Many
Americans are taking advantage of an increasingly popular health care option
known as a health savings account (HSA). For eligible individuals, HSAs offer a tax-favorable way to set aside funds (or have
their employer do so) to meet future medical needs. Here are the key
tax-related elements:
Who is eligible? To be eligible for an HSA, you must be
covered by a “high deductible health plan” (discussed below). You must also not
be covered by a plan which (1) is not a high deductible health plan, and (2)
provides coverage for any benefit covered by your high deductible plan. (It's
okay, however, to be covered by a high deductible plan along with separate
coverage, through insurance or otherwise, for accidents, disability, or dental,
vision, or long-term care.)
For 2008, a “high deductible
health plan” is a plan with an annual deductible of at least $1,100 for
self-only coverage, or at least $2,200 for family coverage. For self-only
coverage, the 2008 limit on deductible contributions is $2,900. For family
coverage, the 2008 limit on deductible contributions is $5,800. Additionally,
annual out-of-pocket expenses required to be paid (other than for premiums) for
covered benefits cannot exceed $5,600 for self-only coverage or $11,200 for
family coverage.
An individual (and the
individual's covered spouse as well) who has reached age 55 before the close of
the tax year (and is an eligible HSA contributor) may make additional
“catch-up” contributions for 2008 of up to $900.
A high deductible health plan
does not include a plan if substantially all of the plan's coverage is for
accidents, disability, or dental, vision, or long-term care, insurance for a
specified disease or illness, or insurance paying a fixed amount per day (or other
period) of hospitalization.
HSAs may be established by, or on behalf of,
any eligible individual.
Deduction limits. You can deduct contributions to an HSA
for the year up to the total of your monthly limitations for the months you
were eligible. For 2008, the monthly limitation on deductible contributions for
a person with self-only coverage is 1/12 of $2,900. For an individual with
family coverage, the monthly limitation on deductible contributions is 1/12 of
$5,800. Thus, deductible contributions are not limited by the amount of the
annual deductible under the high deductible health plan.
Also, taxpayers who are eligible
individuals during the last month of the tax year are treated as having been
eligible individuals for the entire year for purposes of computing the annual
HSA contribution.
However, if an individual is
enrolled in Medicare, he is no longer an eligible individual under the HSA
rules, and so contributions to his HSA can no longer be made.
Contributions may be made to an
HSA by or on behalf of an eligible individual even if the individual has no
compensation, or if the contributions exceed the individual's compensation.
Contributions made by a family member on behalf of an eligible individual to an
HSA (which are subject to the limits described above) are deductible by the
eligible individual in computing adjusted gross income.
Rollovers
from IRAs, FSAs, and HRAs. For a limited period (beginning Dec. 20,
2006, and ending December 31, 2011) an eligible individual can make a one-time
transfer of amounts from a health flexible spending arrangement (health FSA) or
health reimbursement arrangement (HRA) to an HSA. The amount transferred is
limited to the lesser of (i) the account balance of
the individual's health FSA or HRA as of September 21, 2006, or (ii) the
account balance of the health FSA or HRA on the transfer date.
Similarly, on a once-only basis,
taxpayers can withdraw funds from an IRA, and transfer them tax-free to an HSA.
The amount transferred can be up to the maximum deductible HSA contribution for
the type of coverage (individual or family) in effect at the time of the
transfer. The amount so transferred is excluded from the taxpayer's gross
income, and is not subject to the 10% early withdrawal penalty.
Employer
contributions.
If you are an eligible individual, and your employer contributes to your HSA,
the employer's contribution is treated as employer-provided coverage for
medical expenses under an accident or health plan and is excludable from your
gross income up to the deduction limitation, as described above. Further, the
employer contributions are not subject to withholding from wages for income tax
or subject to FICA or FUTA. The eligible individual cannot deduct employer
contributions on his federal income tax return as HSA contributions or as
medical expense deductions.
An employer that decides to make
contributions on its employees' behalf must make comparable contributions to
the HSAs of all comparable participating employees
for that calendar year. If the employer does not make comparable contributions,
the employer is subject to a 35% tax on the aggregate amount contributed by the
employer to HSAs for that period.
Contributions are comparable if
they are either: (1) the same amount; or (2) the same percentage of the annual
deductible limit under the high deductible health plan covering the employees.
For these purposes, comparable participating employees (1) are covered by the
employer's high deductible health plan and are eligible to establish an HSA;
(2) have the same category of coverage (either self-only or family coverage);
and (3) have the same category of employment (either part-time or full-time).
(IRS regs provide detailed guidelines for comparable
contributions.)
An exception to the comparable
contribution requirements applies for contributions made on behalf of nonhighly compensated employees. Under this exception, an
employer may make larger HSA contributions for nonhighly
compensated employees than for highly compensated employees.
Employer contributions are also
excludable if made at the election of the employee under a salary reduction
arrangement that is part of a cafeteria plan (i.e., a plan which allows you to
elect to use part of your salary towards a variety of benefits). Although
contributions to an employee's HSA through a cafeteria plan are treated as
employer contributions, the comparability rule does not apply to contributions
made through a cafeteria plan.
Earnings. If the HSA is set up properly, it is
generally exempt from taxation, and there is no tax on earnings. However, taxes
may apply if contribution limitations are exceeded, required reports are not
provided, or prohibited transactions occur.
Distributions. Distributions from the HSA to cover an
eligible individual's qualified medical expenses, or those of his spouse or
dependents, are not taxed. Qualified medical expenses for these purposes
generally mean those that would qualify for the medical expense itemized
deduction. If funds are withdrawn from the HSA for other reasons, the
withdrawal is taxable. Additionally, an extra 10% tax will apply to the
withdrawal, unless it is made after reaching age 65, or in the event of death
or disability.
Distributions from an HSA
exclusively to pay for qualified medical expenses are excludable from the gross
income of the account beneficiary even though the beneficiary is no longer an
“eligible individual,” e.g., the individual is over age 65 and entitled to
Medicare benefits, or no longer has a high deductible health plan.
As you can see, HSAs offer a very flexible option for providing health care
coverage, but the rules are somewhat involved. Again, please call if you would
like to discuss this topic further.