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Incorporation brings tax advantages for law firms

There are both tax and non-tax related reasons for lawyers to consider incorporation, but to date, only a small number of firms have structured themselves in this way, Toronto tax litigation lawyer David J. Rotfleisch tells Law Times.

Law firms have been able to incorporate since 2001, but as Rotfleisch, founding tax lawyer at Rotfleisch & Samulovitch Professional Corporation, explains, “lawyers have always been notorious for their lack of tax planning.”

As Law Times notes, the main benefit of incorporation is tax deferral by retaining earnings in the professional corporation. A professional corporation can also take advantage of the $800,000 capital gains exemption available for the sale of a small business, which can be claimed on the sale of shares of a qualifying corporation, but not for the sale of a sole legal proprietorship or a legal partnership, says the article.

Another advantage is that professional corporations incorporated in Canada by lawyers who are Canadian residents will most likely qualify as a “Canadian-controlled private corporation,” and can therefore claim the small business deduction. 

“The small business deduction features a reduction of the normal corporate income tax rate on the first $500,000 of a corporation’s annual taxable income earned from carrying on an active business in Canada,” Rotfleisch says in the article. 

Depending on the province, the corporation will pay tax at between 11 and 16 per cent on its first $500,000 of taxable income, with the remaining tax paid by shareholders when they receive dividends.

“The deferral is significant, especially for a taxpayer in the top marginal tax bracket, and means that approximately twice the funds are available for investment, since in effect tax money is being retained in the corporation and invested,” says Rotfleisch.

When it comes to non-tax benefits to incorporation, the main advantage is liability protection, says Rotfleisch. However, he explains, a professional corporation provides no additional limitation on liability for professional negligence claims.

“But it can provide some protection from creditors from whom the corporation has borrowed money,” he adds.

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