Understanding the Medical Expense Tax Credit (METC) in Canada

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, provides a detailed sample calculation, and compares it with the HSA, a cost-effective alternative for small 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 your taxable income.

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 $2,759 (for the 2024 tax year).

How the METC Calculation Works

The formula to calculate the METC involves several steps. Let’s break it down:

1. Net Income (A): Your total income after deductions.
2. Eligible Medical Expenses (B): The total amount of your medical expenses that qualify.
3. Lowest Provincial Marginal Tax Rate (C): The lowest tax rate for your province. E.g. For Alberta, it is 10%.

Formula Steps

1. Calculate 3% of your net income (A * 0.03 = A1).
2. Compare A1 with $2,759 and take the lower amount (A2).
3. Subtract A2 from your eligible medical expenses (B - A2 = X).
4. Multiply X by the combined provincial and federal lowest tax rates (X * (C + 0.15) = 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 (C = 10%)

Calculation Steps:

1. $100,000 * 0.03 = $3,000
2. Compare $3,000 with $2,759: Pick the lower amount ($2,759).
3. $5,000 - $2,759 = $2,241
4. $2,241 * (0.10 + 0.15) = $560.25

In this case, you would have a non-refundable Medical Expense Tax Credit of $560.25.

What is a Health Spending Account (HSA)?

A Health Spending Account (HSA) is CRA-approved and enables incorporated business owners to convert 100% of their after-tax medical expenses into before-tax business expenses. This means that medical expenses become fully tax-deductible for the business, providing 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: 36%

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 / (1−0.36) = $7,812.50

Calculate the tax cost:

$7,812.50 × 0.36 = $2,812.50

Therefore, when paying a $5,000 expense personally, the true cost (before tax) is $7,812.50. $2,812.50 of this amount is tax.

How Much Could You Save With an HSA?

The total cost of the $5,000 medical expense when paid for using a Health Spending Account (HSA) is $5,525, whereas this same expense when paid personally is $7,812.50.

This represents a savings of $2,287.50 (29.00%) when paying for the exact same expense using a Health Spending Account (HSA).

Comparison: METC vs. HSA

The METC and HSA both offer ways to reduce your medical expenses, but they work differently:

• METC: Reduces your taxable income through a non-refundable tax credit. The benefit is limited by your income and the amount of your medical expenses.
• HSA: Allows small 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. HSA is only for incorporated business owners.
• 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.