Introduction: A Health Spending Account is a self-insured health plan

A Health Spending Account (HSA), also known as a Health Care Expense Account, is an account to be used by individual employees for health care expenses not covered under the provincial health insurance or other group insurance plans provided by the employer. The expenses can be reimbursed by the employer to the employees or paid directly to the health service providers. For the employer, such expenses are deductible business expenses. Effectively, the HSA functions as a self-insured health plan by the employer to cover health care expenses otherwise paid out-of-pocket by the employees.

Entitlement to tax-free benefits under an HSA

The benefits received by the employees under the plan are not taxable employment benefits, meaning these amounts are not included in the taxable income of the employees, provided that the HSA set up by the employer is qualified as a Private Health Services Plan (PHSA). Should the HSA not be qualified as a PHSA, then any benefit received must be included in the employee’s income and taxed accordingly.

An HSA must meet all the following conditions to be considered a PHSP:

• An HSA, to be a PHSP, must be a plan of insurance i.e., it must contain a reasonable element of risk. Thus, if the HSA is created where there is little chance of being used by the employees, then it is not an HSA or a PHSP and the benefit received by an employee, if any, is a taxable benefit.
• The expenses must be eligible for medical expense tax credits. Such expenses include medical and dental expenses paid to a medical practitioner, dentist or nurse or a public or licensed private hospital in respect of medical or dental services, and other medically connected expenses. For instance, those expenses can be prescription medications, hospital services, dental services, vision care, wellness and specialist care, maternity and reproductive health services, health equipment and devices, among others. Ineligible expenses include over-the-counter vitamins, contact lens, or generic reading glasses. Purely cosmetic procedures or weight loss programs are also not eligible, unless they are deemed medically necessary.
• All or substantially all (the threshold for “substantially all” in the Income Tax Act is generally 90%) of the benefits received under the HSA must be for eligible expenses. The ceiling amount for each type of expenses set out under an HSA is irrelevant in considering the plan’s qualification.
• HSA covers not only the employee but also his or her spouse or common law partner, or any member of the household with whom the employee is connected by blood, marriage, or adoption.

Pro-tax tips-Caution when setting up an HSA for your employees

A Health Spending Account is an attractive way for a business to take care of its employees and their family members, thereby enhancing workplace satisfaction and loyalty. However, to take advantage of the tax-free benefits provided under the HSA, the taxpayer needs to be careful to ensure that the plan is indeed a Private Health Services Plan.

Not every employer-provided health plan is a PHSA. Moreover, there are different types of PHSA, of which HSA is one. Each type of PHSA has a slightly different qualification; an HSA does have its distinct feature (threshold standard is based on benefits actually received, not preset ceiling amounts). Check with a top Canadian tax lawyer specialist to make sure that the HSA that you plan to set up for your employees is fully compliant.

FAQ

My employer is an unincorporated business or a sole proprietorship, am I eligible for an HSA?

Unlike incorporated businesses whose employees (including shareholder employees and all other corporate employees) are eligible to participate in an HSA, the owner and employees of an unincorporated business or a sole proprietorship are eligible only if the business has at least one arm’s length employee. When the business has no arm’s length employee, the benefit shall be considered personal income of the recipient and not be deductible from business income of the payor.

Can employees withdraw money from an HSA?

The employees may withdraw money from an HSA. But in that case, the plan is no longer an HSA because the employer’s contribution to the plan is then not for medical expenses. As a result, all benefits received under the plan, including money withdrawn and previous reimbursements for eligible medical expenses, will be included in the employee’s taxable income. Similarly, if the employees are able to transfer the credit under an HSA to a non-health care group benefit such as an RRSP, the plan is no longer qualified as an HSA. If the credit can instead be allocated into another private health services plan (PHSP), the plan is still a PHSP.

DISCLAIMER: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a top Toronto tax lawyer.