Is Incorporation Right for my Situation From a Tax Point of View? or “What Brokers Acting on behalf of an Agency Should Know Before Planning to Practice Through a Corporation”

Source: M^e Alain Ranger from Fasken Martineau

As of January 1, 2012, brokers who act on behalf of an agency may carry on brokerage activities through a business corporation under their control, in accordance with the terms, conditions and rules set out in the Real Estate Brokerage Act and determined by the OACIQ.

Incorporation certainly has its advantages, but also carries its share of disadvantages; the pros and cons will vary with each broker’s situation.

A few basic tax questions apply when considering whether or not to incorporate one’s practice. The following information is, however, of a general nature only and is not intended to be tax advice to any particular broker or group of brokers, nor to constitute an exhaustive list of all the tax considerations that could affect one’s analysis. Rather, this text is intended to be a point of departure for brokers thinking of incorporating their practice, who should first consider the following factors.

1 - What kind of income do I need to sustain my lifestyle?

One of the primary tax advantages of incorporation of brokerage activities is the possibility of benefitting from the advantageous tax rates that apply to a corporation’s earnings. For example, a corporation that is eligible for the small business deduction would have been able, in 2015, to benefit from a 19% tax rate, instead of the 49.97 % that applies to income subject to the top marginal personal tax rate.¹ If a corporation is not eligible for the small business deduction because it operates a personal services business (see number 2 below), it would have been taxed at a rate of 39.9 %.

These tax savings, as attractive as they may seem, are nonetheless only real with respect to the amounts that remain in the corporation. If all the profits generated by the corporation’s activities are required to maintain the broker’s lifestyle, then the corporation’s earnings will have to be paid to the broker by the corporation, either in the form of salary or bonuses deductible at the corporate level, or in the form of taxable dividends. Incorporation of brokerage activities could therefore translate into increased tax cost for brokers who need all the profits generated by the economic activities, as these brokers must take into account the personal taxes that have to be paid on income thus received from the corporation. The net result of this could therefore be that the net amount that they would retain after corporate and personal taxes would be practically identical to, or even less than, the amount they would have retained prior to incorporation.

When considering incorporation, it is also important to take into account the additional operating costs that such a transition would incur. Incorporation consists in adding a corporation through which the brokerage activities will be exercised. Creation of a corporation involves costs for incorporation and compliance with taxation and corporate authorities. Record keeping, preparing financial statements and yearly income tax returns, complying with the Registraire des entreprises’ annual reporting requirements, and drafting annual resolutions and dividend declarations where applicable are among the normal expenses that arise from operating a corporation. If the amounts that a broker expects to be able to leave in the corporation and the related tax benefits are insufficient to compensate for these operating costs, incorporation might not be the best solution for that broker’s needs.

2 - What type of relationship exists between the broker, the corporation and the agency and what type of income does the corporation earn?

When a corporation is considered for tax purposes to be operating a “personal service business,” it is not eligible for the small business deduction and the deductions available in computing its income are limited. In addition, the corporation that operates a personal service business cannot benefit from a reduction in the general corporate tax rate enjoyed by most corporations operating an active business. Thus, in 2015, the personal service businesses were subject to a tax rate of 39.9 %.

A personal service business exists when an individual provides services to an agency on behalf of a corporation and where it is reasonable to consider that the broker would be an employee of the agency to whom the services are provided if it weren’t for the existence of the corporation. There is a risk of the corporation being considered, following incorporation of one’s brokerage activities, as operating a “personal services business” if, before incorporation, the broker practiced its activities as an employee of the agency and if the business relationship that existed between the broker and his or her former employer did not truly change following incorporation of the brokerage practice. It is therefore important to determine this status before taking any steps towards incorporation.

3 - What is the projected use of the tax savings retained in the corporation?

While the tax savings that may be retained in the corporation can justify its existence in some cases, the ultimate use that will be made of these amounts should also be considered as part of analysis of the option to use corporation to practice one’s brokerage activities.

If the savings thus accumulated by the corporation are put into investments that generate passive income for the corporation, for example interest or dividend income, the corporation would have initially been taxed, in 2015, at a rate of 46.6% and 33.33% respectively, compared to the 49.97% rate that applies to individuals subject to the top marginal personal tax rate. The tax savings on the passive income earned by the corporation could therefore be minimal, depending on the case, and the amount of time that the amounts are kept in the corporation before distribution to the broker in the form of a taxable dividend becomes another factor to consider.

The amount of tax savings realized by the professional activities (i.e. available for investment) can, however, facilitate acquisition of value growth investments, such as rental properties or shares in publicly-traded companies. The tax savings would then allow for significant leverage that could be used for accumulation of capital. Again, all this depends on the period during which one plans to leave the amounts in the corporation.

4 - Can I do some income-splitting?

Income splitting is one of the other tax benefits of operating through a corporation. Essentially, income splitting allows for revenue to be earned by individuals in a lower tax bracket than the individual who would normally earn that income. For example, if a spouse who does not have other income receives a dividend from the broker’s corporation, the net tax to be paid would be lower than had the broker received that same dividend. But income splitting is generally only permitted for persons of legal age; incorporation today would not usually be justified if the deciding factor was to be able to split the income taxable dividends with children who won’t reach the age of majority for another ten years, for example.

These four factors can be useful in considering whether incorporation would be advantageous from a taxation viewpoint.

Brokers for whom incorporation is an option, however, are strongly encouraged to consult a tax professional in order to precisely evaluate their situation and determine the tax impact of incorporation on their professional activities and their personal and financial life.

Note:
¹ In its March 2015 budget, the Government of Québec  announced that the small businesses deduction would be limited to companies with more than three full-time employees as of 2017. The tax rate of companies incorporated by professionals will be increased by approximately 4% for the first $500,000 of income generated by the company.