Health Spending Accounts (HSAs) for Sole Proprietors

Can a sole proprietor set up an HSA? Yes! Unfortunately, it's complicated.

As an unincorporated business, you can establish an HSA in Canada. However, tax law makes it significantly more complex and restrictive compared to an incorporated business, often rendering it impractical. Let's break it down!

Tax Rules for HSAs

The Canada Revenue Agency (CRA) defines a Private Health Services Plan (PHSP) in Interpretation Bulletin IT-339R2. A Health Spending Account (HSA) is a type of PHSP in which the employer agrees to reimburse their employees for eligible medical expenses up to a pre-determined limit. An HSA must function as a plan of insurance, meaning that pre-agreement and an element of risk (obligation to fund the plan to a certain pre-determined amount) are essential elements for an HSA to be CRA-compliant.

For a business with no arms-length employees (unrelated by blood or marriage), it's also important that the HSA not function exclusively as a shareholder benefit. For example, a sole employee-shareholder must demonstrate that they are receiving the benefits of the HSA in their capacity as an employee and NOT in their capacity as a shareholder.

In the case of an Incorporated Individual, the HSA can be structured this way by demonstrating that they:

1. are actively working in the role of an employee;
2. are being paid as an employee (through T4 income); and
3. have an annual contribution limit that's "reasonable" when compared to employees in a similar role.

Sole Proprietors Without Employees

While an HSA for a sole proprietor can be structured to include most of these essential elements, the absence of a legal distinction between a corporation and an employee means that, without arms-length employees, a sole proprietor is ineligible to establish an HSA. Unfortunately, fraudulent providers have misled individuals by falsely claiming sole-providers are eligible for their plans, resulting in unexpected tax liabilities. For more information, please see the following release from the CRA Newsroom.

Sole Proprietors with Employees

Got arm's-length employees? The CRA allows you to set up an HSA —just keep in mind there are a few hoops to jump through.

First, To be eligible either:

1. 50% of your total personal income must be derived from your sole proprietorship (for the previous or current year); or
2. your total income from all other sources (investments, rental income, other employment) must be less than $10,000.

Second, unlike for an Incorporated Business:

1. all qualified employees who wish to be included in the plan, must be included in the plan.

Lastly, even if you meet the above tests, your contribution limits are far more restricted than those of an incorporated business. As an owner, your maximum annual contribution limit cannot exceed the limit you offer to your lowest-paid employee. Plus, if fewer than 50% of your employees are arm's-length, your contributions are capped at $1,500 per covered adult and $750 per child. For a family of four, that means a maximum annual limit of $4,500 for your household. Therefore, if you as an owner want $4,500 in benefits for your family, you are obligated to extend that same amount, at a minimum, to all your employees.

Key Takeaways

Due to these complicated tax regulations, Frontier HSA does NOT recommend establishing an HSA an a sole-proprietor. That is why Frontier HSA only offers plans to incorporated individuals or incorporated businesses with staff.

When setting up your HSA, it's crucial to choose a qualified provider who can ensure your plan is CRA-compliant. A trusted provider, like Frontier HSA, helps safeguard you from costly errors and potential tax penalties. To get started today, head over to frontierhsa.ca and start saving on healthcare costs.