Said to be the vehicle that provides the ultimate flexibility in benefits programs, the health care spending account (HCSA) is gaining in popularity. The HCSA is an individual employee account that provides reimbursement to the employee for health and non-health related expenses that are not covered under provincial health insurance plans or other benefits plans sponsored by the employer or employer of a spouse, if applicable. An HCSA may be introduced on a stand-alone basis offering the only element of flexibility to an existing traditional benefits plan, or it may simply be another option within a broader flexible benefits program.
Introducing HCSAs into benefits plans is a matter of employer discretion. They have experienced rapid growth for several reasons:
• employers can offer new types of health-related benefits to employees without being locked into providing benefits that may become expensive in the future and also without being subjected to unexpected utilization;
• employers can deliver benefits tax effectively;
• employees get some relief if employee cost-sharing is increased through features such as deductibles and coinsurance;
• employees are provided with the opportunity to claim for expenses which would otherwise
not have been reimbursable under the benefits option;
• employers are able to test the concept of flexibility on a limited scale, without committing
to a broader, full choice-making program; and
• as discussed earlier, coverage for predictable expenses, such as vision care, may be
eliminated from benefits options to reduce the potential for adverse selection and coverage
provided through this avenue instead.
Covered Expenses
Health care spending accounts are useful in broadening the scope of benefit expenses eligible for reimbursement. Specifically, an item is eligible for reimbursement through a health care spending account if:
• it is an item for which the employee is not receiving benefits coverage under a provincial
health insurance plan or under any other employer-sponsored benefits plan; and
• it would be considered a deductible expense on an employee's income tax return,
as outlined in the Income Tax Act regulations and Revenue Canada's Interpretation Bulletins.
Generally, covered expenses also include deductible and coinsurance amounts as well as amounts in excess of benefit maximums, which would otherwise represent an out-of-pocket expense to the employee.
Revenue Canada defines which expenses are eligible for reimbursement under the HCSA.
Like employer-sponsored health care plans in Canada (with the exception of Quebec), an HCSA must be structured like a Private Health Services Plan (PHSP) in order to receive a favourable tax status as summarized in Table 8.2. A PHSP, as defined by Section 248 (a) of the Income Tax Act, is any vehicle created to provide to or reimburse a group of employees for health care and dental care expenses, where the provider of the benefits earns a tax deduction for amounts spent on the plan and the employees bear no tax burden for benefits received. Revenue Canada's Interpretation Bulletin 339R lists the five basic elements that a health care benefits plan must contain to qualify as a private health services plan:
• it must be an undertaking of one person
• to indemnify (reimburse) another person
• for an agreed consideration
• from a loss or liability in respect of an event
• the happening of which is uncertain.
Therefore, for an HCSA to resemble a true form or insurance and qualify as a PHSP
to provide reimbursement on a tax-effective basis, some element of insurance risk or
uncertainty that the risk covered will actually occur must be incorporated in the account
design. Simply put, there must he some chance that the employee will lose the funds allocated to the account. Funds list in very much the same way that an employee would not be able to recoup premiums paid for insurance coverage if the insured risk never occurs.
Revenue Canada has since relaxed the rules; however, it has since outlined three different design features that must be included in a health care spending account to introduce the required element of risk.
They are:
• employees must make elections for the account only once annually. I this means at the start of each plan year, employees determine how many credits will be contributed to their accounts
for the coming year. However, once made, this allocation decision is irrevocable, unless the
employee's family status has changed due to reasons such as a marriage or the birth of
a child.
• Funds allocated to an HCSA must be used to reimburse expenses incurred during that year.
Revenue Canada states that plans can deal with unused HCSA credits at plan year-end in one
of two ways, by incorporating either:
• a use-it-or-lose-it feature, under which any remaining amount in the account at plan year-end
is forfeited and returned to the employer; or
• a carry-over or roll-over feature, under which the unused flex credits will be rolled over for the
following 12 months (without any tax consequences to the employee), or the unclaimed
expenses for a given year can be carried forward to the following 12 months, but not both.
Roll-over of unused credits is the most prevalent feature. When this feature is chosen, the first-in/first-out rule is normally applied; this means that the credits rolled-over from the prior plan year are used up first before the credits deposited for the current plan year, which serves to minimize the chances of forfeiting the rolled-over credits at year-end. Which feature is adopted is a matter of employer discretion, but paying out the unused credits in cash is not an alternative.
• The HCSAs must incorporate a use-it-or-lose-it feature for unused credits when an employee:
• terminates
• retires
• dies
• goes on general leave of absence greater than 30 days.
If these requirements are met, then payments of eligible expenses through health care spending accounts are deductible by the employer and not taxable to the employee.
The following two examples show sample tax calculations on benefits paid in Ontario and Quebec.
Sample Tax Calculation on Benefits Paid in Ontario
Employee" A" lives in Ontario. She submitted a claim for $300 under her HCSA.
The tax would be calculated as follows:
Premium Tax $300 x 2% = $6.00
Retail SalesTax $300 x 8%= $24.00
Total Tax $30.00
Therefore, employee "A" will be reimbursed $300.00 and the HCSA will be debited $330.00.
Sample Tax Calculation on Benefits Paid in Quebec
Employee "B" lives in Quebec. He submitted a claim for $300.
The tax would be calculated as follows:
Premium Tax $300 x 2.35% = $ 7.05
Quebec Sales Tax $300 x 9% = $27.00
Total Tax $34.05
Therefore, employee "B" will be reimbursed $300.00; however, the HCSA will be debited $334.05.
Quebec considers the amount reimbursed plus the Quebec sales tax to be a taxable benefit for
provincial income tax purposes. Therefore, $327 is a taxable benefit to Maurice and should be reported on a Relev form at year-end.
The Mechanics of Health Care Spending Accounts
With annual election required by Revenue Canada, an employee must decide how many credits are to be directed to the HCSA prior to the start of the plan year. Once this opening balance is determined, money is not deposited in a trust fund nor are assets separated. Rather, the employer creates a book account for an employee's HCSA. This means accounts are carried on the books of the employer, tracking deposits (credits) and reimbursements (debits).
The total amount of credits designated to the spending account does not necessarily have to be deposited at the start of the plan year. Credits are allocated in full at the beginning of the plan year, the employer is potentially at financial risk of an employee exhausting all the funds in the account and terminating employment before the end of the year. Consequently, many accounts are credited on a monthly or quarterly basis, and expenses reimbursed only up to the amount available in the account for the current month. Any remaining amount that must be reimbursed is carried forward and reimbursed from funds credited to the account in the following month.
The growth in the prevalence of HCSAs programs will likely continue unabated in the future. With this plan, employees can tailor benefits not only to their personal needs today, but also their changing needs in the future. Likewise, employers can provide benefits that change with the times and, therefore, continue to reflect the needs of a diverse work force all within a framework that provides the opportunity to better manage costs. Changes in government policies that affect the advantageous tax status of employer-sponsored benefits plans also act as an impetus to the prevalence of Health Care Spending Account programs.
