The following article was written by Company Founder James Byrne for the Orthodontics Society Ireland.
The purpose of this article is to discuss the tax benefits of incorporation and to highlight some possible pitfalls, regulatory issues are outside the scope of the article.
Incorporation as a company (limited or unlimited) has been quite common across professions such as pharmacy and architecture where there are no regulatory impediments. Up to recently however the medical and dental profession have shied away from incorporation.
The benefits of incorporation can be summarised under the following two headings:
1) A significantly lower rate of tax for profits retained in the company compared to the top personal rate.
2) A more favourable pension environment for pension investments.
Corporation Tax Rate Verses Personal Tax and Levies
The standard corporation tax rate is 12 ½ %. For a professional services company which is a closed company (i.e. a company controlled by 5 or fewer people) there is an effective surcharge of 7 ½ % of undistributed income. This is an effective tax rate of 19%.
The disadvantage of this is that to avail of this low rate, the money must be left inside in the company and is not available for personal use. It can however be used to acquire investment or placed on deposit.
An orthodontist makes a profit of €350,000 before his directors salary, and takes €150,000 directors salary. He pays normal income tax on the €150,000 as if he was self employed except he pays it through the PAYE system.
Corporation tax on €200,000 is €38,000.
If the income was earned as a sole trader the tax including PRSI, levies etc on the additional €200,000 is €109,500 an effective rate of 54.75%.
If the profit left in the company is subsequently taken as salary PAYE is payable at the full rate. If the funds are left in the company long term they can be extracted at retirement or death with a much reduced tax rate or depending on the circumstances no additional tax.
Improved Pension Contributions
For a self employed person pension contributions are restricted to a percentage of your income depending on age but it is also restricted to a maximum pensionable income of €150,000. Thus for a person of 60 years the maximum contribution is €150,000 @ 40% = €60,000.
The position for a company director is totally different. There are far less restrictions on a company scheme. A company scheme cannot have more than €5M approximately in the funds for each member and cannot provide for a pension greater then two thirds of salary for the director. The effect of this is that larger pension contributions can be made when the practise is carried on through a company then as a sole practitioner.
Capital Gains Tax
On transfer of the practise to a company a charge to capital gains tax can arise on any asset (including goodwill) which is transferred at in excess if its original cost. There is a relief where the practise is transferred as a going concern, and all the assets are transferred for shares. There can be practical problems where the orthodontist owns the premises and does not wish to transfer this to the company. These problems can in general be solved but it is important to take appropriate professional advice.