Private health services plans for small businesses

If you own a small business and are tired of paying medical and dental bills for you and your family with personal after-tax dollars, 
you should investigate a little-known section of the tax act.

A private health services plan is a structure allowed under section 248 of the Canadian Income Tax Act. Once set up, a private health services plan (PHSP) allows for the deduction of qualified medical expenses by corporations, proprietors, and partnerships on behalf of their employees and their family members. The PHSP, in turn, returns the amount paid for medical expenses tax free to the employee. For small business corporations, proprietorships, and partnerships, the benefits can provide substantial savings for employees and their family members who are not covered by group health plans. Establishing a PHSP should help retain existing employees and attract new employees for growing businesses.
Many conditions must be met; business owners should consult with qualified tax professionals before setting up plans. While the terms health and welfare trust and private health services plans are often used interchangeably, there is a subtle difference in that a health and welfare trust is used as a vehicle to implement a PHSP, whereas a private health services plan is a standalone plan. Health and welfare trusts are generally sponsored by insurance companies, while PHSPs are offered through third-party specialists. This article will focus on PHSPs for business owners.
First and foremost, PHSPs must be created for the benefit of all full-time employees of the incorporated business, but individual employees can opt out of the plan — unlike a group benefits plan offered by many corporations. While this may seem like a potential burden for small business owners with a large employee base, there are provisions that permit scaled payout schedules based on classifications such as executives, managers, or regular staff employees. Part-time employees may be excluded.
The benefits are extended to include direct family members. Eligible expenses under a PHSP include, but are not limited to, dental, vision care, medical devices (hearing aids), MRIs, prescription drugs, and many alternative health-care providers. If the PHSP administrator is not a tax specialist, it’s strongly recommended that you seek the advice of a qualified tax practitioner. He or she can review the plan documentation to ensure it meets all criteria and to clarify the eligibility of the expenses associated with the PHSP. In addition, it is important that you verify the eligibility of any medical claim prior to undertaking the medical procedure. Having an expensive procedure undertaken that is either denied or later challenged by Revenue Canada could create an unwanted future tax burden.
{advertisement} It is important that administrators stay current with tax legislation and any proposed changes while administering a private health services plan. Not all plans are created equal; you should have your tax adviser review the plan administrators and their credentials.
For high-income earners, the tax savings can be significant. If you consider the highest personal marginal tax bracket is 43 per cent in B.C., while the small business corporate tax rate is 13.5 per cent, and that the tax savings of using a PHSP (in the case of a business owner) are realized personally, then the savings can be reinvested in the corporation in the form of a tax-paid shareholder loan.
Third-party administrators will set up your PHSP. Some administrators will adjudicate your claims to make certain they’re eligible, while others structure the plans so that the burden is on the business owner to determine if expenses are eligible. Depending upon the provider, there is an initial one-time setup fee that can range from $200 to $300. The administrator acts as the third-party representative maintaining the privacy of employees and typically charges a claim fee of between five and 10 per cent of each underlying medical claim. Business owners need to be aware that coverage of expenses starts with the commencement of the establishment of a PHSP. Any expenses incurred prior to the PHSP will be excluded by Revenue Canada.
Here is an example of how a PHSP would benefit a business owner:
John Smith of ABC Business Corp. is married with two young children and is about to face the significant cost of putting braces on both children. Smith personally pays his orthodontist $10,000 for the braces and gets a receipt. He has now just paid a medical cost with after-tax dollars and is out of pocket $10,000. With a PHSP, he submits a claim and the receipt to his third-party administrator. The administrator invoices the corporation (the employer) for the $10,000 orthodontic bill plus the claim fee (assume 10 per cent). The employer then pays the third-party administrator the full cost of the claim. At this point, both the corporation and the employee are out the cost of the medical claim. The third-party administrator now reimburses the employee with a cheque for the full cost of his orthodontic bill. This payment is received tax free as allowed under the Income Tax Act. The full amount of the claim, including the fee, is a tax deduction for the corporation.
How much will Smith save if his personal tax bracket is 40 per cent? Without a PHSP, he would be required to earn $16,667 pre-tax in order to pay his orthodontic bill. With a PHSP, the employer’s cost is $11,000, which is the claim plus the administrative fee. The savings to the owner (Smith) is $16,667 minus the $11,000, or $5,667 — a 34 per cent savings.
A PHSP can work in conjunction with a group health insurance plan. It enhances the overall coverage for the employee/business owner. For example, due to limitations on certain coverage within group plans, many business owners without a PHSP will find themselves paying significant medical costs.
Let’s suppose ABC Business Corp. has a group insurance plan to which all employees must belong, and John Smith has two medical issues. First, he needs prescription glasses or contact lenses. The group health plan may not cover vision care or may have coverage limitations. If the costs of the prescription glasses are $700 and are not covered, then Smith would have to pay those costs personally with after-tax dollars. If the group health coverage for glasses has a maximum inclusion of $200, Smith would be subject to a $500 after-tax cost. If ABC Business Corp. has a PHSP, Smith can reduce outstanding costs completely.
As for medical issue number two, Smith has a pre-existing condition requiring medications that are not covered by the group health insurance or limited in coverage. If ABC Business Corp. has a PHSP, those costs would be covered under the plan, and Smith will have eliminated his after-tax medical bills.
In summary, the advantages of a PHSP is that it provides medical expense coverage not included under existing group health or other plans. We believe business owners should use PHSPs as an incentive to attract and retain good employees. Unlike a wage increase, which is fully taxable and incurs holiday pay, CPP, and EI costs, a PHSP is a tax-free benefit to the employee and a full tax deduction for the employer and/or business owner.
In our example above, Smith and ABC Business Corp. would realize significant tax and cost savings through a private health services plan.
Steve Bokor, CFA, is a licensed portfolio manager and Ian David Clark is a certified financial planner with PI Financial Corp., a member of CIPF.