A Health Spending Account is used by small business owners in Canada as an alternative to traditional health and dental insurance.
Here's they key terms you should be familiar with.
Backdating and Limits
A frequent topic of interest is Health Spending Account backdating. The question is can a HSA be backdated?
The short answer is no. Here's our expanded response:
An HSA, is in fact a Private Health Services Plan (a PHSP, which distinguishes itself from our Public Health Care System) and is defined in Section 248(1) of the Income Tax Act (Canada) and further explained in Interpretation Bulletin IT-339R2.
The Income Act (Canada), in summary, states that an employer can provide health benefits to an employee, and further the benefits to the employee are not taxable (tax free) and the benefits paid by the employer are a business outlay (tax deductible). This implies that CRA (Canada Revenue Agency) would expect a contract of employment between the employer and the employee to insure compliance with the act.
IT Bulletin 339-R2 discusses the meaning of PHSP and states that a PHSP can take a number of forms but regardless of name or form must be “a plan in the nature of insurance”. In this respect the plan must contain the following basic elements.
- An undertaking by one person (or entity)
- To indemnify another person (or entity)
- For an agreed consideration (some form of compensation, such as a premium)
- From a loss in respect of an event
- The happening of which is uncertain
A PHSP or HSA, or any “insurance “ plan that offers employees health benefits must show, at a bare minimum, the following:
- An employer-employee relationship (this can be established by the acts within a contract). This necessity is clearly expressed in the Act
- A plan in the nature of insurance. Specifically, point 5 above answers the original question - can a HSA be backdated.
If a happening (an event) is uncertain, then one can insure against that event. An obvious example is home insurance, where a contract must be in place to insure a home before the event. This is obvious to all and follows all the elements stated above. Once a house has been damaged it cannot be insured for that damage.
It may be less obvious when considering a PHSP or a HSA, but as in home insurance claiming a loss before a contract is in place between the employer and an employee contravenes point 5 above and would render the contract invalid.
Before and After Tax Medical Expense
It's critical to understand the comparison between a medical expense that is paid for with after tax dollars versus before tax dollars.
The amount you pay for medical expenses personally, with money out of your pocket, is considered an after tax expense. For those of you that have no health insurance, this represents all of the medical expenses that are not covered by your provincial plan. For those of you with a health insurance plan, this represents the amount paid for uncovered portions.
The true cost of an after tax medical expense is the total amount of income that is required to pay for the expense. For example, and I'll assume you are a business owner in Ontario with a marginal tax rate of 43% (see below for a definition of marginal tax rate), a $100 medical bill has a true cost to your business of about $178. Your business pays you $178 in salary or management fee, 43% or $78 is your income tax, and then you are left with $100 after tax.
Personal medical expenses become a business expense when they are paid through a Health Spending Account. In other words, the after tax expense is converted to a before tax expense. What does this mean? The cost to your business for your $100 medical expense just decreased $78. Your personal medical expense that has been paid for with after tax dollars is now paid for by your business with before tax dollars. Eliminating tax paid on your medical expenses is the core of a Health Spending Account.
Classifications of Benefits Levels
A Health Spending Account for a business with employees involves establishing classifications for spending limits. Here's 5 things you need to know about classifciation levels.
Dependants are defined as your legal spouse and unmarried, unemployed dependent children, including natural, adopted and step-children. Children of your common law spouse may also be considered an eligible dependant if living with the plan holder. In order to be considered an eligible dependant you must be claiming them on your personal income tax return.
Dependent children are eligible for benefits until the age of 21. Exceptions may be made in the case of full time students. If you declare a disabled or dependent adult on your personal income tax return, they may also be considered for eligibility.
You and your dependants can claim up to $15,000 per year. This amount is for the entire family. Under exceptional circumstances where an unusually large medical expense is required, a one-time adjustment can be made to accommodate the expense.
If you have spousal insurance, the Health Spending Account is the last payer. In other words, if there is a spousal plan or another health and dental plan in place, any premiums paid to that plan is an eligible medical expense. Likewise, any co-pays or items not covered under those plans can be included when submitting a claim through your Health Spending Account. Submit all claims, if eligible, to other providers first and any co-pay would be included in your HSA claim.
Find out if your upcoming family medical expense are going to be eligible for your HSA in Canada. Want the complete list of expenses? Here's 124 eligible expenses for a Health Spending Account.
Employer - Employee Relationship
It's important to establish an employer-employee relationship for the purpose of an HSA. Contributions made by an employer to or under an HSA on behalf of an employee are excluded from the employee's income. The contribution qualifies as a business expense for the employer. For an owner / operator business, ensure the owner is in fact an employee. A source of T4 income is one key requirement.
IT Bulletin 339-R2 is an important document from CRA that discusses the meaning of a Private Health Services Plan / HSA.
Marginal Tax Rate
The amount of tax paid on an additional dollar of income. The marginal tax rate for an individual will increase as income rises.
Medical Expense Tax Credit
The Medical Expense Tax Credit (METC) is non refundable tax credit. Small business owners that do not have an insurance plan will often apply for this credit. While the METC does provide some relief, there are restrictions that limit it's effectiveness.
The credit is available on eligible medical expenses that exceeds the lesser of $2,171 or 3% of net income. The lowest maginal tax rate for your province is then used as the percentage credit you receive for the amount that exceeds the threshold.
For example: you live in Ontario and have a net income of $60,000. You have medical expenses of $2,000. 3% of your net income is $1,800. The lowest marginal tax rate is 20%. You would therefore receive a METC that equals 20% of the amount that exceeds the difference between the amount of your medical expenses ($2,000) and the lowest threshold ($1,800). In this example, you would receive a $40 credit.
A Health Spending Account for small businesses in Canada has several requirements in order to properly qualify. One of those requirements is the Health Spending Account rollover. Specifically, an HSA cannot rollover perpetually.
Tax Deduction vs Tax Free
A deduction from gross income that arises due to various types of expenses incurred by a taxpayer. Tax deductions are removed from taxable income (adjusted gross income) and thus lower the overall tax-expense liability. For example, employer contributions in an HSA tax deductible. Contributions can be deducted to reduce the amount of tax owed.
Tax free refers to certain types of financial products that are not taxed. For example, benefits (reimbursements) are tax free to employees. These benefits are not included as a part of income.
Are you a small business owner in Canada with no arm's length employees? Take a look at our free Beginner's Guide to Health Spending Account.
Do you own a small business in Canada with a number of employees? Take a look at our free Beginner's Guide to Health Spending Accounts for a business with employees.