Since the federal government removed income splitting with family members in 2017, many physicians and dentists had to pay more taxes in order to maintain the same standard of living. Since this change, other tax deferral strategies such as IPP and RCA have gained their appeal. We are also seeing more clients making use of life insurance to shelter a portion of their corporate surplus.

Surplus Stripping

One particular strategy that gained a lot of traction in the past two years was surplus stripping. The usual method to extract savings out of the corporation is through dividend. In Ontario, if you are in the highest marginal tax rate, the dividend tax rate is 47%. The Surplus Stripping strategy, in a nutshell, is to convert these dividends to capital gain, resulting in a tax arbitrage of about 20%. For example, for a $100,000 withdrawal, you would save about $20,000 in taxes by converting the dividends to capital gain, assuming you are in the highest tax bracket.

Why isn't everyone using it?

1. It is a sophisticated strategy that involves a tax lawyer to layer the steps properly. The setup cost is high and it only makes sense if you have substantial savings in the corporation for extraction.

2. The tax savings are highest if your income is already in the highest marginal tax rate. The savings will be less if your marginal rate is lower.

3. You are still paying taxes on the withdrawal - taxes that can be deferred if you leave the money in the corporation for investment. That is why our clients who have used this strategy are not using it for investment purpose, but to reduce personal debt.

It may not be the best time to consider this strategy as many accountants and lawyers predict that the government will be closing this loophole in their next budget. They already tried killing it in 2017 but due to massive push-back from lawyers and accountants, it was put on hold. It would be a good idea to look into this surplus stripping strategy if it survives another budget.

Clarity MD Services