For eligible individuals, health savings accounts (HSA) 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:
- contributions you make to an HSA are deductible,
with limits,
- contributions your employer makes aren't taxed to
you,
- earnings on the funds within the HSA are not
taxed, and
- distributions from the HSA to cover qualified
medical expenses are not taxed.
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 2005, a “high deductible health plan” is a plan with an annual
deductible of at least $1,000 for self-only coverage, or at least $2,000 for
family coverage. Additionally, annual out-of-pocket expenses required to be
paid (other than for premiums) for covered benefits cannot exceed $5,100 for
self-only coverage or $10,200 for family coverage.
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. The monthly limitation on deductions for a person with
self-only coverage is 1/12 of (1) the lesser of the annual deductible or (2)
$2,650. For an individual with family coverage, the monthly limitation on
deductions is 1/12 of (1) the lesser of the annual deductible or (2) $5,250.
For example, if for the entire year, an individual has family coverage
with an annual deductible of $4,000, the monthly limitation is $333.33 (1/12
× $4,000 (the lesser of the annual deductible of $4,000 or $5,250). The
deduction limit for the year would be 12 × $333.33, or $4,000. No other
limits apply except that the deduction cannot exceed compensation. 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.
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.
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.
