Health Spending Accounts for Sole Proprietors

By using a Health Spending Account sole proprietors can write off their families’ and employees’ health expenses as a business expense. Although the rules regarding Health Spending Accounts are more stringent for sole proprietors than for corporations, when properly structured they are a simple and cost-effective tool for rewarding employees and reducing taxes.

A tax deduction made just for you

The Canada Revenue Agency offers two major opportunities for sole proprietors to write-off their personal expenses as a business expense: the home office deduction, and the Private Health Services Plan (PHSP) deduction. A Health Spending Account (HSA) is a form of PHSP that is self-insured (otherwise known as ‘cost-plus’) and qualifies for the PHSP deduction. Whereas writing off home office expenses is a universally popular tax strategy for sole proprietors, HSAs remain largely overlooked and often misunderstood despite the significant tax savings available. This is likely due to the complexity of the CRA’s guidance on PHSPs for sole proprietors, which has been made all the more confusing by poor rule adherence by some HSA Providers and their customers.

Sole proprietors must follow more stringent rules than their corporate cousins when it comes to HSA structure and eligibility. However, with a little guidance sole proprietors can set up an HSA plan that is cost-effective, painless to manage, and that offers a high level of employee satisfaction. Below we’ll answer some common questions about HSAs for sole proprietors, and show you just how beneficial this tax deduction can be for you and your employees.

How does an HSA work for a sole proprietor?

  1. As the owner, you decide the maximum annual HSA benefit for you and your employee(s) according to the limits described in the next section. This is the amount that you and your employee(s) can claim in eligible health expenses each year. This amount does not accumulate but instead renews at the same level each year. 
  1.  You and your employee(s) submit health or dental expense claims for yourselves and your families through our online submission form.
  1. We review claims for eligibility and invoice your business monthly for approved amounts plus 5% (our fee) and applicable taxes.
  1. Your business pays us, and we reimburse you and your employee(s) 100% of the expense. We also provide you with a receipt that allows you to write off the full amount as a regular business expense.
  1. Your business does not pay any set up fees, annual fees, transaction fees, termination fees or other fees. We also do not require any advance payments. Your business only pays for what you use, when you use it.

Are all unincorporated businesses eligible for an HSA Benefit Plan?

No. Part of the misconception about HSAs stems from their complex eligibility rules. Unincorporated businesses including sole proprietorships and partnerships are eligible for an HSA plan only if they employ at least one arm’s length employee (ie, not related by blood or marriage) who is full-time and has been continuously employed by the business for over three months. These individuals are known by the CRA as a ‘Qualified Employee’.

A sole proprietorship with no employees is not eligible for an HSA but could be eligible for a different kind of PHSP: an insured PHSP offered by an insurance company. While not usually cost-effective, a sole proprietorship could purchase a traditional private health insurance policy for the owner and write it off as a business expense.

What happens if you have an HSA but no longer have 'Qualified Employees'?

A sole proprietorship needs to have at least one Qualified Employee to be eligible for the HSA tax deduction. So what would happen to your HSA benefit plan if you lost your Qualified Employee(s) part way through the year? With EasyHSA your HSA would still exist, but you would only be able to write off your own family’s HSA expenses in proportion to the fraction of the year that you employed a Qualified Employee. For example, if your employee quit after 6 months you could write off the full cost of their HSA expenses but only 50% of your personal HSA expenses for the year. At the end of the year your plan with EasyHSA could be terminated or placed on hold without any fee or penalty until your business once again employs a Qualified Employee.

Are sole proprietors always eligible to be included in their business' HSA plan?

No. While your business may be eligible to offer an HSA plan to your employees, the CRA has additional eligibility criteria just for owners. To be included, 50% of your total personal income for the previous or current year must have come from your business, or if you don’t meet that criteria, then your income from other sources cannot exceed $10k. In addition, all Qualified Employees of your business must be included in the plan if you wish to also be included. Basically, the CRA wants to ensure that HSA benefit plans are used for their intended purpose rather than as a tax loophole for business owners.

How large can a sole proprietor's Health Spending Account be?

Unlike HSAs for incorporated businesses, sole proprietors are much more constrained when it comes to maximum annual benefit levels. As the owner, your maximum benefit must be equivalent to what you offer your employee with the least benefits. In addition, if less than 50% of the employees in your HSA plan are arm’s length, then you are limited to a maximum benefit of $1,500 for you, your spouse, and any adult dependent (over 18 years old), plus $750 per child. For a typical family of four this would mean an annual health expense limit of $4,500 for you, and equivalent coverage for your employee(s).

What are the benefits of an HSA for a sole proprietor?

  1. Use your business to pay for 100% of your family’s health and dental expenses. This will save you money compared to the alternative of paying for these expenses out of pocket and claiming them on your personal income tax return using the Medical Expense Tax Credit (METC) program. How much more could you save compared to using the METC? This depends on your income, province of residence and tax situation. You can use the table below to estimate your savings.
  1. Cost-effectively attract, retain and reward employees. With our fee structure all employers can afford to offer their employee(s) a health benefit plan; as the owner you set employee limits and pay only for what is used, when it is used. HSAs are popular with employees who appreciate that an HSA can save them 100% of the cost of their health and dental expenses, which is akin to receiving a tax-free cash bonus from their employer. Since there are no payroll costs to you (including CPP and EI), it is also less expensive to offer an HSA than an equivalent salary or bonus. To further add to its cost-effectiveness, HSAs are a secondary form of health coverage, meaning that your employee must use any additional private health insurance coverage they have first (such as a spouse’s plan), before submitting any remaining amounts to their HSA.
  1. Encourage your employees to stay healthy. Your employees are more likely to visit the dentist and get their prescriptions filled if it is 100% covered.

How much could a sole proprietor save with an HSA?

Here we look at three different scenarios, an owner who makes $50k, $100k, and $150k per year in gross annual income. For the purposes of this calculation it is assumed that the owner lives in Ontario where RST and PPT provincial taxes also apply to HSAs – In all other provinces (except Quebec and Newfoundland) the savings would be greater.

Owner’s Gross annual income

$50k

$1,500 HSA

1 %
Savings

$3,000 HSA

1 %
Savings

$4,500 HSA

1 %
Savings

For example, if you earn $50k (before tax), live in Ontario, and use EasyHSA to pay for $1500 in health expenses, you could save up to 19% or $284.61 (after-tax) compared with using the METC program. This is after taking into consideration all EasyHSA fees and taxes as well as 2020 METC and personal income tax rates. Please speak with your accountant to better understand the savings available to you for your particular tax situation.

Owner’s gross annual income

$100k

$1,500 HSA

1 %
Savings

$3,000 HSA

1 %
Savings

$4,500 HSA

1 %
Savings

For example, if you earn $100k (before tax), live in Ontario, and use EasyHSA to pay for $1500 in health expenses, you could save up to 35% or $522.87 (after-tax) compared with using the METC program. This is after taking into consideration all EasyHSA fees and taxes as well as 2020 METC and personal income tax rates. Please speak with your accountant to better understand the savings available to you for your particular tax situation.

Owner’s gross annual income

$150k

$1,500 HSA

1 %
Savings

$3,000 HSA

1 %
Savings

$4,500 HSA

1 %
Savings

For example, if you earn $150k (before tax), live in Ontario, and use EasyHSA to pay for $1500 in health expenses, you could save up to 37% or $549.91 (after-tax) compared with using the METC program. This is after taking into consideration all EasyHSA fees and taxes as well as 2020 METC and personal income tax rates. Please speak with your accountant to better understand the savings available to you for your particular tax situation.

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