Legislation approved January 24, 2008 and effective January 1, 2009, now allows BC real estate licensees to form Personal Real Estate Corporations. Licensees will have to be to have been licensed for 2 or more years before they can incorporate.
Until now, the only persons who could operate a real estate sales agency as a corporation were the actual real estate brokerages, not the individual agents. As a result, real estate agents operated as proprietors, and had no access to the lower corporate tax rates and limited liability inherent in a corporation.
The liability protection from the use of a corporation may not to be of much use to realtors, given the licensing provisions of the Real Estate Council. Like other incorporated professionals such as doctors, lawyers and accountants, the governing body (in this case the Real Estate Council of BC) will not allow realtors to avoid liability for their professional conduct through use of a corporation.
There are a number of attractive features of incorporation for individual real estate agents.
The Personal Real Estate Corporation pays tax on the first $400,000 of active business income at only 15.5% on profits retained in the company. Income in excess of $400,000 is still only taxed at 31.5%. There are two implications of this lower tax rate.
First, since $400,000 of net income is taxed at the flat rate, fluctuations in income can be “smoothed” in a corporation compared to a proprietorship. In a proprietorship, whatever the net income is for the year, it ends up being taxed at successively higher rates as the income increases. The highest marginal tax rate for an individual is 43.7% – much higher than even the highest corporate business tax rate. If a proprietor experiences a pattern of years of high income and years of low income, rather than a steady amount, they will pay taxes at a higher marginal rate in the good years, and at a lower marginal rate in the poor years. The result is that the total taxes paid is higher than if the net income in each year was the average amount. Compare this with a corporation where income is taxed at a flat tax rate up to $400,000. Effectively, this evens out the income by retaining some of the income from good years in the corporation, to be paid out in poor years, instead of paying it all out each year.
The second implication relates to acquiring assets in the corporation. Because assets are acquired with after tax funds, a successful business operated as a proprietorship is at a disadvantage compared to a business operated as a corporation. A proprietor pays tax at 43.7% on income over $120,000, while a corporation still only pays tax at 15.5%. This means that the corporation will have more cash available to fund purchases such as vehicles, buildings, and equipment.
Personal Real Estate Corporations also offer better opportunities to split income with spouses and other family members. Dividends paid out of a Personal Real Estate Corporation to the shareholders result in a dividend tax credit which reduces the taxes payable by the recipient.
Canada Revenue Agency may challenge wages or management fees paid to spouses or family members, requiring the business to prove that the amounts paid were for work that was actually done, and that it was paid at fair market value, ie, the same amount that would have been paid to a non-related person. In contrast, dividends are paid based on shareholdings, not on the work done for the corporation in the year. This allows dividends to be paid to spouses and other family members who are not active in the business. Note that only licensees will be allowed to be voting shareholders. This still allows for non voting shares to be issued to non licensees.
If you are a real estate agent, talk to your accountant to find out if incorporation is right for you.