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BDO Fast Facts
November 1998
Release No: 98-07

Health Insurance Deductions for the Self-Employed

If you're a self-employed proprietor or partner, you haven't been able to take advantage of an opportunity that's been available to incorporated business people - the ability to deduct premiums for private health care plans, drug plans and dental plans for yourself and your family. That is, until changes in the 1998 Federal Budget were introduced. Under the budget proposals, unincorporated partners and proprietors will be allowed to claim a tax deduction on their personal tax returns for private health services plan (PHSP) premiums. The proposed deduction will be available for premiums incurred after 1997.

1998 Budget Proposals

In late October, the Federal government released draft legislation for the tax proposals announced in the February 1998 Federal budget, including the proposed PHSP premium deduction for unincorporated business people. The proposed deduction is similar to Revenue Canada's administrative policy for corporations, as the deduction is based on coverage provided to arm's-length employees. In addition, given that more and more individuals are carrying on business without employees, a special rule has been introduced for these individuals. Before looking at the specific rules for calculating the deduction however, all individuals will have to determine whether they meet a test designed to ensure that their income from self-employmnt is significant when compared to their income as a whole.

Initial Screening

To qualify for the new deduction, you must meet one of the following two tests:

bulletYour net income (excluding losses) from businesses in which you are regularly and activelyengaged must represent at least 50% of your net income for the year, or
bulletYour net income from sources other than business does not exceed $10,000.

For the purposes of applying these tests, business income from a partnership is included provided that you are an active partner.

If you meet one of these two tests and you have entered into a PHSP contract with one of the parties listed in the legislation (which include most insurance carriers), the next step is to determine how much of the premiums you incur qualify for the deduction. For this purpose, individuals are divided into two groups - those with employees and those without.

Group 1 - Employers

If you (or the partnership in which you are a member) have employees, you'll be included in this group if:

bullet You (or the partnership) employ one or more individuals on a full-time basis, and
bulletThe number of these employees who are insured and deal at arm's-length with you represent 50% or more of all insured persons involved in the business (either as employees or partners).

If you meet these tests, your deduction will be determined based on the coverage you provide to your employees. If you don't meet these conditions, you'll be eligible for the restricted deduction for the individuals without employees, which we discuss in the next section.

Under the draft legislation, the amount you can deduct can't be more than the amount you pay for the PHSP coverage for your employees. This principle is best illustrated by way of an example.

Assume that you are a sole proprietor of a business with four full-time employees and you deal at arm's-length with these individuals. You pay 90% of the PHSP premiums for all four employees. You and your family have additional coverage under the plan, which isn't available to your employees. Your enhanced coverage costs $2,000 while the coverage for an employee would cost $1,200 (on the assumptions that an employee has the same number of dependants as you do and the difference in premiums is due to the level of benefits provided).

In this situation, two adjustments are required in determining the deductible portion of your premiums. First, your premiums have to be adjusted because your coverage is more extensive than the coverage provided to your employees. In this case, only $1,200 will be eligible for the deduction. In addition, because you pay only 90% of your employees' premiums, your deduction will be reduced further, to $1,080 (90% of $1,200).

Group 2 - Individuals Without Employees

If you don't fall into Group 1 above, you will still qualify for a restricted deduction. Your deduction will be subject to an upper limit, based on the number of dependants covered under your plan. This upper limit is equal to:

bullet $1,500 each for you, your spouse and members of your household who are 18 years of age or older, plus
bullet$750 for other members of your household.

This limit is prorated where the length of your business' fiscal year is less than 365 days.

Some Final Points

There are some other rules that you should keep in mind:

bulletIf you are a member of a partnership, you'll claim the deduction personally, even if the partnership incurs the premiums.
bullet

The amount deductible under the proposed changes is based on premiums payable.

bulletIf a portion of your premium does not qualify as a deduction because of the restrictions discussed earlier and the premium was actually paid, the difference can be claimed as a medical expense.

These new rules will help the playing field for individuals who choose not to incorporate or those who can't incorporate due to professional reasons. Although the proposed deduction is straightforward in concept, it may be more difficult to apply the deduction rules in practice. If you need assistance in determining whether you qualify for the new deduction or how much your deduction will be, consult your BDO tax advisor.

 
 
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