Are Health Spending Accounts (HSAs) Taxable in Canada?
Health spending accounts (HSAs) are a great choice for small businesses seeking a more flexible alternative to private group health insurance plans. That being said, there’s a lot that people don’t know about how HSAs work. We wrote an entire blog answering common questions we get asked about HSAs, but there was something important we didn’t cover; if they can, and how they could, affect your taxes.
Today, we’ll be providing a comprehensive guide on how HSAs can impact your taxes and answering the primary question: Are Health Spending Accounts (HSAs) Taxable in Canada?
Keep reading to find out.
Please note that this is general information and may not apply to your situation. For tailored advice, please reach out to a professional.
Are Health Spending Accounts (HSAs) Taxable in Canada?
If you're a Canadian employee or business owner using a Health Spending Account (HSA), you may be wondering: Are the funds in my HSA considered taxable income?
The short answer is: No, HSAs are not taxable. A Health Spending Account is a tax-free benefit.
Using a HSA correctly and as intended should not have any effect on your year-end taxes or result in any tax penalties. Business owners must be sure to deduct the HSA costs from their business expenses during tax season.
Talk to a Certified Tax Strategist in Waterloo for help managing your business taxes!
Is HSA Money Taxable for Employers?
Money contributed by employers to an HSA is classified as a business expense and 100% tax-deductible. It could reduce your taxable income, assuming the HSA is CRA-compliant.
Is HSA Money Taxable for Employees?
No, HSA reimbursements are not considered taxable income for employees. As long as your employer has structured your plan properly, you shouldn’t run into any tax issues. The CRA treats HSA claims the same way it treats traditional group benefits (tax-free for employees, tax-deductible for employers).
When Your HSA Could Become Taxable and Non-Tax Deductible
If not being used correctly, funds taken from your HSA could become taxable for the employee, and no longer be a tax-deductible for the employer. Here are two of the most common scenarios in which your HSA can become taxable:
The HSA is managed by a sole proprietorship who has no “arms-length” employees
An “arms-length employee” is an employee who doesn’t have a blood relationship, marital relationship, or common interest with the employer outside of the employment itself.
HSAs are classified as a Private Health Service Plan as long as you have at least one “arm-length” employee.
If your plan does not follow Private Health Service Plan rules, it is no longer non-taxable or tax-deductible.
Unfortunately, many insurance brokers are still selling HSAs to businesses without arms-length employees. Please be careful about who you work with, and get a second opinion if needed. Our tax planners can help ensure your HSAs are CRA-compliant.
Using Funds for Non-eligible Expenses
If an employee withdraws from the HSA to cover any non-eligible expenses, that amount is now subject to tax.
Non-eligible expenses include, but are not limited to:
Any expenses not related to medical needs.
Cosmetic surgeries unless medically necessary.
Liposuction.
Teeth whitening.
Hair replacement.
Weight loss programs not prescribed by a physician.
Vitamins or supplements not prescribed by a physician.
Red Flags for Incorrectly-Structured HSAs
The HSA is owned by a sole proprietorship that has no arm’s-length employees—meaning there are no employees who are unrelated or not closely connected personally (such as family members or romantic partners) to the owner.
The plan reimburses non-eligible medical expenses, including non-prescription vitamins, supplements, and treatments.
The plan benefits shareholder-owners who do not receive T4 employment income. When an HSA reimburses medical expenses for shareholders who aren’t official employees, the CRA treats these reimbursements as taxable shareholder benefits that can’t be deducted from your business taxes.
There is no formal written plan outlining eligibility and benefit limits. Without documented plan rules, the HSA does not meet CRA requirements for a Private Health Services Plan.
Benefit limits are unreasonable among employee classes (Unjustified disparities in coverage). If the highest limit is more than ten times the lowest, or if the limits are not based on a reasonable employee compensation structure, then it could lead to tax issues.
Reimbursements are made directly from company funds without proper administration. Without a third-party administrator or a separate account for the HSA, the CRA may consider reimbursements a taxable income for employees or shareholders.