Income Tax on Employee Benefits
Health spending accounts receive favourable tax status as a non-taxable benefit.
- Health benefit claim payments are non-taxable.
- The employer contribution toward the cost of eligible health benefits are not subject to federal income tax.
- The employer contribution toward the cost of eligible health benefits are not subject to provincial income tax except for residence of Quebec.
Tax Deductible Business Expense
The employer’s cost of providing benefits (claims, fees and taxes) is a tax deductible business expense. Corporations need to monitor the reasonableness of benefits provided to employees who are also shareholders.
Deductions for unincorporated businesses are limited based on reasonableness as outlined in the private health services plan (PHSP) premiums section of the Business and Professional Income Guide. The following provides some highlights of the extensive criteria detailed in the guide:
- Scenario A
If you don’t have any permanent full-time arm’s length employees:
- The deduction for yourself is limited to $1,500, plus $1,500, if you have a spouse plus $1,500 for each adult child, plus $750 for each minor child.
- Scenario B
If at least half of your plan members are permanent full-time arm’s length employees:
- The deduction for you is limited to the lowest deduction for any permanent full-time arm’s length employee.
- Scenario C
If less than half of your plan members are permanent full-time arm’s length employees:
- The deduction for you is limited to the lower of Scenario A and Scenario B.
Eligibility of Expenses
The Income Tax Act and regulations control the extent to which health expenditures are eligible for reimbursement through a health spending account. While the list of permitted products and services is extensive and listed in interpretation bulletin IT-519R2, the rules have become more restrictive over time.
Most health spending accounts are structured as a private health services plan as described in interpretation bulletin IT-339R2. While it is possible to structure your benefit plan as a health and welfare trust, there is little advantage for the employer to do so considering obligations inherent under trust law.
Canada Revenue Agency Interpretation Bulletins
The following documents govern taxation of employee health benefits.