Case Study: How dividend tax changes hurt two Hamilton Physicians

This is a real-life situation from last week.  I’ve changed the names and some of the personal details, but the key takeaways are the same.

By now, all business owners and physicians have heard about the proposed passive tax changes (we’re expecting to hear the details during the upcoming budget).  But there was one change effective January 1, 2018 that has had a very real impact on business owners/physicians.  Tax on split income (TOSI)This is a real-life example (using fake names) from a meeting last week:

Client Profile
Dr. Mike Jones (45 years)
Dr. Emily Jones (43 years)
2 Children, 10 & 8

Client Circumstances
Mike & Emily met while attending medical school at The University of Florida.  Upon their graduation in 1996, they immigrated to Hamilton, Ontario.  Mike has been a full time pediatric specialist in Canada since 1999.  While Mike was building his professional practice in Hamilton, Emily stayed home to raise their brand new babies.  Fast forward, the children have gotten older and Emily is back at school to re-qualify as a physician (OBGYN) and is now in residency (for another 2 years).

Both Mike & Emily are shareholders of the same Medicine Professional Corporation.  While the family has earned one income, the corporation paid a dividend to both Mike & Emily for the past several years (this has been ‘normal’ tax planning for many years).  This type of income planning is commonly referred to as ‘dividend or income sprinkling.’

I sat down with Mike and Emily back in early 2016 to talk more specifically about their retirement planning (ie. savings, tax, wills, etc.) and review their insurance.  Given Mike is the only income earner for the family (until Emily becomes a full time physician), we all felt it was important to make sure he had adequate life, disability and critical illness insurance to make sure his family is protected in the event of a catastrophic health event (or death).  We implemented some term life insurance, a maximum long term disability contract with the Ontario Medical Association (OMA) and a critical illness insurance contract.

What Happened?
Effective January 1, 2017, the Liberal Government implemented new rules for dividends (referred to as “Tax on Split Income” or “TOSI”).  The biggest impact on Mike and Emily was the change of definition of “specified individual” which now excludes Emily’s ability to receive a dividend from the Medicine Professional Corporation (even though she’s a shareholder and a physician).

The new rule requires that Emily to satisfy a “reasonableness” test:

  • The work performed by the individual (min 20 hours per week);
  • The property contributed directly or indirectly by the individual (their corporation owns no property);
  • The risks assumed by the individual in respect of the business (not applicable);
  • The total amounts already paid to or for the benefit of the individual in respect of the business (not applicable); and
  • Any other factors that may be relevant.

Since Emily is a resident (and earning a salary from the hospital), she does not satisfy the reasonable test outlined above (if she were able to work 20 hours per week (in addition to the 60+ hours resident doctors currently work), it would be considered ‘reasonable’).

Why is raising a family not contribution? My friends at Moody Gartner said the following:

“Finally, as has been common with our existing government, a gender-based analysis commentary is included as part of the TOSI proposals:

Data show that men represent over 70% of higher-income earners initiating income sprinkling strategies, and women represent about 68% of recipients of sprinkled dividends (and 58% of recipients of income derived from trust and partnerships). While this income is of benefit for recipients, it also creates incentives that reduce female participation in the workforce. Increased participation of women in the workforce is a source of economic opportunity for individuals and is a major driver of overall economic growth.

We had to read the above twice to make sure the government was serious when they produced such commentary. Really? This statement is shocking especially to members of our firm who have children and stay-at-home spouses. Without exception, the decision for members of our firm who have stay-at-home spouses was made for the betterment of the family as a whole with tax impacts not at all being part of the analysis for the resulting decision. To suggest that the income-sprinkling proposals will contribute to incentives for stay-at-home females to enter the workforce is nonsensical and offensive (notwithstanding that the authors are not economists and have not studied gender-based issues but instead rely on real life and common sense).” (source)

As a result of this change in tax rules, I received a call from Mike and Emily last week saying that due to their increased tax burden (caused by the elimination of dividend sprinkling) they need to cancel the critical illness insurance that was intended to protect them.

Personally, I’m outraged.  We have two highly trained individuals who immigrated to Canada and help our children/families each day.  Despite their efforts to move ahead with proper planning and implement strategies to protect their own family, the rug has been ‘pulled out’ from under them, leaving their family at a financial risk if something unexpected happens to Mike.

Is this what the Liberal government intended?   Why are we treating our physicians this way?