Tax Planning Opportunities Involving Professional Corporations

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1 Tax Planning Opportunities Involving Professional Corporations A Discussion Paper Prepared by: Alan Koop, CA Prepared for: The Saskatchewan Provincial Court Judges Association

2 Table of Contents Executive Summary... 1 Introduction... 2 Tax Rates and Assumptions... 2 Tax Planning Opportunities... 3 Wages vs. Dividends... 3 Income Splitting... 4 Income Splitting with a Spouse... 4 Income Splitting with Adult Children... 5 Income Splitting through a Discretionary Family Trust... 6 Income Deferral... 6 Incorporation and the Ability to Deduct Expenses... 7 Additional Considerations... 7 Concluding Comments... 8 Appendix A Tax Brackets and Selected Tax Rates... 9 Personal Tax Brackets and Effective Rates (2011)... 9 Corporate Tax Effective Rates (2011)... 9 Appendix B Comparison of Taxes Paid in Selected Scenarios Scenario 1: Income Earning Spouse and Two Children in University Scenario 2: Income Earning Spouse and No Children Scenario 3: Non income Earning Spouse and Two Children in University Scenario 4: Non income Earning Spouse and No Children Scenario 5: No Spouse and No Children Page i

3 Executive Summary The primary tax planning opportunities available to an incorporated lawyer are the ability to receive personal compensation in the form of wages or dividends, split income with a spouse or adult children and defer personal income tax on income in excess of the amount required for living expenses. An incorporated lawyer who chooses to receive only dividends from their professional corporation will pay less tax than an unincorporated lawyer or a judge earning the same amount of income in the form of a salary. There is also the opportunity for the incorporated lawyer to avoid CPP premiums through the receipt of dividends rather than wages. However, when only dividends are received by the incorporated lawyer, they forgo the potential future benefits of CPP and RRSPs. Income splitting allows a lawyer with a spouse or adult children to reduce their overall tax liability by shifting income from the lawyer who is in a higher tax bracket to adult family members in a lower tax bracket. Income splitting is most commonly accomplished through the payment of dividends to a but may also be accomplished through the payment of wages in certain situations. A judge does not have the ability to implement income splitting strategies using either wages or dividends. An incorporated lawyer earning income in excess of the amount required for living expenses can defer the personal level of taxation by retaining and investing the excess income in their professional corporation thereby reducing the amount of income taxed at the individual level. This allows an incorporated lawyer an opportunity for tax deferred investing that is not available to judge. The table below summarizes the income splitting illustration scenarios contained in Appendix B. The two situations included below are that of a salaried judge and a lawyer receiving only dividends from their professional corporation. The assumptions used in these calculations are detailed in Appendix B and should be reviewed as they form an integral part of this comparative analysis. Income Before Tax Family Income after Tax, CPP and EI Judge Lawyer Difference Income earning spouse, two children $ 300,000 $ 194,891 $ 222,558 $ 27,667 Income earning spouse, no children 300, , ,516 14,225 Non income earning spouse, two children $ 250,000 $ 160,727 $ 194,685 $ 33,958 Non income earning spouse, no children 250, , ,579 22,452 No spouse and no children 250, , ,149 9,200 Page 1

4 Introduction Lawyers in Saskatchewan have the ability to incorporate their practices under The Professional Corporations Act (Saskatchewan). Tax planning opportunities that are available to an incorporated lawyer include the ability to control whether they receive personal remuneration in the form of wages or dividends 1, the ability to potentially split income with their spouse and children and the ability to defer the personal level of taxation on income earned in excess of the amount required for living expenses. The body of this paper details the various tax planning options available to incorporated lawyers. The deduction of expenses and other related considerations are also discussed. The appendices to this paper contain a quantified comparison of the taxes that would be paid by a salaried judge and an incorporated lawyer in selected scenarios focusing on income splitting strategies. Tax Rates and Assumptions Before looking at the various tax planning opportunities available to an incorporated lawyer, it is important to understand the tax rates that are used in determining the benefit of certain tax planning options. This paper assumes that all individuals, corporations and trusts are resident in Saskatchewan for tax purposes. Appendix A details the 2011 personal tax brackets and effective tax rates for both wages and dividends as well as 2011 corporate tax rates for active business income earned in a corporation below the $500,000 small business limit. The effective personal tax rates on dividends are calculated based on the personal tax rate in the applicable bracket less the related dividend tax credit. The analysis contained in this paper uses the 2011 personal tax brackets and rates and a combined corporate tax rate of 13.00% which prospectively came into effect on July 1, 2011 and applies to income below the $500,000 small business limit. Calculations contained in this paper have been prepared based on specific assumptions and will not exactly reflect any individual s particular situation. This paper focuses on the tax planning opportunities available to an incorporated lawyer that would not be available to a judge by virtue of the fact that a judge receives salaried remuneration and cannot incorporate. An overall comparison of the compensation received by a judge and a lawyer in public practice is beyond the scope of this paper. This paper is not intended to be used as the basis for personal tax planning. Personalized professional advice should be sought before pursuing any tax planning strategy. 1 As this paper assumes income in all scenarios of less than $500,000, eligible dividends are not relevant as there is no income subject to taxation above the $500,000 small business limit threshold that would allow for the payment of eligible dividends. Accordingly, all references to dividends are to dividends other than eligible dividends, commonly referred to as ineligible dividends. Page 2

5 Tax Planning Opportunities Wages vs. Dividends Tax planning discussions often start by comparing the income tax treatment of wages 2 and dividends. Based on the 2011 tax rates an individual earning a salary of $250,000 with no other sources of income will pay income tax of $92, An individual earning this same amount in a professional corporation will pay corporate tax of $32,500 and personal tax of $53,351 when paying out the remaining funds to themselves as dividends for total taxes paid of $85,851. Alternatively, an incorporated individual can choose to pay the income out to themselves in the form of wages in which case the corporation will claim a deduction for the wages paid and pay no taxes, and the individual will be in the exact same tax situation as an individual earning salary with no corporation. An incorporated individual earning $250,000 can save $6,983 in income tax by shifting the form of their remuneration from wages to dividends. Canada Pension Plan ( CPP ) premiums should also be considered when comparing wages and dividends. A judge receiving salaried remuneration will have $2,217 4 in CPP premiums withheld and remitted to CRA on their behalf as the employee 5 contribution to the CPP and their employer will pay a matching contribution. A lawyer with an unincorporated law practice will be required to pay both the employer and employee portion of the CPP or $4,434 in total as will an incorporated lawyer drawing up to $46,300 6 in wages from his or her corporation. The lawyer, or their corporation, will be able to claim a deduction for the employer portion of CPP and in all cases the lawyer, or the judge, will be able to claim a tax credit for the employee portion of any CPP paid. It is important to note that the eventual payout of CPP to a retired individual is based on CPP premiums paid and that CPP premiums are only paid with respect to wages. Therefore, an individual receiving only dividends from their professional corporation will not pay any CPP premiums, but will not be entitled to the related CPP benefits in retirement. Some individuals view CPP as a retirement investment, while other individuals view CPP as a tax due to the lack of control over their CPP investment and the uncertainty sometimes associated with the future of the CPP system. If an incorporated lawyer views the CPP as a tax and does not want to pay into the CPP, it is possible for them to avoid CPP premiums through the payment of dividends from their professional corporation rather than wages. 2 From a tax perspective, there is no difference between wages or salary. These terms are used interchangeably throughout this paper. 3 Assuming the individual has no spouse or children and claims no deductions or tax credits other than the basic personal credit and credits related to the receipt of wages. 4 CPP rates are updated annually, typically increasingly slightly year over year. This paper assumes the 2011 CPP rates and pensionable earnings level. 5 This is not to imply that judges are considered employees, employee contribution is simply the colloquial term for the portion of CPP premiums withheld from an individual s pay and remitted on their behalf. 6 The maximum pensionable earnings amount for Wages paid to an individual in the year above this amount are not subject to CPP. Page 3

6 RRSPs are also an important consideration when comparing wages and dividends. The creation of RRSP contribution room requires earned income such as wages. Accordingly, an individual receiving wages will be able to contribute to their RRSP 7 while an individual receiving only dividends from their professional corporation will not generate RRSP contribution room. While this is an important discussion, it often hinges on the individual s preferred investment style and ties closely to the ability to defer the personal level of income tax by investing excess income in the professional corporation. This matter is discussed in greater detail below in the section entitled Income Deferral. The discussion of wages and dividends forms the foundation for tax planning involving professional corporations. At the assumed income level of $250,000, dividends through a professional corporation attract less taxation than salary earned either through a professional corporation or directly. There is also no requirement to pay CPP premiums related to dividends. However, when an incorporated lawyer decides to receive personal remuneration solely in the form of dividends, the potential future benefits of CPP and RRSP contribution room are forgone. Income Splitting Income Splitting with a Spouse A lawyer with a spouse may be able to benefit from an income splitting strategy. A couple with one spouse earning $250,000 and the other spouse earning no income will pay significantly more tax than a couple where each spouse earns $125,000 since the Canadian tax system is based on graduated tax brackets 8 and spouses are required to each file a separate income tax return. Accordingly, a common tax planning strategy is to shift income from the high income spouse to the low income spouse in order to subject that income to tax in a lower bracket. Generally, the lowest combined tax is paid in a situation where each spouse is earning roughly the same amount of income. 9 It is possible to accomplish income splitting using either wages or dividends. However, the payment of wages is limited to a reasonable amount based on services performed whereas there is no such reasonableness test with respect to the payment of dividends since dividends are paid as a return on investment and not as compensation for services. 7 RRSP contribution room is calculated as 18% of earned income from the previous year up to a maximum of $22,450 for 2011, plus any contribution room not used in a previous year. Earned income includes wages, business income and rental income. If the individual is also a member of a pension plan, their RRSP contribution room will be reduced based the contributions to their pension plan and whether the pension plan is a defined benefit or defined contribution plan. 8 Graduated tax brackets work by taxing income earned in excess of certain thresholds at higher tax rates. For example, federally, the first $41,544 that an individual earns is taxed at 15.00%. If that same individual instead earns $70,000, $41,544 is still takes at 15.00% but the additional $28,456 of income is taxed at 22.00%. All of the provinces also use a system of graduated tax brackets and the provincial tax is in addition to the federal tax. 9 It is important to note that there are certain possible exceptions to this general rule, particularly where one spouse may be eligible for certain benefits, such as Old Age Security, that are clawed back after a certain income level or otherwise income tested. Page 4

7 If the spouse is providing some sort of valuable service for example book keeping and administrative services wages to the spouse that are reasonable given the services provided can be justified. This option may be attractive where the couple would like to build up CPP and RRSP contribution room. Wages can also be used by an unincorporated lawyer to split income with his or her spouse as any such wages paid are deductible to the lawyer regardless of whether or not they are incorporated. However, if the lawyer is incorporated, paying wages to the spouse is typically less preferable than paying dividends due to the higher effective tax rates attracted by wages as discussed above. The requirement that wages be reasonable also presents a problem as it is typically difficult to achieve a 50/50 income split through the use of wages given this restriction. For instance, given our scenario of a lawyer earnings $250,000, it would be difficult to justify paying $125,000 for book keeping services. Additional reasons that wages may be less attractive include the administrative burden of payroll withholding and remitting requirements and possible Workers Compensation Board ( WCB ) premium exposure 10. Although dividends are typically the preferred method for splitting income with a spouse, it is important to note that there are certain tax deductions and credits that are not available to an individual whose only income is in the form of dividends. These deductions and credits include the deduction for certain child care expenses incurred as well as the Canada employment tax credit. Income Splitting with Adult Children A lawyer with adult children 11 receiving some sort of financial support from the lawyer should also consider an income splitting strategy involving these children. The same discussion regarding income splitting with a spouse using wages is applicable with respect to children, but in practice it is very uncommon for children to be providing any services to the lawyer and so wages generally cannot be justified as reasonable. Instead, income splitting strategies with children typically involve structuring the professional corporation such that dividends can be paid to the children. This approach is only available to a lawyer who is incorporated. This option can be very attractive in a situation where the lawyer will be funding the child s university education. For instance, a student paying $8,000 per annum in tuition and attending school full time for 8 months per annum can be paid $40,000 in dividends without incurring any personal tax. If the same $40,000 in dividends were paid to the lawyer instead of the child, and the assuming the lawyer is already in the highest personal tax bracket, the lawyer would pay $12,832 of tax related to the additional $40,000 of dividends. Furthermore, an adult child not in university and with no related tuition or education tax credits is still able to earn $24,000 in dividends before paying any tax and so an 10 Similar to CPP, some individuals view WCB premiums and the related coverage as a benefit rather than an added expense. However, depending on personal circumstances, it would likely be more desirable and cost effective to obtain private health or disability coverage instead of paying a salary simply to obtain access to WCB coverage. 11 It is important to note that dividends may only tax effectively be paid to children who have attained the age of 18. If dividends from a professional corporation are paid to children under the age of 18 then a kiddie tax will apply effectively taxing these dividends at the highest tax rate and thus negating any benefits of income splitting. Page 5

8 incorporated lawyer wishing to provide some financial assistance to such an adult child can save $7,700 in tax by paying the dividends directly to the child. These examples assume the adult child has no other income in the year. Income Splitting through a Discretionary Family Trust In order to pay dividends to a spouse or child, that spouse or child must own the shares on which the dividends are paid. 12 If the shares are owned directly by the spouse or child, they legally have the right to do with those shares as they please and could theoretically sell those shares to a third party. While this may not be a significant concern in a close family, it is usually desirable to interpose a family trust to hold the shares, with the lawyer as the trustee and the family members as beneficiaries. In this manner, the family members may be allocated dividends through the trust but would not have the ability to unilaterally control the related shares. The inclusion of a family trust in a professional corporation structure does not necessarily impact the end tax result, but it does provide additional flexibility and control for the incorporated lawyer. Income Deferral Income deferral is the other significant tax planning opportunity related to incorporation. As noted in Appendix A the effective corporate tax rate on the first $500,000 of income earned in a professional corporation is 13.00% as compared to the top effective marginal tax rate on salary of 44.00%. An incorporated lawyer earning $250,000 but only requiring $150,000 for living expenses, including income taxes, can leave the remaining income in his or her professional corporation. This incorporated lawyer would have $87,000 remaining in their professional corporation ($100,000 less the 13.00% corporate tax) that could be invested. By comparison, an individual earning the same income as a salary would only have $56,000 ($100,000 less the 44.00% personal tax) remaining after tax to invest. There is no time limit to how long the incorporated lawyer can defer paying this income out to themselves personally. If the incorporated lawyer is still in the highest marginal tax bracket when they do pay this income out in the form of a dividend, then they will pay tax of approximately $28,000 based on the current rates. However, it is possible that they may defer paying out this income until they are in retirement and may conceivably be in a lower tax bracket. Accordingly, this deferral may also result in an additional reduction of tax. Sometimes, deferral is compared to an RRSP or other pension plan, but with 13.00% tax up front. However, it is important to understand that any investment income earned is still subject to tax in the corporation, and investment income earned in a corporation generally attracts a slightly higher tax rate than investment income earned personally. Generally though, this tax disadvantage on any investment 12 The Law Society of Saskatchewan stipulates that all voting shares of a legal professional corporation must be held by a practicing member of the Law Society, while non voting shares may be held by members or spouses, children or parents of members, or by a trust all the beneficiaries of which are members or spouses, children or parents of members. Page 6

9 income earned is outweighed by the availability of additional investment capital due to the lower taxes paid up front. While potentially significant, the benefits of income deferral are difficult to quantify due to the number of variables involved. Furthermore, if an incorporated lawyer does not have income in excess of that required for living expenses, then no income is deferred and no benefit is realized. It is also difficult to draw a quantified comparison between an individual with the ability to defer income in held in a professional corporation but with no pension or personally held retirement savings, and an individual who cannot incorporate but who has personal retirement savings and/or a pension plan to assist in funding their retirement. Incorporation and the Ability to Deduct Expenses Whether or not a lawyer is incorporated does not impact their ability to deduct expenses. The deductibility of expenses is not based on the corporate form of the business proprietorship, partnership, corporation but rather it is based on the nature of the expenses incurred. If the expenses are incurred for the purposes of gaining or producing income, and are reasonable in the circumstances, then they are deductible. 13 Therefore, the deductibility of expenses for a lawyer is not relevant to the incorporation decision. An individual, such as a judge, receiving salaried remuneration would not have the same ability to deduct expenses although, in theory, this is because they would not be incurring the same expenses. That is, because they are not carrying on a business they would not be incurring expenses to gain or produce income from a business. However, there are situations where employees and others receiving salaried remuneration are required to incur certain expenses as a condition of employment. Most commonly, these expenses would include home office expenses, automobile expenses, and perhaps salary for an assistant. If the salaried individual does not receive any allowance or reimbursement for these expenses they are able to claim a deduction provided that their employer provides them with a signed form declaring the same. It is a rare situation where an individual incurs reasonable expenses related to an office, employment, or business and is not able to deduct those expenses. Additional Considerations In addition to the potential tax planning advantages of incorporation, an individual may also choose to incorporate for certain liability related reasons. Whether or not a corporation will protect the individual 13 Subject to certain specific limitations; but again, these limitations are based on the type of expense and not the corporate form of the business. Page 7

10 from liability, either with respect to litigation or creditors, is very situational and so there are no guarantees in this regard. It is also important to understand that setting up a corporate structure adds additional complexity and additional costs. Typically, an incorporated lawyer will have two or three corporations in their structure and there may be a family trust established as well. From an accounting and tax compliance perspective, financial statements and tax returns must be prepared for each corporation and a tax return must also be prepared for the Trust. There are also additional reporting requirements related to the payment of wages, dividends and trust distributions. From a legal perspective, there are costs associated with incorporating the companies and drawing up a trust agreement. There are also ongoing costs related to annual filings and documenting corporate and trust proceedings. This additional administrative burden, and the associated costs, must be weighed against the tax benefits of incorporation and, in some instances; the costs may outweigh the benefits. This is most commonly the case where an individual has no spouse or adult children and most of the individual s income is required for ongoing living expenses since there is no ability to split or defer income in this type of situation. Concluding Comments The most significant benefits of incorporation from a tax planning perspective are the ability to receive either wages or dividends, split income with a spouse or adult children and defer personal income in excess of the amount required for living expenses. The ability to receive personal income in the form of dividends instead of wages results in an immediate tax savings and allows an individual to avoid paying CPP. However, before choosing to receive only dividends, an individual should consider the resulting loss of CPP and RRSP contribution room. Income splitting also provides an immediate tax savings, especially where the spouse is in a lower tax bracket or the individual is already planning to provide financial support to their adult children. However, income splitting opportunities would be minimal in situations without a spouse or where the spouse is already in the same tax bracket, and without adult children in receipt of financial support. Income deferral can provide a form of tax deferred investing and potentially result in tax savings in the future depending on future income levels. However, income deferral is only beneficial if income is earned in excess of required living expenses. There are definite tax planning opportunities available to an incorporated lawyer that would not be available to a judge receiving salaried remuneration. However, it is important to remember that the availability and relative benefit of these various opportunities is always dependent on the individual s specific situation. Page 8

11 Appendix A Tax Brackets and Selected Tax Rates Personal Tax Brackets and Effective Rates (2011) Federal Personal Tax Brackets and Effective Tax Rates $41,544 or Less $41,545 to $83,088 $83,089 to $128,800 More than $128,800 Tax Rate Wages 15.00% 22.00% 26.00% 29.00% Tax Rate Dividends % 10.83% 15.83% 19.58% Saskatchewan Personal Tax Brackets and Effective Tax Rates $40,919 or Less $40,920 to $116,911 More than $116,911 Tax Rate Wages 11.00% 13.00% 15.00% Tax Rate Dividends % 10.00% 12.50% Combined Personal Tax Brackets and Effective Tax Rates $40,919 or Less $40,920 to $41,544 $41,545 to $83,088 $83,089 to $116,911 $116,912 to $128,800 More than $128,800 Tax Rate Wages 26.00% 28.00% 35.00% 39.00% 41.00% 44.00% Tax Rate Dividends % 12.08% 20.83% 25.83% 28.33% 32.08% Corporate Tax Effective Rates (2011) The effective Federal tax rate on the first $500,000 of active business income earned by a corporation, subject to the small business limit, is 11.00% in 2011 and going forward. The effective Saskatchewan tax rate on the first $500,000 of active business income earned by a corporation, subject to the small business limit, is 2.00% effective July 31, 2011, and going forward. Accordingly, the effective combined tax rate on the first $500,000 of active business income earned by a corporation, subject to the small business limit, is 13.00% effective July 31, 2011, and going forward. 14 As this paper assumes income in all scenarios of less than $500,000, eligible dividends are not relevant as there is no income subject to taxation above the $500,000 small business limit threshold that would allow for the payment of eligible dividends. Accordingly, effective tax rates are only presented for other than eligible dividends, commonly referred to as ineligible dividends. Page 9

12 Appendix B Comparison of Taxes Paid in Selected Scenarios The below scenarios are intended to illustrate the tax impact of income splitting. All scenarios are based on the following assumptions: 1. The judge or lawyer earns $250,000 per annum. With respect to the judge, this is their gross annual salary. With respect to the lawyer, this is the net earnings in their professional corporation after all expenses but before taxes. 2. In order to keep the scenarios comparable, it is assumed that the lawyer will pay all funds out of the professional corporation. The funds will be paid in the form of wages or dividends, after any applicable taxes and employer CPP premiums have been paid by the professional corporation. 3. Neither the judge or lawyer, or the spouse, is old enough to draw either CPP or Old Age Security. 4. Children are age 20 or over. This is relevant as we cannot effectively split income with a child under the age of 18. Furthermore, certain tax credits are available for parents of children up to age 19, but not after age 19. Therefore, including children age 19 and under would reduce the clarity of the examples due to these tax credits which are not related to the issues at hand. 5. No additional income is earned other than the income specified in the scenarios. That is, in order to remain focused on the issues at hand, we have assumed there are no portfolio investments, rental properties, etc. 6. No deductions are claimed including for contributions to an RRSP or other pension plan. 7. The only federal and Saskatchewan tax credits claimed are: personal, spousal, tuition transfer from children, credits related to salary income, and the dividend tax credit as applicable. There are three hypothetical situations in each scenario. The first situation is that of a judge where income splitting is not available. The second situation is that of an incorporated lawyer who pays only dividends out of the professional corporation. The third situation is that of an incorporated lawyer who pays $125,000 of wages out of the professional corporation in order to maximize RRSP contribution room, and pays the remaining income out of the professional corporation in the form of dividends. In scenarios with children receiving financial support, it is assumed that the judge will pay this support to the children out of after tax income. The incorporated lawyer will pay dividends to the children out of the professional corporation and these dividends will be taxed in the children s hands. It is assumed the children have no other income and so will not pay any tax on the dividends received as discussed above. It is important to note that by receiving dividends of only $25,000 the children will not be able to utilize all of their dividend tax credits as well as their tuition and education tax credits and so some credits will be lost as the dividend tax credits cannot be carried forward. 15 However, even with the lost credits, it is still beneficial from a tax perspective to pay dividends to the children where possible. 15 The credits would be fully utilized if the children each received dividends of approximately $40,000. However, it may not be desirable to provide this level of financial support to the children. Page 10

13 Scenario 1: Income Earning Spouse and Two Children in University The judge or lawyer s spouse is employed and earns a salary of $50,000 per annum. The couple has two children in university, each receiving $25,000 per annum in financial support to help pay for tuition, books, rent, vehicle and living expenses. Situation 1 Situation 2 Situation 3 Judge Lawyer Lawyer (Dividends) (Wages) Income allocation: Judge/Lawyer: Salary/Wages $ 250,000 $ $ 125,000 Dividends 104,000 Spouse: Salary/Wages 50,000 50,000 50,000 Dividends 63,500 56,822 Child 1 Dividends 25,000 25,000 Child 2 Dividends 25,000 25,000 Retained in Prof. Corp. to pay taxes/cpp 32,500 18,178 Total Income 300, , ,000 Taxes, CPP and EI paid: Prof. Corp. Taxes 32,500 15,961 Prof. Corp. CPP 2,217 Judge/Lawyer Taxes 90,234 16,937 37,948 Judge/Lawyer CPP 2,217 2,217 Spouse Taxes 9,655 25,002 23,093 Spouse CPP 2,217 2,217 2,217 Spouse EI Taxes paid by children Total taxes, CPP and EI paid 105,109 77,442 84,438 Income after taxes, CPP and EI: Combined income 300, , ,000 Combined taxes/cpp/ei 105,109 77,442 84,438 Income after taxes, CPP and EI 194, , ,562 Difference from Situation 1 27,667 20,670 The above calculations are intended for illustration and discussion purposes only. The assumptions stated on page 10 are an integral part of the above comparative analysis. In situation 1, any financial support paid to the children is paid by the Judge out of after tax income as there is no ability to split income with the children. The judge will claim the maximum tuition transfer amount from the children. In situation 2, the children are each paid $25,000 of dividends and the remaining dividends are split Page 11

14 between the lawyer and spouse so that they each have approximately the same taxable income. In situation 3 the lawyer is allocated $125,000 of wages, the children are each paid $25,000 of dividends, and the remaining funds are paid to the spouse in the form of dividends so that the spouse and the lawyer will have approximately the same taxable income. In situations 2 and 3 there is no tuition transfer from the children to the lawyer as the children use their tuition credits themselves against the $25,000 of dividends received. Page 12

15 Scenario 2: Income Earning Spouse and No Children The judge or lawyer s spouse is employed and earns a salary of $50,000 per annum. The couple has no children receiving significant financial support. Situation 1 Situation 2 Situation 3 Judge Lawyer Lawyer (Dividends) (Wages) Income allocation: Judge/Lawyer: Salary/Wages $ 250,000 $ $ 125,000 Dividends 130,000 25,000 Spouse: Salary/Wages 50,000 50,000 50,000 Dividends 87,500 81,822 Child 1 Dividends Child 2 Dividends Retained in Prof. Corp. to pay taxes/cpp 32,500 18,178 Total Income 300, , ,000 Taxes, CPP and EI paid: Prof. Corp. Taxes 32,500 15,961 Prof. Corp. CPP 2,217 Judge/Lawyer Taxes 92,834 25,278 45,855 Judge/Lawyer CPP 2,217 2,217 Spouse Taxes 9,655 32,702 30,880 Spouse CPP 2,217 2,217 2,217 Spouse EI Taxes paid by children Total taxes, CPP and EI paid 107,709 93, ,133 Income after taxes, CPP and EI: Combined income 300, , ,000 Combined taxes/cpp/ei 107,709 93, ,133 Income after taxes, CPP and EI 192, , ,867 Difference from Situation 1 14,225 7,576 The above calculations are intended for illustration and discussion purposes only. The assumptions stated on page 10 are an integral part of the above comparative analysis. In situation 2, the dividends are split between the lawyer and spouse so that they each have approximately the same taxable income. In situation 3 the lawyer is allocated $125,000 of wages and the remaining funds are paid out in the form of dividends split between the lawyer and the spouse such that the lawyer and the spouse will have approximately the same taxable income. Page 13

16 Scenario 3: Non income Earning Spouse and Two Children in University The judge or lawyer s spouse does not earn any income other than dividends from the professional corporation in the case of the lawyer. The couple has two children in university, each receiving $25,000 per annum in financial support to help pay for tuition, books, rent, vehicle and living expenses. Situation 1 Situation 2 Situation 3 Judge Lawyer Lawyer (Dividends) (Wages) Income allocation: Judge/Lawyer: Salary/Wages $ 250,000 $ $ 125,000 Dividends 83,750 Spouse: Salary/Wages Dividends 83,750 56,822 Child 1 Dividends 25,000 25,000 Child 2 Dividends 25,000 25,000 Retained in Prof. Corp. to pay taxes/cpp 32,500 18,178 Total Income 250, , ,000 Taxes, CPP and EI paid: Prof. Corp. Taxes 32,500 15,961 Prof. Corp. CPP 2,217 Judge/Lawyer Taxes 87,056 11,408 37,948 Judge/Lawyer CPP 2,217 2,217 Spouse Taxes 11,408 4,933 Spouse CPP Spouse EI Taxes paid by children Total taxes, CPP and EI paid 89,273 55,315 63,276 Income after taxes, CPP and EI: Combined income 250, , ,000 Combined taxes/cpp/ei 89,273 55,315 63,276 Income after taxes, CPP and EI 160, , ,724 Difference from Situation 1 33,958 25,997 The above calculations are intended for illustration and discussion purposes only. The assumptions stated on page 10 are an integral part of the above comparative analysis. In situation 1, any financial support paid to the children is paid by the Judge out of after tax income as there is no ability to split income with the children. The judge will claim the maximum tuition transfer amount from the children. In situation 2, the children are each paid $25,000 of dividends and the remaining dividends are split Page 14

17 between the lawyer and spouse so that they each have approximately the same taxable income. In situation 3 the lawyer is allocated $125,000 of wages, the children are each paid $25,000 of dividends, and the remaining funds are paid to the spouse in the form of dividends; the spouse will have significantly lower taxable income than the lawyer, but this is a result of the lawyer requiring $125,000 in wages in order to maximize RRSP contribution room. In situations 2 and 3 there is no tuition transfer from the children to the lawyer as the children use their tuition credits themselves against the $25,000 of dividends received. Page 15

18 Scenario 4: Non income Earning Spouse and No Children The judge or lawyer s spouse does not earn any income other than dividends from the professional corporation in the case of the lawyer. The couple has no children receiving significant financial support. Situation 1 Situation 2 Situation 3 Judge Lawyer Lawyer (Dividends) (Wages) Income allocation: Judge/Lawyer: Salary/Wages $ 250,000 $ $ 125,000 Dividends 108,750 5,000 Spouse: Salary/Wages Dividends 108, ,822 Child 1 Dividends Child 2 Dividends Retained in Prof. Corp. to pay taxes/cpp 32,500 18,178 Total Income 250, , ,000 Taxes, CPP and EI paid: Prof. Corp. Taxes 32,500 15,961 Prof. Corp. CPP 2,217 Judge/Lawyer Taxes 89,656 18,461 39,438 Judge/Lawyer CPP 2,217 2,217 Spouse Taxes 18,461 16,283 Spouse CPP Spouse EI Taxes paid by children Total taxes, CPP and EI paid 91,873 69,421 76,116 Income after taxes, CPP and EI: Combined income 250, , ,000 Combined taxes/cpp/ei 91,873 69,421 76,116 Income after taxes, CPP and EI 158, , ,884 Difference from Situation 1 22,452 15,757 The above calculations are intended for illustration and discussion purposes only. The assumptions stated on page 10 are an integral part of the above comparative analysis. In situation 2, the dividends are split between the lawyer and spouse so that they are each have approximately the same taxable income. In situation 3 the lawyer is allocated $125,000 of wages and the remaining funds are paid out in the form of dividends split between the lawyer and the spouse such that the lawyer and the spouse will have approximately the same taxable income. Page 16

19 Scenario 5: No Spouse and No Children The judge or lawyer has neither a spouse nor children. Situation 1 Situation 2 Situation 3 Judge Lawyer Lawyer (Dividends) (Wages) Income allocation: Judge/Lawyer: Salary/Wages $ 250,000 $ $ 125,000 Dividends 217, ,822 Spouse: Salary/Wages Dividends Child 1 Dividends Child 2 Dividends Retained in Prof. Corp. to pay taxes/cpp 32,500 18,178 Total Income 250, , ,000 Taxes, CPP and EI paid: Prof. Corp. Taxes 32,500 15,961 Prof. Corp. CPP 2,217 Judge/Lawyer Taxes 92,834 53,351 72,105 Judge/Lawyer CPP 2,217 2,217 Spouse Taxes Spouse CPP Spouse EI Taxes paid by children Total taxes, CPP and EI paid 95,051 85,851 92,500 Income after taxes, CPP and EI: Combined income 250, , ,000 Combined taxes/cpp/ei 95,051 85,851 92,500 Income after taxes, CPP and EI 154, , ,500 Difference from Situation 1 9,200 2,550 The above calculations are intended for illustration and discussion purposes only. The assumptions stated on page 10 are an integral part of the above comparative analysis. In situation 2 the lawyer is paid entirely in the form of dividends. In situation 3 the lawyer is allocated $125,000 of wages and the remaining funds are paid out in the form of dividends. Page 17

20 Value Worth Expertise Our goal is to provide timely, practical solutions and strategic business advice on every engagement. If you want to explore a partnership with Virtus Group please contact us at: Regina Central Park Place Scarth Street Regina, Saskatchewan S4P 2J6 Phone: Fax: Toll free: Saskatoon The King George Building Suite nd Ave North, Saskatoon, Saskatchewan S7K 2A9 Phone: Fax: Toll free: Website:

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