The Benefits of Incorporation

I am often asked “why would anyone want to incorporate their business?”.  I can understand the headache of more paperwork and reporting (I am living it right now), but what I cannot understand is why a business owner with an employee base would let incorporation stop them from truly benefiting from a health spending account.

For sole-proprietors, the only HSA available is a private health services plan or PHSP.  If they are a small business with no employees, then it makes sense to stay unincorporated – unless their annual maximums do not meet their needs in terms of annual medical expenses.  It is when a sole-proprietor has employees that the benefits of incorporation are revealed. 

If a sole-proprietor has employees and wants to offer a health spending account to them, the employees would be eligible for a health and welfare trust (no limits, unlimited roll-over) while the business owner would be eligible for a private health services plan (caps on contributions, 2 years forfeiture of funds from date of deposit).  But the real headache comes from the contribution limits for sole-proprietors in a group setting.

You see, the rules for unincorporated groups states that the business owner can only deposit as much into their PHSP as the smallest amount offered to their employees in an HWT.  Let’s clarify this with an example…

A sole-proprietor (let’s call him Bob) has three employees, two salespeople and a receptionist, representing two employee classes in terms of compensation and role in the company.  The two salespeople are entitled to a health and welfare trust of $1,200 a year and the receptionist is entitled to $800 a year.  Bob has a wife and two dependent children under 18 years of age.  In theory, Bob should be able to claim up to $4,500 each year in PHSP deposits (2x$1500 + 2x$750).  However, because the receptionist is entitled to only $800, a year, Bob is now limited to the same amount, as she represents the lowest amount being deposited amongst employees.  This means that Bob is losing out of $3,700 in HSA contributions each year.

The solution?  Incorporation of course!  If Bob incorporated the business, he could still deposit $1,200 and $800 into the salesperson’s and receptionist’s health and welfare trusts respectively.  However, Bob would also be able to deposit whatever amount he wanted into an HWT for himself, as long as it was reasonable to his needs and role/position in the company.  Anything perceived as excessive would be considered a shareholder benefit.  Either way, he could at least deposit the full $4,500 he would have been entitled to as a sole-proprietor and receive an additional $3,700 business deduction – more than enough to cover the $250 Industry Canada Fee to incorporate.