Law Times

Law Times • December 1, 2008 Tax Assessments Professional Appraisal Opinions - Trusted Values Find a professional real estate appraiser www.oaaic.on.ca 416-695-9333 Focus On BUSINESS OF LAW Incorporating law firms offers tax advantages L BY IAN HARVEY For Law Times Clifford M. Goldlist, a senior tax partner at Lerners LLP in Toronto, who finds himself spending more of his time guiding fellow members of the bar through the process. "Until 2001 Ontario awyers seeking tax relief should consider incorpo- rating their businesses, says sionals were prohibited from incor- porating," he says. "Even after the Ontario Business Corporations Act was amended that year, it was sev- eral years before the Law Society Act was amended to make it permissible for lawyers to incorporate." Since the path has been cleared to incorporate, lawyers have begun to do so and while it hasn't exactly been a stampede, Goldlist says that the pace is picking up of late. "Certainly their accountants profes- claims such as from landlords and suppliers. The big advantage is the significantly lower marginal corpo- rate tax rate and tax-planning op- portunities to reduce and defer tax. "The small business deduction is available only to Canadian-con- trolled private corporations," says Goldlist. "Income which qualifies for the small business deduction (generally, active business income net of expenses not exceeding the annual business limit –– $400,000 federally and $500,000 in Ontar- io) is taxed at a combined federal and Ontario rate of 16.5 per cent in 2008 and 2009. That's about 30 per cent less than the combined federal-Ontario top personal mar- ginal tax rate of 46.41 per cent which most practising lawyers in Ontario are paying." are pushing them this way," he says. "And there's been much dis- cussion of the subject of late at professional conferences. By the time they get to my office and sit down, they have a good idea and want to know if the tax benefits are really worth the effort." He says there are several clear advantages, especially in the area of tax savings and deferral. There are a couple of wrinkles around incorporating, he says, one is that to qualify under the rules the practitioner must first get a certifi- cate from the Law Society of Up- per Canada and the other is that all shareholders of the company must be lawyers. No non-lawyers may be shareholders, which means spouses, children, and other administrative staff or managers cannot hold an equity position. Also, the only busi- ness the corporation is permitted to carry on is the practice of law. On the non-tax front, though incorporation does not offer any additional shield from professional liability claims, it does afford liabil- ity protection for non-professional Leaving the money in the corporation to shoulder the overhead and other business ex- penses, including a salary to the practitioner, will immediately cut the tax rate as long as the profes- sional does not need the remain- ing money to live on. Also, leav- ing the money in the corporation, including the 30 per cent annual tax savings creates a greater source of capital to finance the practice or invest in other things, he says. "You can reinvest with 83.5-cent after-tax dollars rather than with 53.5-cent after-tax dollars," Goldlist points out. "It' see that this alternative can be very attractive to a mature lawyer earn- ing good money with adult children and who does not need to spend everything he or she earns." While the rules don't allow for "income splitting" in the tradition- al sense, they do open the door to channel funds to spouses and adult children in other ways. First, he says, lawyers whose s not rocket science to society's rules to be shareholders. under the law Clifford Goldlist says there are several clear advantages to incorporating, especially in the area of tax savings and deferral. yers happens more often than you might think," he says. "Many law- yers' spouses maintain their pro- fessional qualification but don't practise for a variety of reasons." There's also an option to set up a management corporation owned by a trust to benefit the practitio- ner's spouse and adult children, which can be administered by the practitioner as trustee. The management corporation "That both spouses are law- Goldlist says that alternative is generally not as effective for tax-planning purposes where the practitioner has a professional cor- poration because associated cor- porations must share the annual small business limit. In those cases where the management corpora- tion does not provide any added benefit, a degree of income split- ting can still be achieved by having the professional corporation em- ploy the spouse and adult children and pay them a reasonable salary. Another potential advantage, he says, is the corporation can pay for certain non-deductible expenses, such as corporate-owned term life insurance premiums and the non- deductible portion of corporately leased automobile costs, and meal and entertainment expenses (in- cluding golf club membership, and social and sports club dues and fees), where they are business de- velopment related and there's scope for the professional corporation to set up and administer an individual pension plan for the practitioner. For those already practising in spouses are lawyers but not prac- tising can also benefit from the professional corporation because they are allowed can provide leased premises, staff- ing, administrative, and other sup- port services, such as computer, photocopier, and other equipment leasing arrangements, IT services, bookkeeping, and the like to the professional corporation on a cost- plus-15 per cent basis. The in- come earned by the management corporation will generally qualify for the small business deduction. If the spouse and adult children have no other income they can receive up to $32,000 a year each in tax-free dividends from the management corporation. They can also be paid a reasonable salary by the management corporation if they are employed to provide services to the practice. ning to reorganize the firm so the professional services of the partners are rendered to the partnership through their own independent professional corporations. The central management and administration functions of the firm are still provided by the partnership. The lawyers' pro- fessional corporations invoice the partnership for their services while the partnership in turn invoices the clients as before. As a result, the practitioners earn most of their income not as mem- bers of the partnership, but through the billings of their professional cor- porations to the partnership. Those billings will thus reduce the income of the partnership accordingly. partnership, including a limited liability partnership, a profes- sional corporation can also offer significant tax advantages. The latter needs careful plan- rules and some pitfalls, including stickhandling around the require- ment that the small business de- duction must be shared amongst partners, ensuring the operation is not deemed a "personal services business" and thus not qualified for small business deduction. Avoiding the "general anti- There are, however, a myriad of PAGE 9 avoidance rule" as such means an advance income tax ruling should be sought first, but Goldlist says there are several instances over the last few years where favourable rul- ings have been obtained. Though the dual structure can overcome these adverse income tax rules, it is not entirely without some issues of its own. One is the CRA apparently will not consent if the lawyers' professional corporations are not free to solicit work for them- selves free of any responsibility not to compete with the partnership. "That stipulation can certainly there, but I'm not sure how realistic it is, is the potential $750,000 lifetime capital gains exemption in the event of a sale of the practice or on the death of the lawyer," says Goldlist. In a sale, the buyer must agree to buy the shares of the profes- sional corporation which must also be "qualified small business corpo- ration shares." However, he says, if the professional corporation is successful, as is hoped, it will have significant retained earnings in the form of investments which likely will render it unable to qualify. cause problems at the partnership level," he says. On the downside there are some compliance costs and added ac- counting costs, including income tax returns and GST registration and remittances on behalf of the professional corporations, he says. And there can also be issues around allocating profits derived from as- sociates which will continue to be generated at the partnership level. "The last carrot dangled out LT Generate, search and submit documents for registration, then manage the transfer of closing funds — all from your desktop. The Conveyancer® www.doprocess.com Software Teraview® www.teraview.ca Software Closure™ www.closure.ca Service Access to and use of the services and products available are subject to terms and conditions, availability and pricing, all of which can be changed without notice. © 2008 Teranet Inc. Teranet, Teraview and the Gateway design are registered trademarks of Teranet Inc. Closure is a trademark of Teranet Enterprises Inc. The Conveyancer is a registered trademark of Do Process Software Ltd. All rights reserved. Untitled-13 1 www.lawtimesnews.com 4/16/08 4:25:13 PM 3571/04.08

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