Tax Hacks And Strategies to Enhance Your Small Business

Very long-time Canadian MoneySaver readers may recall that I wrote several articles between 1994 and 2003. Back in the day, I wrote about contrary investing and the Dow Jones Industrial Average (“Beat the Dow”). Years later, I contributed stories talking about the inclusion of Private and Alternative Equities in your investment plan. After a five-year hiatus, I’m delighted to be back.

I started my sales agency in late 2020 and developed a love affair with small businesses and the professionals who make them run. In the months ahead, we’ll investigate how professionals and small business owners can enhance their family’s health, productivity and the success of their businesses while mitigating the taxes they pay.

Readers would be best served by consulting with their tax professionals before deploying any of the strategies we will be discussing, as your situation may be different.

Today, we will consider how incorporated professionals and small businesses in Canada can enhance their access to healthcare while saving taxes in accordance with Canada Revenue Agency (CRA) guidelines. The vehicle of choice is referred to as a Healthcare Spending Account (HSA).

HSA guidelines specify that business owners cannot avoid or minimize the taxes they pay unless they are securing these healthcare services in their capacity as an employee of the corporation, and additionally, must extend the same type of facilities to other employees of the corporation. It may be a curious distinction, but incorporated solopreneurs must ensure they are paid T4 earnings and be classified as an employee of their own firm to establish and utilize an HSA.

There are several HSA providers in Canada, including specialty benefits firms and generalists like life insurance carriers, third-party administrators and pharmacy benefit managers (the firms that offer pay-direct drug cards, accepted at pharmacies across the country). The prime directive for all these service providers is to ensure that the plan structure meets the requirements as a qualifying HSA, and that all submitted expenses represent qualified and bona fide healthcare expenses. The list of these qualifying expenses is quite broad and is available from any HSA provider, usually as a downloadable file on their websites.

An HSA plan member would simply check their list of qualifying expenses to ensure they are eligible, their total available funding, and then make their purchase. Purchases must be made with qualified vendors, including pharmacies, listed paramedical service providers (paramedical services include registered massage therapists, chiropractors, etc.) and health supply stores where consumers can purchase health supplies, including crutches, wheelchairs, ostomy and diabetic supplies, etc. They would then pay for the goods purchased, submit their expenses to their HSA vendor and be reimbursed for their purchased products and services in pre-tax dollars directly from their corporation’s bank account.

Yes, it sounds complicated. In execution, however, when it is transacted correctly it works very well;  simple,  fast and beyond question.

The correct procedure for a qualifying purchase is as follows:

1. 1.     The plan sponsor (employer) sets up an HSA facility and funds their plan member accounts to provide immediate settlement when claims are submitted.
2. 2.     Plan members make their purchases and pay with cash or credit.
3. 3.     Plan members submit their claims with supporting documentation (receipts and possibly prescriptions or letters of direction provided by their licensed healthcare professional or doctor.)
4. 4.     The plan account for the member in question is debited for a charge that includes the cost of the service, applicable taxes and the HSA provider’s administration charges.
5. 5.     The net amount for the service is then sent back to the member to reimburse them for the purchases made.

Why Is This A Good Deal?

In short, there are two reasons why HSAs are popular. The first is that HSA rules are much simpler, and the costs governing their set-up and operation are much lower than the constituent parts of a conventional group health benefits insurance policy. Second, the CRA guidelines are such that an employer can fund their employee healthcare costs with pre-tax dollars.

In addition, Canadians who aren’t the beneficiaries of these HSA plans have very little recourse to pay for medical expenses that aren’t covered by their group benefits plans, if they are even covered by such plans at work. CRA provides minimal relief in the form of the Canadian Medical Expense Tax Credit (METC). While it sounds impressive, it pales in comparison to a conventional benefits plan or Healthcare Spending Account. The METC allows Canadians to claim qualifying medical expense claims, subject to the lesser of 15% of their medical expenses or those expenses in excess of 3% of their net earned income.

A Canadian who earns $60,000 would need to pay the first $1,800 in medical expenses (drugs, paramedical services, etc.) out of pocket in after-tax dollars before they can claim the costs of their expenses. Under an HSA, a covered employee would be able to claim the entirety of their out-of-pocket expenses, once the employer satisfies the applicable costs, as described above. This is an entirely better solution as it truly democratizes the nature of claiming healthcare expenses by all employees in the corporation.

Let’s now dive deeper into the actual costs of the HSA as compared to the METC. I will approximate costs to illustrate the relative costs and benefits of both claiming models.

John is not covered by a health benefits plan at work and makes $75,000 annually, and lives in Ontario. John has $5,000 in allowable medical expenses. Fifteen per cent of $5,000 is $750.00. John’s net income is approximately $53,300 per year. Three per cent of this sum is $1,599. In this example, the METC would apply to expenses in excess of $1,599. John has expenses of $5,000, which is $3,401. BUT, the METC will only allow the claim of the lesser of the two sums, meaning John can only claim $750. Bummer. Under an HSA, John could claim the entirety of his medical expenses for the year.

What’s the alternative? The total taxes and expenses charged by HSA providers are roughly 21% - 22% plus the cost of the pure medical expense. A $100 expense would cost approx. $122.00. An executive paying themselves salary and perhaps dividends might be withholding and paying into their RP payroll deductions account 32% of their declared pay, or more—perhaps much more.

If an executive were to pay themselves $150,000 annually (no matter the combination of salary and dividends), the payroll remittance might be paid at as much as 50%. That would mean the $100 medical expense would require as much as $150 in earnings to create the cash reserves to pay the $100 expense. With a properly constructed and maintained HSA plan, the total expense of $122 sure sounds a lot better than taking $150 into personal income, paying $50 in withholding tax to pay the same cost. Make sense?

There are, of course, other limits placed on these plans by CRA. Namely, HSAs must be kept reasonable. A plan limit must be established in the context of the total compensation plan for that employee, executive or otherwise. Most “owners”—who must be designated as employees—would do well to limit their allowable claims to a reasonable amount of no more than 15% of their paid income. If John was such an individual, it would be advisable that his allowance be limited to no more than $11,000. If John was also earning dividends in addition to his declared salary, then these amounts could be incorporated into the HSA funding decision. Rule of thumb? Don’t declare your HSA is funded by $25,000 annually if the income numbers don’t substantiate that amount. The red flag flying at CRA would be as big as a bus if you were to be as bold and unreasonable as that sum would indicate.

What happens if you establish a $10,000 allowance for an executive employee of the plan and fail to spend that amount? In this situation, the unspent amount can be carried forward for one year and added to the allowance for the following year. You might want to execute that particular play if you know you have expensive dental work, such as implants or expensive children’s orthodontics to come. Unspent amounts at the end of the second year are forfeited. Does this mean you pay money into the account and lose it? No. CRA may be tough as nails, but they are not heartless and unreasonable. HSA service providers will work with you to fund the expenses that make sense for you to fund. They won’t allow you to pay funds in pre-tax dollars into a tax-advantaged account to avoid paying taxes and let it sit there at your disposal indefinitely. That would be tax avoidance.

CRA Heartless? No. Are they naïve and unwitting benefactors? Also, no.

An employee would simply lose the ability to arrange for such funding for the amounts not spent and start the allowance mathematics all over again at the beginning of Year 3.  

The bottom line is that incorporated companies of 1 or 10,001employees and more can establish the tax-advantaged means of paying for their medical benefits. In fact, what is happening here is the conversion of personal expenses into corporate pre-tax expenses vs the obligation of paying taxes first, and medical expenses second.

As you can see, the devil is in the details. Next time, we’ll discuss some of the finer details as to how you could establish and take advantage of an HSA plan. Please do reach out should you have any questions.

With over 42 years of experience as a sales professional and business owner, Bob works with small business owners, incorporated individuals and their advisors to provide guidance on their investments, insurance and benefit plans. He has developed a specialty helping Canadians navigate the executive and specialty healthcare and individual private medical insurance market.

bob.carter@carterconsultingcorp.ca

Disclosure: The information presented reflects the opinions of the author and not Canadian MoneySaver Magazine. Readers should do their own research and, where applicable, request and read a prospectus. Investing carries risks, including the risk of losing capital.

www.probityhealthandwealth.ca

info@probityhealthandwealth.ca