to consider is whether a similar loan from the DPC given to an arm’s length employee?
If it was not, then there are less chances of supporting your case with CRA that you fall into the exception category. If the loan is repaid, CRA requires you to include in your income a deemed interest benefit at the CRA’s prescribed interest rate (currently 1%) for the period the loan is outstanding. There is still the risk of CRA adding the withdrawal as income in the year of drawing.
12. Investment Tax Strategies
A popular topic of interest is what to do with excess cash and how to invest it. As professional Colleges do not encourage keeping investments in a DPC the suggested strategy is to move the funds into an investment holding company. Regardless, the question of investment income and tax rates still comes into play. The tax paid depends on the type of income earned, such as interest income, Canadian dividends, or capital gains.
- On $1,000 of interest income earned, the tax paid is approximately 50%, leaving approximately $500 in the corporation after tax.
- On $1,000 of capital gains income earned, the tax paid is approximately 25%, leaving approximately $750 in the corporation after tax.
- On $1,000 of dividend income earned in a corporation, the tax paid is approximately 38%, leaving approximately $610 in the corporation after tax.
If the funds are not required, one suggestion is to continue deferring the income in the corporation. Corporate class funds allow for the deferral of accrued dividend and interest income into capital gains income that will be taxed upon the sale of the mutual funds or stocks.
These are meant to be practical tips that can help you refine your practice financially. For many dentists, 2020 was a wake up call. For others, it was an opportunity to continue perfecting the systems they had in place before.
Either way, a prudent cashflow and tax planning strategy is critical to the health and success of any dental practice moving forward. These 12 tips can really enhance your practice if done right. It's always best to seek professional advice to better understand your situation and how any/all of these strategies can help you in the long term.
Ali Raza Jaffer - CPA, CGA, MBA, BCOMM
AR Jaffer Professional Corporation - firstname.lastname@example.org - (905)-629-7720 - www.arjcpa.ca