Financial Planning, Investment Counselling, Tax and Accounting

Contents

Converting medical expenses to deductions for business owners
EI reform for the self-employed
Tax effective perks

How business owners can convert medical expenses from a tax credit to a deduction

The frustrating tax rules on medical expenses disallow any claims below the threshold (3% of your net income or $2,000, whichever is higher) and can only be claimed as a low refund tax credit. However, the Health and Welfare Plan (HAWP) is a better alternative for professionals, business owners, their families, and certain key employees. HAWP provides expanded medical and dental coverage as well as a tax-efficient way of deducting medical expenses.

How it works

1. Your company sets up a special purpose trust to pay medical/dental expenses, then the business owner/covered plan member pays their own medical/dental expenses.
2. When their medical expense receipts are presented for re-imbursement the appropriate notation is made in the trust register, and the corporation then makes a payment to the trust.
3. The trust refunds the business owner/covered plan member 100% of their expenses.

The employer's contributions to the trust cannot be more than the amounts required to provide the benefits listed in the agreement. The trust should be treated as a temporary holding account for medical expenses already paid by the employee.

HAWP requires similar treatment for all members within a classification.

For example, if the company wishes to make the HAWP available to directors, then all directors must be included.

The HAWP must be set up for two or more employees (ref. ITR IT85R2 Health and Welfare Trusts for employees, paragraph 6) or for a single worker provided the benefits are available to future non-shareholder employees. Alternatively, a HAWP can also be created in a closely-held corporation where the shareholders are also the only employees.

What are the advantages?

• Contributions made to the HAWP are tax deductible for the company.
• Out-of pocket medical costs are turned into tax-deductible corporate expenses.
• Administration costs are reduced as the HAWP is internally administered.
• Flexibility is increased in providing additional coverage for employees.

Critical illness and long term illness

For many businesses, the use of a HAWP can be instrumental in providing health benefits and planning for contingencies. The use of a HAWP to make the pure insurance portion of the Critical Illness (CI) premium deductible allows a company to provide these benefits on a more cost effective basis.

What is covered?

Each year the Canada Revenue Agency (CRA) publishes an extensive list of procedures and treatments which are eligible for coverage by a HAWP. Many of the items covered are listed in the left hand column.

Case study

A business owner considers a "Cost Plus" coverage program for medical/dental expenses but rejects the additional cost of the 8-10% administration fee for each covered procedure. Instead, she establishes a HAWP to benefit her and her family.

One year later, the business owner's youngest daughter requires braces. The business owner pays the orthodontist a fee of $5,000 and submits the receipt to the office bookkeeper who makes the appropriate notation in the trust register. The company makes a payment to the trust and, in turn, the trust pays the business owner $5,000. 

Under the HAWP the company absorbs the cost of the braces and the $5,000 cost is now a tax deductible corporate expense.

Without the HAWP

If the HAWP is not in place, the owner has two less favourable alternatives:

1. Increase her salary and pay tax at her marginal tax rate in order to pay for the procedure. She would then claim the braces on her annual tax return and be eligible to receive, at most, a 21% tax credit above the annual medical expense minimum threshold of about $2,000 (in 2009). This way she can only claim $3,000 of the procedure and receive tax relief of 21% x $3,000.
2. Maintain her salary, pay for the procedure with after-tax dollars and receive a medical expense credit for 21% on $3,000 as described above. This way she would essentially be "less wealthy" as a result.

By creating the HAWP, the owner pays for the procedure through the company with before-tax dollars.

EI reform for the self-employed

At present, self-employed individuals do not pay Employment Insurance (EI) premiums and do not qualify to receive EI benefits. However, Bill C-56, the Fairness for the Self-Employed Act, was introduced in the House of Commons and passed first reading on November 3, 2009. This proposed legislation would allow self-employed persons to pay EI premiums on a voluntary basis in order to qualify for EI special benefits including maternity, parental, sickness and compassionate care benefits.

Under the proposed legislation, prior to claiming benefits, self-employed Canadians:

1. would be required to opt into the program at least one year prior to claiming benefits.
2. would need to have earned a minimum of $6,000 in self-employed earnings (net income from self-employment) over the preceding calendar year.
3. could opt out of the EI program at the end of any tax year, as long as they have never claimed benefits.
4. would have to contribute on self-employed earnings for as long as they are self-employed if they have claimed benefits.
5. would pay the same EI premium rate as salaried employees.
6. would not have to pay the employer portion of premiums.
7. would not have access to EI regular benefits.

The proposed program has a start date of January 2010, so claims could be made as early as January 2011.

Self-employed Québec residents would still receive maternity and parental benefits through the Québec Parental Insurance Program (QPIP) provided by the Québec government. They would also be eligible to take advantage of the EI sickness and compassionate care benefits being offered by the Government of Canada. If they opt into this program, their premium rates would be the same as the rates for employees in Québec.

Tax effective perks

by Thomas Ryan, CFP

Business owners have a unique advantage in that they can structure their own compensation packages, including perks. However it is important to stay “on-side” with the income tax regulations if the intention is to do so in a tax effective basis.

Zero-interest rate loans

An individual who is the owner/manager of his or her own company can borrow funds from the corporation at a zero rate of interest. These are referred to as Shareholder Loans. However, any shareholder loan that is not repaid within one year from the end of the corporation’s most recent year-end following the advancement of the funds must be included in income. If properly structured, a shareholder can borrow funds at a zero rate of interest for 2 years.

Paul is the owner/manager of XYZ Company. The company has a year-end of January 31, and retained earnings of $150,000. Paul has a secured line of credit with an outstanding balance of $100,000, and an interest rate of 3.5%. On February 1st, 2010, Paul borrows $100,000 from the company and pays down the line of credit saving himself $3,500 a year. This shareholder loan must be repaid by January 31st, 2012, otherwise Paul must include this amount as income and pay tax on the full amount.

Hire family members

A business owner can hire a family member, and compensate them for the work that they do. The compensation must be reasonable in the circumstances. The test of “reasonableness” is what compensation would be paid to an unrelated third party for similar services.

Paul wants to expand his business, and obtains a quote from a local media company to design a multi-faceted marketing strategy. He receives a quote for $17,500. Paul’s spouse, Brenda, is a part-time marketing assistant with a medium size local company. Paul hire’s Brenda on a contract basis to develop and implement a marketing strategy which includes a new brand name, a website, business cards, brochure, and other collateral material. Paul pays Brenda $17,500 for this engagement.

Business owners have a unique advantage in that they can structure their own compensation packages, including perks. However it is important to stay “on-side” with the income tax regulations if the intention is to do so in a tax effective basis.

Business and personal travel

Any travel that is for business purposes is a direct business expense, and is fully deductible for tax purposes. The frugal business person will structure their personal or vacation travel such that they can piggy-back on a business trip.

Paul must travel to Banff, Alberta, to attend a marketing and business development conference. At the conclusion of the conference, he decides to stay a few additional days and enjoy some skiing. The travel cost to get to and from Banff is a business expense, as is the accommodation cost while Paul attends the conference. The additional accommodation costs and the ski passes are personal expenses, and are not tax deductible.

It is also conceivable that Paul would invite Brenda to join him at the conference as she is now his marketing advisor. Brenda’s travel costs would also be tax deductible. It should be noted that this may be perceived by CRA as “aggressive tax planning”, therefore Paul is cautioned to ensure that Brenda’s participation truly has a sound business purpose.

Golf expenses

This is a no-no. Golf membership fees and golf fees (green fees, cart rental) are not considered to be a business expense, and are not tax-deductible.