Managing medical expenses can be challenging, but the Canadian tax system offers ways to ease the financial burden. Two common methods are the Medical Expense Tax Credit (METC) and Health Spending Accounts (HSA). This article explains how the METC works, walks through a sample calculation, and compares it with the HSA, a cost-effective alternative for incorporated business owners.
What is the Medical Expense Tax Credit (METC)?
The Medical Expense Tax Credit (METC) is a non-refundable tax credit that you can claim on your personal tax return. Since it is non-refundable, it can reduce the amount of tax you owe but cannot bring your tax balance below zero. If you incur eligible medical expenses, you may claim this credit to reduce the tax you owe.
Common METC Rules
- Eligibility: Only expenses that qualify under the Income Tax Act can be claimed. Examples include prescription drugs, certain medical devices, and professional health services.
- Claim Period: You can claim medical expenses incurred within any 12-month period ending in the current tax year, as long as they have not been claimed before.
- Threshold: You can only claim the amount of medical expenses that exceeds the lesser of 3% of your net income or a set dollar amount that is indexed each year. The CRA publishes the federal amount for each tax year, and your province uses its own amount for the provincial credit.
How the METC Calculation Works
The formula to calculate the METC involves several steps. Let’s break it down:
- Net Income (A): Your total income after deductions.
- Eligible Medical Expenses (B): The total amount of your medical expenses that qualify.
- Lowest Provincial Marginal Tax Rate (C): The lowest tax rate for your province, which your province uses to calculate its credits.
Formula Steps
- Calculate 3% of your net income (A * 0.03 = A1).
- Compare A1 with the federal dollar amount for the tax year and take the lower amount (A2).
- Subtract A2 from your eligible medical expenses (B - A2 = X).
- Multiply X by the lowest federal tax rate for the year to get the federal credit. Your province calculates its credit the same way, using its own dollar amount in step 2 and its lowest rate (C). Add the two credits together for the total METC.
Sample METC Calculation
Let’s use a practical example for an Alberta resident:
- Net Income (A): $100,000
- Eligible Medical Expenses (B): $5,000
- Province: Alberta
Calculation Steps:
Following the formula steps above: compare 3% of the $100,000 net income with the federal dollar amount for the tax year, subtract the lower amount from the $5,000 of expenses, and multiply what’s left by the lowest federal tax rate. Alberta’s credit is worked out the same way with Alberta’s own dollar amount and lowest rate. The CRA’s tax forms for each year show the current figures.
What is a Health Spending Account (HSA)?
A Health Spending Account (HSA) that meets the CRA’s rules for a private health services plan enables incorporated business owners to pay all of their eligible medical expenses with before-tax business dollars instead of after-tax personal dollars. This means that the medical expenses, and the HSA provider’s administration fee, are generally tax-deductible for the business, which can provide significant tax savings.
How Does an HSA Work?
An HSA allows your corporation to reimburse you for out-of-pocket medical expenses, making these reimbursements tax-free for you and tax-deductible for your company. This turns personal medical costs into business expenses, reducing your overall tax burden.
Sample HSA Calculation
Using the same figures as in our METC example:
- Net Income: $100,000
- Eligible Medical Expenses: $5,000
- Province: Alberta
- Marginal Tax Rate: your combined federal and provincial rate on your last dollar of income (R)
Calculation Steps:
The $5,000 medical expense is an after-tax cost. To find the true cost, we need to calculate the before-tax cost:
$5,000 / (1 − R) = the before-tax income you need
Calculate the tax cost:
That before-tax income × R = the tax you pay on it
Therefore, when paying a $5,000 expense personally, the true cost is the before-tax income you need to earn to have $5,000 left after tax, and the difference is tax.
How Much Could You Save With an HSA?
When paid personally, the $5,000 medical expense needs enough before-tax income to leave $5,000 after tax. When paid using a Health Spending Account (HSA), it costs your corporation $5,000 plus the HSA provider’s administration fee (and any tax on the fee), paid with before-tax business dollars. Fees vary by provider, so ask your provider for theirs.
Comparison: METC vs. HSA
The METC and HSA both offer ways to reduce your medical expenses, but they work differently:
- METC: Reduces the tax you owe through a non-refundable tax credit. The benefit is limited by your income and the amount of your medical expenses.
- HSA: Allows incorporated business owners to make medical expenses tax-free by converting them into business deductions. This often results in greater tax savings compared to the METC.
Key Differences
- Eligibility: METC is available to all taxpayers with eligible expenses. An HSA is an employee benefit offered through an incorporated business, so it’s for incorporated business owners who work in their business and for their employees.
- Tax Benefit: METC provides a tax credit, reducing tax owed. HSA converts expenses to pre-tax deductions, offering potentially greater savings.
- Administration: HSAs require setup and may have administrative fees, but they offer immediate savings with no minimum threshold.
Additional Benefits of an HSA
- Immediate Savings: Start claiming medical expenses as soon as they occur.
- No Minimum Threshold: Unlike the METC, there’s no minimum amount needed to qualify.
- Full Reimbursement: 100% of your medical expenses can be reimbursed.
Important Note: You cannot claim the same medical expenses under both the METC and an HSA. You must choose one method for each expense.
Conclusion
For many Canadians, especially those who are incorporated business owners, an HSA can provide significant tax savings compared to the METC. Understanding how each option works and which one suits your situation can help you better manage your medical expenses and reduce your overall tax burden.
Frequently asked questions
What expenses can I claim for the medical expense tax credit?
Only expenses that qualify under the Income Tax Act, such as prescription drugs, certain medical devices and professional health services.
Which period can I claim medical expenses for?
You can claim expenses from any one-year period ending in the current tax year, as long as you haven’t claimed them before.
How is the medical expense tax credit calculated?
Take your eligible medical expenses, subtract the threshold (the lower of a share of your net income or a set annual amount), then multiply what’s left by the lowest federal tax rate. Your province works out its own credit the same way, with its own amount and lowest rate.
Is a health spending account better than the medical expense tax credit?
For incorporated business owners, an HSA often gives greater tax savings, because expenses become business deductions with no minimum threshold. HSAs do need to be set up and may have administrative fees.
Who can use the medical expense tax credit and who can use an HSA?
The credit is available to all taxpayers with eligible expenses. An HSA is an employee benefit offered through an incorporated business, so it’s for incorporated business owners who work in their business and for their employees.