A Health Savings Account—HSA—allows employees covered by a High Deductible Health Plan (HDHP) to take a deduction for Adjusted Gross Income (AGI) for contributions to an IRA type account to pay for or to be reimbursed for qualified medical expenses. This article will explain the eligibility rules regarding qualified individuals, limits on contributions and withdrawals, treatment of distributions, reporting contributions and distributions on form 1040 and supporting schedules.
General Rules and Eligibility
Eligible persons can set up a HSA with an insurance company, bank, or other financial institution approved by the IRS. The HSA must be established before expenses are incurred. Earnings on contributions to a HSA are not taxable. To be eligible to make contributions, a person must not be enrolled in Medicare part A or B (but see below for partial year Medicare enrollees) and not be a dependent of another taxpayer. A qualifying HDHP is required to have an annual minimum deductible and a maximum annual limitation on out-of-pocket costs (see table below). The limitation is applicable to co-payments and deductibles but not health care premiums (see exceptions under Distributions). A taxpayer cannot have coverage under a HSA unless it meets the high deductible requirement of a HDHP, but there are exceptions. Permitted coverage includes expenses for vision, dental, long-term care, accidents, and disabilities. Permitted insurance includes coverage for per-diem while hospitalized, specific illnesses or diseases (e.g., cancer, diabetes, asthma, heart failure), and insurance for workman’s comp liability, tort liability, or liabilities related to owning property (for example, a car or house).
Coverage Type |
Self-Only |
Family |
||
2016 |
2017 | 2016 | 2017 | |
Maximum Deductible Contribution* |
$3350 |
$3400 |
$6750 |
$6750 |
Minimum HDHP deductible |
$1300 |
$1300 |
$2600 |
$2600 |
Out-of-Pocket caps (excluding premiums) |
$6550 | $6550 | $13,100 |
$13,100 |
*For taxpayers not enrolled in Medicare and 55 or older by the end of the year, an additional $1,000 can be contributed.
Limitations on Deductible Contributions
Contributions are reported on Form 5498-SA. The contributions are allowed up to the maximum (see table above) regardless of the number of months you were eligible (but see below for limits if enrolled Medicare during the year) and can be made up to the due date of the tax return in the following year.
If a taxpayer is married, has HDHP family coverage, and both spouses are eligible for a HSA, allocations of HSA contributions can be made as they agree. You can have more than one HSA but the maximum annual contribution applies to the aggregate of all HSAs. Employer contributions to an employee’s HSA are not taxable. If an employee contributes more than the annual limit, the excess is not deductible and a 6% surtax applies to the excess.
Excess employer’s contributions to an employee’s HSA, are included in the employee’s income and subject to the 6% excise tax. If the excess is withdrawn before the due date of the tax return, including extensions, it is not subject to the excise tax, the earnings on the excess are not taxable in the year of withdrawal, and the excess contribution distributed is not taxable. If the employer contributes less than the maximum allowed, the employee can make contributions but the employer and employee combined amounts can’t exceed the maximum allowed.
Form 8889 is used to report the contributions which are deductible FOR AGI (line 25, form 1040).
Prorated Contributions Limit for Year Enrolled in Medicare
In this case, contributions are allowed only for the months prior to enrolling in Medicare. For example:
- self-only plan—In 2016, A taxpayer has a self-only HDHP and turns 65 on August 1 and enrolls in Medicare. The full year contribution is $4,350 ($3,350, plus $1,000 for being over 55). The contribution allowed for January-July is $1,953 (7/12 x $4,350).
- family plan—Assume the taxpayer is married and the wife enrolls in Medicare in August. Her family HSA contribution is limited to $3,938 (7/12 x $6,750) which can be divided between their HSAs any way they choose. She may also contribute $583 (7/12 x $1,000 for age 55 and over) to her own HSA.
- family plan— Husband continues with self-only coverage after September until he turns 65 and enrolls in Medicare in November. He must prorate the full year limit of $3,350 for 10 months (January-October before enrolling in Medicare). He may make a contribution of $3,792 [(10/12 x $3,350) + $833 ($1,000 x 10/12 for age 55 and over)] to his own HSA.
Distributions
Withdrawals made to pay qualified medical expenses for the taxpayer, spouse, and dependents are tax free. If the withdrawals are made for non-qualified purposes, they are taxable. If taxpayer is under age 65, they are subject to a 20% penalty tax. There is no penalty if taxpayer is 65, disabled, or dies during the year.
Distributions can be taken in any year following the one in which the expenses are incurred (for example, funds in the account were insufficient to cover the expenses when they were incurred). Expenses paid with the HSA funds can not be taken as an itemized deduction and records must be maintained to substantiate expenses paid with the withdrawals not covered by other insurance or otherwise reimbursed and not taken as an itemized deduction.
“Qualified” medical expenses are those allowed as a medical expense itemized deduction and over-the-counter medications obtained with a doctor’s prescription. A HSA can also be used to, pay premiums for Consolidated Omnibus Budget Reconciliation Act (COBRA), health care continuation coverage, employee share of health care premiums on employer sponsored health insurance plans (including retiree benefits), health care coverage while receiving unemployment, and for Medicare parts A and B, Medicare Supplemental and Advantage plans. It can also be used to pay premiums for long-term care insurance up to the age based deductible limit.
Any excess is taxable and subject to a 20% penalty, if under age 65. If a husband and wife both have a HSA, either one can use the funds in their own plan to pay for the other spouse’s expenses but both HSAs can’t be used to pay the same expenses. If a distribution is taken to pay expenses that the person mistakenly believes are qualified expenses the amount used can be repaid to the HSA to avoid tax on the unallowed withdrawal, but only if the plan allows such repayments. If it does not, the unallowed withdrawals are taxable and subject to the 20% penalty if under 65.
The funds must be repaid by April 15 following the first year that the account holder knew or should have known about the mistake. Taxable and non-taxable distributions and the 20% penalty are reported on form 8889, part II. The taxable distribution is then reported on line 62 (other income) of form 1040. Any 20% penalty is reported on form 1040, line 62 (other taxes).
Inherited HSA
A surviving spouse who becomes the beneficiary of a HSA is now the owner and subject to the same rules as the deceased spouse. If the beneficiary is not the surviving spouse, the account is no longer a HSA on the date of the owner’s death and the value of the account on the date of death must be included in the beneficiary’s income. Any medical expenses paid for the decedent out of the HSA, within one year from date of death, reduces the taxable amount. A beneficiary is not subject to the penalty on taxable distributions. The HSA custodian or trustee reports the distributions on Form 1099-SA.
Conclusion
A HSA is beneficial for taxpayers to make contributions to supplement their normal health care coverage because contributions are tax deductible and earnings and distributions used to pay qualified medical expenses are tax free. But, a HSA has several requirements that must be met for taxpayers to be eligible to establish one and there are restrictions on the timing and amounts that be contributed and deducted each year. Taxpayers must be careful to abide by these restrictions and limitations or they may have additional income subject to tax.
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