Taxing core benefits

The devil is in the details when it comes to proper administration

The taxation of benefits seems pretty simple at first glance — then again, so do many areas of tax. As HR professionals know, however, the devil is in the details. Unfortunately, good benefit plan design, proper payroll administration and effective employee communication depend on these details.

HR and payroll need to understand when employer contributions towards a benefit are taxable, as well as whether the benefit received from a plan is taxable. For example, the premiums paid by an employer to fund life insurance are taxable to an employee, whereas the benefit paid on death is not.

Medical benefits

Premiums paid by an employer are not taxable to employees. Benefits paid to employees are also not taxable to the employees. Many plans are provided on an administrative services only (ASO) basis, where an insurance company is used strictly for administrative purposes: to adjudicate claims and process payments. The employer reimburses the insurance company for the amount of claims and pays an administration fee. There is no “premium” in such cases.

To be considered a non-taxable medical benefit, the benefit has to be provided through a “private health services plan.” This is a vehicle defined in the Income Tax Act as one that provides for the payment of “medical expenses,” which are in turn defined in infinite detail in the Income Tax Act. The bottom line is if a medical plan provides a benefit that is not a proper medical expense, the provision of that benefit will be taxable and it may jeopardize the tax status of the entire medical plan.

It’s also important to note that medical benefits are taxable in the province of Quebec. This has obvious consequences and challenges for national employers, and particularly for employers with mobile employees or for employees who do not work and live in the same province.

Dental benefits

Dental benefits are considered a type of “medical expense” for the purposes of the Income Tax Act. Provided the dental procedure is a medical expense, the provision of the service to an employee will not be taxable to the employee. The premiums paid by the employer for the coverage will also not be taxable to the employee.

Just as with medical benefits, dental benefits are taxable in the province of Quebec.

Vision benefit

Likewise, vision care benefits are also considered a type of “medical expense” under the Income Tax Act, but are taxable in Quebec.

Life insurance

The premiums paid by an employer for life insurance coverage are taxed in the hands of employees (and retirees). Generally, the amount of the premium paid by the employer is the taxable benefit to the employee. However, the amount of the benefit depends on whether the life insurance policy is a “group term life insurance policy” (GTLIP). A GTLIP is any group life policy in place for employees. In such cases, the taxable benefit is calculated in accordance with detailed regulations. In a nutshell, those regulations permit different premium categories — smoker status, for example — but not age or sex. Given that many employers differentiate premiums based on age, sex and smoker status, this poses some challenges. The result is that the taxable benefit for a particular individual will be slightly different from the premium charged by the insurance company for the coverage.

A group life policy that covers persons other than actual employees — for example, spouses or other dependants — will not meet the definition of a GTLIP. The result is that the taxable benefit is not calculated using the GTLIP regulations. Rather, the taxable benefit is simply whatever premium is paid to the insurance company, using the premium categories agreed to by the employer and the insurance company. This approach is much simpler.

Another interesting twist occurs when life insurance is provided by an employer through an ASO arrangement, as described above. The Canada Customs and Revenue Agency (CCRA) has questioned whether this constitutes true insurance. If it doesn’t qualify as insurance, the benefit paid in the event of death would be a “death benefit” under the Income Tax Act and only the first $10,000 of the benefit would be exempt from tax. The remaining payment would be fully taxable in the hands of the beneficiary. In contrast, regular life insurance proceeds are not subject to tax.

Accidental death and dismemberment

Accidental death and dismemberment coverage is characterized as a “group accident insurance” plan. The premiums paid for the coverage are not taxable to employees and the benefits paid from the plan, in the event of death or dismemberment are also not taxable. This is a win-win situation for employees. Moreover, the premiums are typically quite low — a pretty good deal for an employee from a cost-benefit perspective.

Long-term disability

In its usual roundabout fashion, the Income Tax Act states that a benefit paid from a disability insurance plan to which the employer has contributed is taxable to the employee. What this means is that disability benefits are:

•taxable if paid from an employer-funded plan; and

•not subject to tax if paid from an employee-funded plan.

The crucial point here is that, even if a long-term disability plan is only partially paid for by an employer, it is considered an employer-paid plan and the benefits received will be fully taxable.

Many employers, particularly those with flex plans, have more than one long-term disability plan in order to provide choice to employees. One plan would be a taxable employer-paid plan and the other would be a tax-exempt employee-paid plan. The plans must be separate. Cross-subsidization between plans makes both plans taxable.

Christopher Newton is a lawyer and the head of Hewitt Canada’s legal group. He may be contacted at (416) 225-5001, or [email protected].

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