Case Study

tax deduction Consultant Joe runs his own corporation, Small Business Inc, and lives in Ontario. Joe is the only employee of the corporation.

tax deduction Joe's net income after RRSP contributions is $68,000.

tax deduction Joe has a wife, Joan, and 2 children, Jack and Jill.

tax deduction Joan's net income is $5,000.

tax deduction After filing the annual income tax return, it is discovered that Joe's 2002 marginal tax rate is 43.4% and the Canada Child Tax Benefit which the family receives is clawed back at a rate of 5%. This means that if Joe was to earn an additional $1,000 he would have to pay $434 to the Federal and Ontario governments, and would receive $50 less from the Canada Child Tax Credit. Thus he would only have $516 (= $1,000 - 434 - 50) to spend on other things.

tax deduction Small Business Inc is considering establishing a Self-Directed Benefit Plan TM as offered by Bene-D-Duct. Joe, the president and sole employee of the corporation calculates the cost to provide his benefit costs through the Self-Directed Benefit PlanTM (see rows (2)-(15) , below).

tax deduction He also calculates the amount of salary necessary to pay Joe in order for Joe to end up with enough after-tax salary to pay for his medical expenses. (see rows (16)-(20) , below).

tax deduction He discovers that Small Business Inc. would save an average of $960 per year if it sets up a Self-Directed Benefit Plan TM (see row (21) , below) versus paying an additional salary. The reason is that Bene-D-Duct's Administration Fees are substantially lower than the income tax and clawbacks charged by the governments.

tax deduction Please review the detailed calculations that Joe performed based on an estimated benefit cost of his family.

  Joe and his family's Medical/Dental expenses are as follows:
  Year1 Year2 Year3 Year4 Avg
Twice annual dental check-ups for 4 people $800 $800 $800 $800 $800
Occasionally dental filling required 100     100 50
Three of them wear glasses, so one pair every other year   250   250 125
No one is using monthly prescriptions, but occasional antibiotics 200 140 190 70 150
Out of Country Medical Insurance premium for trips 50 50 90 50 60
Jack needed speech therapy in year 1 400       100
Jill needs braces starting year 4       1600 400
(1)Total Medical Expenses 1550 1240 1080 2870 1685
 
(2)Company pays to Bene-D-Duct 2100 1600 1400 3560 2165
(3)Less Ontario's Retail Sales Tax =8%x(4) 156 119 104 264 160
(4)Net Contribution paid to Bene-D-Duct =(2)-(3) 1944 1481 1296 3296 2005
 
(5)Service Plan 5 Fees =12x$5.75 69 69 69 69 69
(6)Initial Fee ($75 First Year Only) 75       19
(7)Percentage Fee @10% =10%x(4) 194 148 130 330 200
(8)Total Fees Deducted by Bene-D-Duct =(5)+(6)+(7) 338 217 199 399 288
(9)GST on Fees Only =7%x(8) 24 15 14 28 20
(10)Total Deducted For Fees and GST =(8)+(9) 362 232 213 427 308
 
(11)Accumulation Account Balance at Start of Year (Carried Forward) 0 32 41 44  
(12)Contributions After Taxes and Fees =(4)-(10) 1582 1249 1083 2869 1696
(13)Less Benefit Reimbursement Cheques =(1) (1550) (1240) (1080) (2870) (1685)
(14)Accumulation Account Balance At Year End =(11)+(12)+(13) 32 41 44 43  
 
The cost to the company in Ontario is on row (2) and is fully deductible to the company. If the company was located in any province other than Quebec and Ontario the cost to the company need only be those shown on row (4) since no provincial sales tax is payable.
 
Joe receives Benefit Reimbursement Cheques as shown on row (13) and does not include them as taxable income since they are received under a Private Health Services Plan established by the company.
 
(15)Ratio of Benefits to Cost
(a) in Ontario =(13)/(2) 74% 78% 77% 81% 78%
(b) Provinces other than Ontario, Quebec =(13)/(4) 80% 84% 83% 87% 84%
 
The following chart shows the Gross Salary that would need to be paid to the consultant in order to generate the same amount of Net Salary to pay for the Medical/Dental benefit. It assumes Federal and Ontario's provincial tax rates for 2002.
(16)Gross Salary Required   3000 2400 2100 5000 3125
(17)2002 Personal Income Taxes
(a) Federal Tax =26%x(16) 780 624 546 1300 813
(b) Ontario Tax =11.16%x(16) 335 268 234 558 349
(c) Ontario Surtax =56%x(17b) 187 150 132 312 195
(d) Medical Tax Credit Federal ={(1)-$1,728}x16% 0 0 0 (183) (46)
(e) Medical Tax Credit Ontario ={(1)-$1,740}x9.44% 0 0 0 (107) (27)
(f) Total Personal Income Tax =(a)+(b)+(c)+(d)+(e) 1302 1042 912 1880 1284
 
(18)Decrease in Canada Child Tax Benefit =5%x(16) 150 120 105 250 156
(19)Net Salary =(16)-(17f)-(18) 1548 1238 1083 2870 1685
(20)Ratio of Net Salary to Gross Salary =(19)/(16) 52% 52% 52% 57% 54%
 
Note: The Net Salary row (19) is virtually equal to the Benefit Reimbursements on row (13) and row (1) , proving that the Gross Salary required to match the value of a Self-Directed Benefit Plan TM is indeed accurate.
Small Business Inc. can either set up a Self-Directed Benefit Plan TM to reimburse its employee(s) the cost of the Medical/Dental benefits, or it can pay additional salary to the employee(s) so that he has enough money to pay the benefits out of his own pocket (after income tax and clawbacks from government support programs). In this Case Study the company saves on average $960 per year if it sets up a Self-Directed Benefit Plan TM as seen below.
 
(21)Company Savings =(16)-(2) 900 800 700 1440 960
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tax deduction Additional Note: Small Business Inc. has $43 in its Accumulation Account at the end of the 4th year. It has been able to claim the GST Tax Credit for the amount of GST paid to Bene-D-Duct (see row 9) averaging $20 per year offset by the 2% premium tax payable on its Ontario Corporate Tax Form, averaging $34 per year.

tax deduction Final Note: Joe realizes that if or when he hires a new employee that his corporation will be responsible for reimbursing the new employee's medical/dental expenses. He knows that the employee will also benefit from the lower taxes created by the Plan. He makes a note to himself to discuss this in the hiring phase and ensure that the total compensation offered to the new employee is properly in line.
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