A Health Spending Account (HSA) in Canada is a form of Private Health Services Plan (PHSP) that is available to incorporated and unincorporated employers of all sizes – but with important caveats. In fact, Health Spending Account CRA eligibility rules differ by employer type. With a little guidance, employers of all size and structure can craft CRA-friendly HSAs.
We encourage a conservative interpretation of the CRA’s HSA rules.
Better yet, we walk our clients through how to comply with the CRA’s rules both in how their HSA is set up, and in how their service agreement is written.
Is your business eligible?
In order for your company’s HSA to qualify as a tax-free employee health benefit, the CRA has specific requirements that must be met, as well as less rigid general guidance that should be followed. These requirements differ depending on the structure of your business and are broadly outlined below.
Keep in mind that the onus is on you as the business owner to understand the rules of PHSPs and ensure that your HSA is compliant. Companies that offer HSA administrative services are not legally responsible if your HSA is deemed ineligible by the CRA. This may explain why ‘fast and loose’ interpretations of PHSP regulations can be found on HSA providers’ websites (and in some cases in their service agreements as well ), and why others opt to provide little guidance at all to their customers.
Health Spending Accounts for Incorporated Businesses.
According to Health Spending Account CRA eligibility rules incorporated businesses of all sizes can qualify, from a single owner-employee business such as a professional corporation, to multinational corporations. But certain criteria must be met: the plan needs to be set up to fit the definition of a Health Spending Account (which is technically a ‘self-insured Private Health Services Plan’), and there are specific rules regarding if and how company shareholders can be included under the plan.
The CRA has established these requirements to ensure that PHSPs are used for their desired purpose (paying for health care expenses) and not as a tax loop-hole to transfer wealth out of corporations without paying tax.
- Shareholders (whether it be one or many) need to behave as true employees to be included: They should be able to demonstrate that they are employees by being actively engaged in business activities on a regular and ongoing basis and have an employment contract in place. For businesses with a single shareholder – employee (or comprised of family members only), best practice dictates that the employment contract be amended to include mention that a Health Spending Account plan is being offered, that the corporation is required to reimburse employees for all eligible health expenditures incurred and properly submitted to the HSA plan up to the plan limit, and that the corporation cannot modify or terminate the HSA plan at any time without notice, or at its sole discretion. This is necessary to ensure that the HSA (which is a form of ‘self-insured’ Private Health Services Plan) behaves as an insurance plan between two parties (the corporation and the employee).
- Shareholders (whether it be one or many) need to be paid as employees: They should be paid some form of salary (T4 income) rather than exclusively through dividends. This provides further demonstration that the shareholder is an active employee, and can also help when justifying ‘reasonable’ benefit limits.
- HSA maximums cannot be unlimited for any employee class.
- HSA maximums for shareholders should be ‘reasonable’, which basically means that shareholders should not receive special treatment, and that their benefit maximums should be demonstrably justifiable by employers. This same requirement applies to family members of shareholders (or anyone else who is not considered an ‘arm’s length’ employee). For a sole shareholder who is also the sole employee of the corporation, choosing a ‘reasonable’ benefit level is particularly important. The shareholder should be able to demonstrate that the benefit they offer themselves is similar to what an employee who is not a shareholder and who has similar duties and responsibilities at another corporation of a similar size would receive under a similar Plan.
- An employer can set up different classes of employees (for example: “Executive”, “Manager”, “Worker”), and assign different HSA benefit maximums to each class. However, benefit levels should be fair and equitable across employee classes. Employers can’t exclude employee participation through unreasonably narrow class definitions.
- All employees of a specific class who are eligible to receive HSA benefits must be offered HSA benefits. Employers cannot decide to arbitrarily exclude employees from coverage.
- All covered employees need to be aware of the details of the plan, have unfettered access to their plan, and not have to forgo other forms of compensation in order to get it.
- It is recommended that all arm’s-length full-time employees be included in the plan. Of course it is up to the corporation to decide if it makes sense to include all classes of employees in the company’s plan. However, if a corporation has arm’s-length employees, at least one employee class with at least one arm’s-length employee should be included (the plan should not be offered only to employees who are also shareholders, otherwise it may be considered to be a shareholder benefit instead).
Health Spending Accounts for Unincorporated Businesses.
According to Health Spending Account CRA eligibility rules, unincorporated businesses such as sole-proprietorships and partnerships of all sizes can qualify for Health Spending Accounts (which is technically a ‘self-insured Private Health Services Plan’) as long as they meet specific criteria with respect to how owners are treated under the plan, and how the plan is set up. You can find the CRA’s primary guidance on this topic here.
The CRA has established these requirements to ensure that HSAs are used for their desired purpose (paying for health care expenses) and not as a loop-hole to reduce taxable income.
- Owners (whether it be one or many in the case of a partnership) need to behave as true employees: They should be able to demonstrate that they are employees by being actively engaged in business activities on a regular and ongoing basis.
- Owners need to earn their living from their business: In the current tax year (or previous year) more than 50% of their total income must be derived from their business, or, their total income from all sources other than their business should not exceed $10,000.
- Employers need to have at least one ‘qualified’ employee (and not simply an ‘arm’s length’ employee). This is an employee who is not only considered to be arm’s length, but is also full-time, and has been employed by the business continuously for at least three months. An arm’s length employee is someone who works for you and is not related to you by blood (mother, brother, daughter, etc.), by adoption, or by marriage (this includes common-law relationships). Any business partners you may have do not count as qualified employees, nor do temporary or seasonal workers.
- The maximum benefit that can be offered to owners depends on the percentage of employees considered to be ‘qualified’ employees. Their benefit cannot exceed that given to qualified employees, but in some circumstances it must also be capped, and in other circumstances needs to be “reasonable” and not arbitrarily chosen without demonstrable justification.
- An appropriate PHSP Agreement with a third-party administrator needs to be in place that demonstrates that the plan is a self-insured PHSP (includes necessary elements of risk).
- All qualified arm’s length employees must be included.
- All employees who have been signed up need to be aware of the details of the plan, have unfettered access to their plan, and not forgo other forms of compensation in order to get it.
Have additional questions about your incorporated or unincorporated business? Email us at [email protected] or fill out the contact form below.
We can offer you general information but are unable to offer you tax-related advice specific to your particular circumstances. It is your responsibility to ensure that you are eligible for a Health Spending Account plan. The best strategy is to discuss your specific tax-situation with your accountant.