Healthcare Spending Accounts (HSAs) are a great group benefits solution for single employee incorporated businesses in Canada because they allow business owners to set aside pre-tax dollars for medical expenses in a cost-certain way. This means, an entrepreneur can allocate only whenever they need to healthcare, and reap the tax-benefits.
An HSA is particularly well suited for solo business owners with existing medical expenses because they don’t need to be insured. There is no need to consider pre-existing conditions, minimum number of employees, and claims experience. An HSA can be as simple or complicated as a business wants to make it. At its core, it is a notional accounting principle available to businesses to save money on taxes but must follow certain rules.
The formal name for a Health Care Spending Account (HSA) as per the CRA is a Personal Health Service Plan (PHSP). For a PHSP to abide by CRA regulation, there are limitation.
When setting up a Health Spending Account (HSA), the contract must specify the maximum amount of medical expenses that can be paid out each year. The Canada Revenue Agency (CRA) does not provide a specific amount for this limit, instead requiring that it be “reasonable” according to their guidelines.
The definition of “reasonable” is not provided, and it is left to the discretion of the employer and administrator to establish. If a benefit amount is not stipulated in the contract, the HSA would not meet the criteria for a reasonable degree of risk under subsection 248(1) of the Act and would be considered a taxable benefit. Therefore, it is essential to set annual limits for the HSA to qualify for tax-free health benefits.
Industry leaders have determined that an annual limit should be within 10-15% of the income of a fairly compensated employee in the same role. The CRA in the case of a single owner-employee would likely claim that the HSA given is a shareholders benefit (offside), so upon setting-up the limits—especially for a single owner/operator—you should consider as to why it is a fair compensation plan for the person receiving, regardless of ownership.
"The limits should be no more that 15% of the salary that an equivalent employee would have"
Not abiding by these limitation can open the business owner up to the risk of CRA claiming that the benefit is a shareholder benefits and not an employee benefit which would negate many of the tax-advantages.
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Dividend Income vs. T4 Income
If an individual earns only dividend income and wishes to use their Health Spending Account (HSA), they must provide a letter from their accountant stating that they are both a shareholder and employee of the company. Even if the individual does not receive a T4 income slip, the letter must specify that the annual limit set for the HSA is reasonable compared to what a fairly compensated employee would receive. This requirement ensures that the HSA is being used appropriately and not as a way to bypass taxation. The letter from the accountant serves as proof of the individual’s employment status and justifies the use of the HSA as a legitimate employee benefit.
To be classified as an employee benefit and not a shareholder benefit, a reasonable percentage of a company’s employees must participate in the Health Spending Account (HSA). While not all employees have to participate, the percentage of participants must be reasonable. Any employees who choose not to participate must have a valid reason for doing so. This requirement ensures that the HSA is used for its intended purpose and not as a way for shareholders to bypass taxes. By having a reasonable percentage of employees participate, it shows that the HSA is a legitimate employee benefit.
Employee Benefit Vs. Shareholder Benefit
In order for the Canada Revenue Agency (CRA) to recognize a Health Spending Account (HSA) as an employee benefit and not a shareholder benefit, it must meet certain criteria. Reasonability is key, meaning the HSA must be offered to a reasonable percentage of employees and the benefit limits must be reasonable in relation to industry standards. In the case of a sole employee corporation, the owner should be paid on a T4, not solely through dividends, and the HSA limits should be no more than 15% of the salary of a comparable employee in the same occupation outside of the company. This ensures that the HSA is being used legitimately and in accordance with CRA regulations.