Should You Incorporate Your Business? A Physicians Guide

May 27

Pros and cons of incorporation, tax implications, and financial benefits.

Incorporation is a major decision for any professional, and physicians in Canada have unique factors to consider. This guide breaks down what incorporation means for medical professionals, the potential benefits and pitfalls, and when it might make sense to take that step.

What is a Professional Corporation?

Physicians in Canada may incorporate their practices as "professional corporations." Unlike regular corporations, these are governed by provincial or territorial legislation and medical regulatory bodies. While professional corporations share many tax advantages with regular business corporations, there are important legal and financial differences that affect physicians specifically.

Tax Advantages of Incorporation

The most significant advantage of incorporation is the opportunity to defer taxes by leaving income inside the corporation. Instead of being taxed at the top personal rate, retained earnings are taxed at a lower corporate rate.

Small Business Deduction

Thanks to the Small Business Deduction, the first $500,000 of active business income earned by a corporation is taxed at a reduced rate. In many provinces, this combined federal and provincial rate is around 15 percent.

For physicians who do not need to withdraw all of their income to meet personal expenses, leaving retained earnings in the corporation creates a substantial tax deferral opportunity compared to earning that income personally.

However, physicians in group practices or partnerships may have to share the $500,000 deduction limit across the group, which can reduce the benefit.

Income Splitting Rules

Income splitting used to be a significant advantage of incorporation. However, the Tax on Split Income (TOSI) rules introduced in 2018 restrict the ability to split income with family members through dividends unless certain exemptions apply.

In some provinces, physicians may still have the option to issue non-voting shares to adult family members who are actively involved in the business. Before implementing an income splitting strategy, consult a tax advisor and review the rules set by your province’s medical regulatory authority (such as the College of Physicians and Surgeons).

Choosing Salary or Dividends

Professional corporations give physicians flexibility in how they pay themselves. Income can be taken as salary, which reduces corporate income and creates RRSP contribution room, or as dividends, which are not subject to CPP contributions.

A combination of salary and dividends may offer the most strategic outcome, depending on cash flow needs, retirement goals, and tax planning. For example, some physicians choose to pay themselves enough salary to create RRSP room while leaving the rest in the corporation to take as dividends later, often in lower-income years.

Physicians should work with their tax advisor to determine the optimal mix, especially if they’re planning to retain earnings in the corporation or access the Small Business Deduction.

Key Disadvantages for Physicians

Personal Liability Still Applies

One common misconception is that incorporation protects physicians from professional liability. This is not the case. A physician remains personally liable for professional actions, even when practicing through a corporation. Incorporation does offer some protection from general business liabilities, but not from malpractice or negligence claims.

Higher Costs and Administrative Burden

Running a professional corporation comes with added costs and paperwork. You will need to:

Register and maintain a corporation
File annual corporate tax returns
Prepare T4 and T5 slips for salary and dividend payments
Pay legal and accounting fees

These expenses can outweigh the benefits if your practice does not generate enough surplus income.

Lifetime Capital Gains Exemption Does Not Apply

Unlike many small business owners, physicians cannot use the Lifetime Capital Gains Exemption (LCGE) when selling shares of a professional corporation that holds a medical practice. This is because a physician’s patient base is often considered personal goodwill, not a saleable asset.

In some rare cases where a physician has developed a highly transferable and profitable clinic model, there may be opportunities for partial sale, but the LCGE generally does not apply.

Investing Inside the Corporation

When income is retained within the corporation, it can be invested. However, passive income earned inside a professional corporation is taxed at higher rates than active business income. Interest income is typically taxed at over 50 percent, while capital gains are more tax-efficient because only half the gain is taxable. Eligible Canadian dividends are subject to a refundable corporate tax of approximately 38 percent.

It’s important to note that passive investment income above $50,000 in a given year may begin to reduce the corporation’s access to the small business deduction. If passive income exceeds $150,000, the deduction may be fully eliminated.

Some provinces restrict how much investment activity a professional corporation can undertake. In most cases, the temporary investment of surplus funds is acceptable. Still, physicians should review the rules in their jurisdiction to avoid unintentionally operating an “investment business” or compromising their corporate status.

Holding Companies and Management Companies

Physicians in provinces where holding companies are permitted to own shares in a professional corporation may be able to transfer retained earnings to a holding company via tax-free intercorporate dividends. This structure can offer additional protection from non-practice-related liabilities and greater flexibility for investing surplus corporate funds.

If holding companies are not permitted or feasible due to professional regulatory restrictions, some physicians use management companies to extract profits through service agreements. However, this structure can be complex, may have GST/HST implications, and is not always permitted under provincial rules for professional conduct. Consult your tax advisor before proceeding.