QUESTION:
Dear Mr. Ingram,
I’ve read your Nov 2001 newsletter (along with several e-mail answers) and
you have consistently maintained that one should “kill” their professional
corporation in order to utilize the “cash flow dam” method of the Smith
Manoeuvre.
However, there is seems to be an equally simple way to use the exact same
strategy using a corporation and avoid “killing” it. Many professionals are
incorporated in order to tax defer profits at the small business rate. As
such they have accumulated funds in their company and so it may make no
sense to “kill” the company and pay-out the retained earnings (potential big
tax hit). If there are retained earnings, then the company has to stay alive
and legal/accounting fees will have to be paid anyway.
Consider the following:
1. Professional Corp. sets up 2 bank accounts
2. All revenue is deposited into A/C #1 on and all expenses are paid from AC
#2
3. Shareholder borrows from personal LOC and lends to AC #2 as a
shareholders loan. Interest on LOC is tax deductible since loan can be shown
to clearly pay for operating expenses
4. Company re-pays the shareholders loan from AC #1 which he/she then uses
to pay down mortgage
This is pretty simple to set-up and is no more complicated than the Nov 2001
set-up. Furthermore, if there are multiple shareholders (e.g. husband/wife)
in different income tax brackets, the corporation provides the flexibility
as to which shareholders can contribute towards expenses and thus deduct the
LOC interest. This could be done for example if husband own 100% of class A
shares & wife 100% of class B shares.
In conclusion, simple bookkeeping can ensure that incorporated professionals
can still enjoy tax deferral/small business taxation and still effectively
employ the cash dam strategy in order to make their mortgages tax deductible
without “killing” their professional corporations. Do you agree ?
