Hugh Faloon, CPA, CA, TEP
Under current tax legislation, physicians are entitled to split their income with family members, effectively making spouses and children shareholders in their professional corporations. This is known as income splitting, or “income sprinkling.”
In its communications, the federal Department of Finance is portraying these advantages as unfair to other middle class taxpayers, the bulk of whom are salaried employees.
Because tax law is complex, and difficult for most Canadians to understand, the federal government’s argument may seem, on the surface, to be reasonable. “Why should doctors and other small business owners enjoy special tax benefits, while others pay the federal and provincial tax collectors significant percentages of their income at fixed rates?” some might say.
Let’s examine the ‘why’
First, “income sprinkling” for physicians did not appear from thin air, but emerged, at least in part, from negotiations between doctors and the provinces.
In Ontario, one of the last provinces to allow professionals to incorporate businesses, these tax advantages are “tied” to physician fees – in other words, the fixed amount of taxpayer dollars that Ontario physicians charge for whatever service they provide patients.
Simply put, federal tax incentives that provincial incorporation allows, means Ontario taxpayers are indirectly paying less for health care than would otherwise be the case. As a result, we all benefit.
We all have an appreciation of the costs involved in post-secondary education, but few of us fully understand what a person goes through in terms of years of study and tuition costs to become a doctor. And, in the short term at least, how relatively small the financial rewards are.
From the end of high school through the end of medical school takes approximately seven years. Family doctors require two years of post-graduate training, with usually a third year added for additional training in skills in emergency and/or palliative care.
Internal and pediatric medicine requires four years’ post-graduate, plus (usually) a fellowship year. Cardiac and Neurosurgery training can be six years plus a year of fellowship.
Post graduate salaries range from about $58,000 for the first year to $92,000 by year eight.
During these long training years, doctors are paid as residents, and it is well known that residents do not work 35 to 40 hours a week. They work in a range of 60 to 90+ hours per week.
Let’s not forget the debt. It is not uncommon for doctors to finish their university and post-grad training with $250,000 in debt.
Once in practice, a family doctor incurs costs in the range of 40% of their billings to run their medical practice. This excludes the other potential business costs related to employees, long-term leases, professional liability, etc.
A medical professional corporation (MPC) is taxed 15% on the first $500,000 of net income. If the MPC is part of a partnership, the tax rate is 26.5% on the related partnership income. Dividends are then paid out of the after-tax corporate income to the shareholder for a second round or potential personal tax.
In April 1, 2015, the Ontario government reduced various medical services fees by 2.65%, in addition to the previous reduction of 0.5% in 2013, for a total reduction in fees of 3.15%. Obviously, these reductions represented a decrease to doctors’ income.
I don’t believe there is a significant doctor “brain drain” from Canada to the U.S. at the moment, and I am not suggesting that the loss of an income-splitting advantage will have self-employed Canadian doctors lining up for green cards, but these developments are certainly bringing the thought to consideration.
But consider this: The federal proposals would push physicians’ tax rates 6% higher than in New York City, which is one of the highest tax rates in the U.S.A.
The currently existing income-splitting rules, with a spouse with no other income, actually make Canada competitive with the U.S. In the U.S., you can file joint tax returns with your spouse, which is the U.S.A.’s version of income splitting.
In Ontario, our top rate of tax starts at $220,000. Based on research by the Fraser Institute[1], the top rate of tax in all states in America starts at over $500,000 CAD. In order to get close to that average of tax in the U.S., a Canadian doctor using an MPC must do full income splitting with a spouse in a given year (did I not say our tax system was complex?).
The tax benefit doctors receive through current income splitting is a risk-adjusted return on their investments – investments in the form of years and financial cost of university; training as a resident at low average hourly wage; starting their career later in life; assuming significate business risk; funding their own pensions; and being responsible for the economic welfare of their employees.
In justifying the claw back of the income-splitting benefit, the federal Finance Department compares doctors to the average high-income-earning employee. Yet, the employees have no business and financial risk and, in most cases – especially in the case of government employees – they can look forward to pensions and other benefits that self-employed doctors do not get.
The Department of Finance needs to rethink these proposals
Let’s not create a situation where we give our doctors the best in education and training only to put them in a financial situation that makes them want to look for alternative opportunities.
The government would have us believe that removing this piece of tax relief for physicians is an attack on the rich, when really it is an attack on common sense and sound economic reasoning, and against the best interests of communities across Canada.
Hugh comes from a family of doctors, granting him a unique perspective into the world of health professionals. Hugh relates closely to the doctors he works with; this provides him insight and focus on tax and financial planning for MDs first practicing to beyond retirement.
[1] Watson, W., & Clemens, J. (2017). The History and Development of Canada’s Personal Income Tax: Zeo to 50 in 100 Years. Fraser Institute.
