Introduction
As a small business owner in Ontario, you may not have the safety net of a health insurance plan that many large companies offer their employees. At some point, you are likely in the market for a Health Spending Account for small business owners. There are huge tax benefits for small business owners who set up Health Spending Accounts in their Corporations.
What are Private Health Services Plans?
- Private Health Services Plans are health plans arranged by employers for their employees and family members living in the same household.
- As an incorporated business, private health services plans are an effective way that your corporation can provide tax-free health and dental benefits to you and your family members.
- A valid plan must conform to private health service plan (“PHSP”) rules in the Income Tax Act. The information below clarifies the rules and what you should pay attention to.
What are the tax benefits?
Benefits to your Corproation
- If the HSA is a private health services plan, your company can generally deduct the contributions as a business expense.
Small Business Owner (Shareholder Employee)
- If the Health Spending Account is a private health services plan, you are not taxed on the contributions. Contributions are not included in employment income.
- You should demonstrate that you received the HSA benefits as an employee, not as a shareholder. So make sure you earn a salary from your corporation and the HSA contributions are reasonable.
Example
- Suppose Dr. Elane is considering a health insurance plan.
- Suppose her personal tax rate is 40%.
- In the example, we see that Elane can save $80 (40%) taxes and put money that would’ve gone towards taxes into a private health insurance plan that she can use to pay for medical expenses.
- To get these tax benefits, the plan administrator needs to design the HSA to qualify as a PHSP. Elane and her corporation need to follow the rules outlined below very carefully.
Types of Private Health Services Plans?
- There are different types of private health services plans. These depend on whether the employer has transferred the legal liability to pay benefits to an insurer or not.
Health Spending Account for Small Business Owners
- The most common among small business owners is a Health Spending Account (“HSA”). Here, employees (including yourself) get spending account credits each year.
- Employees are entitled to be reimbursed to the extent of available credits at any given time.
- Most times, an insurance company or a plan administrator administers the HSA.
- When the company contributes to the HSA, it can deduct it as a business expense.
What Small Business Owners Should Consider When Setting Up a Health Spending Account in a Corporation
Employee vs. Shareholder
- Remember how your corporation is a seperate legal person, and you can wear multiple hats: As a shareholder or as an employee.
- The CRA does not want you to use private health services plans as a tax-avoidance tool to extract money from your professional corporation tax-free.
- If you have a professional corporation, you and your employees can participate in a PSHP.
- However, the PSHP cannot be solely for shareholders unless the shareholders are also employees earning a T4 income.
- So, you should receive your PSHP benefits as an “employee” rather than a “shareholder” of your professional corporation. It would be best practice to have an employment contract with your corporation.
- In fact, the CRA requires that under the terms of an employment contract, the employer either insure the employee directly or purchase and maintain insurance from another party so that the party agrees to insure the employee[1].
- Also, make sure that your HSA is in line with what other third-party employees provide for employees in a similar boat.
- Suppose you have a physician colleague who works for the same hospital. Unlike you, she works as an employee. She works in a similar role as you. Suppose the hospital offers a $2,000 HSA for your colleague. You are an incorporated physician. The benefit your professional corporation should provide you with should also be around $2,000. This will make it easier to demonstrate to CRA that you are receiving the HSA benefits for your hard work as an employee of your professional corporation and that the amount is not an unreasonable amount based on what your colleagues are entitled to as employees for doing similar type of work. If you up your benefits to $3,000 per year, CRA may challenge that $1,000 is a shareholder benefit.
Private Health Service Plan (“PHSP”) Rules
- A private health services plan is a plan in the nature of insurance. The plan must contain the following five elements:
- an undertaking by one person
- to indemnify (insure) another person
- for an agreed amount
- from a loss or liability in respect of an event
- the happening of which is uncertain
- Usually, only expenses you can claim as a medical expense tax credit can be covered by the plan. Cosmetic medical costs and procedures do not qualify. Click here to see which medical expenses qualify for the plan to be eligible as a PHSP.
- For example, medical and hospital insurance plans offered by Blue Cross and various life insurers are generally considered private health services plans according to CRA.
- Note that the plan needs to have an element of “uncertainty.” It has to be an insurance contract. Meaning, if you or your family do not make any claims, the health spending credits expire. For this reason, valid plans do not allow you to carry forward unused credits for an unlimited period of time. Valid plans only allow you to carry forward unused credits for 12 months.
Watch Out for “Cost Plus” Plans
- In a “cost-plus” plan, an employer contracts with a plan administrator. Suppose an employee makes a claim for $1,000. The employer promises to reimburse the $1,000 claim plus an administration fee (say 5% or $50) to the plan administrator. The plan administrator has a contract with the employee to reimburse the $1,000 claim.
- In recent years, the CRA has expressed the view that a cost-plus plan where the administrator agrees to reimburse the sole employee-shareholder and family members for actual medical expenses (say $1,000) and receives an amount equal to the amount reimbursed ($1,000) plus an administrative fee (say 5%) from the corporation, does not qualify as a PHSP since it does not contain the necessary elements of insurance[2].
- In this case, the CRA says that the sole employee-shareholder is paying for the personal and medical expenses for himself or herself and his or her family members through his or her solely-owned corporation without the Plan administrator assuming any risks. CRA’s view is that a cost-plus plan for a sole employee-shareholder would not likely constitute a plan in the nature of insurance.
- Suppose you have a self-administered HSA structured as a cost-plus plan, and you don’t have third-party employees in your professional corporation who are under the plan. In that case, the CRA seems to take the position that the plan is not a PHCP.
- This means that the CRA could consider any contributions that your professional corporation makes to the plan a “shareholder benefit” or an “employment benefit.” In other words, you need to pay personal tax on the contributions.
- In addition, the corporation could not deduct the payments made to the plan administrator because they were not incurred to earn income from a business.
How do Health Spending Account Tax Rules Work for Unincorporated Business Owners?
- Before 1998, an unincorporated self-employed business owner could not deduct health insurance premiums if the coverage was for you or your family members. This placed such individuals at a disadvantage compared to incorporated businesses because corporations could deduct such premiums.
- Beginning in 1998, the Income Tax Act now allows self-employed business owner to deduct premiums payable under a PHSP for the individual and family members. However, there is a limit on how much you may deduct.
Key Takeaways for Small Business Owners Setting Up Health Spending Accounts
- Private Health Insurance Plans are tax-effective ways to have your corporation pay for your medical expenses while deducting the costs as a business expense.
- But, you need to proceed with caution.
- It is crucial to have a seasoned tax professional familiar with the ins and outs of these complex rules review your plan. You should make sure that CRA will consider it a “Private Health Insurance Plan.”
- Watchout for cost-plus HSA plans.
- If you are unincorporated, the tax benefits from HSA are limited.
- We are happy to review your plan to see if you can take advantage of tax benefits.
