Background on HSAs & What They Are

The Background on HSAs – A health savings account (HSA) is a tax-favored medical savings account available to taxpayers. HSAs enable taxpayers to pay for current medical expenses and save for future qualified medical expenses on a tax-free basis. HSAs are owned by individuals, but contributions may be made by an employer or any other person. Amounts in an HSA may be accumulated over the years or distributed on a tax-free basis to pay for or reimburse qualified medical expenses.

What is an HSA? An HSA is a tax-exempt trust or custodial account that a taxpayer sets up with a qualified HSA trustee. Distributions from an HSA are nontaxable if the funds are used for qualified medical expenses. A taxpayer must be an eligible individual to qualify to contribute to an HSA. No permission or authorization from the IRS is necessary to establish an HAS.

To set up an HSA a taxpayer will need to work with a trustee. A qualified HSA trustee can be a bank, an insurance company, or anyone already approved by the IRS to be a trustee of an individual retirement arrangement (IRA) or Archer MSA. The HSA can be established through a trustee that is different from the taxpayer’s health plan provider.

An HSA is created by: • Enrolling in a High-Deductible Health Plan (HDHP) and then • Opening a tax-exempt trust or custodial account, with a qualified HSA trustee, to pay for qualified medical expenses.

HSA Benefits

The benefits of having an HSA include: • Amounts contributed to an HSA, except for employer contributions, can be used as an adjustment to income. • Contributions to an HSA by an employer may be excluded from gross income; this includes contributions made through a Section 125 cafeteria plan. • The contributions remain in the account and are carried over, without limit, from year to year until the taxpayer uses them. • The interest and other earnings on the assets in the account are tax-free. • Distributions will be tax-free if used to pay unreimbursed qualified medical expenses. • An HSA is portable, so it stays with taxpayers even if they change employers or leave the work force. • There is no deadline by which qualifying expenses must be reimbursed by the HSA.

Rules for Married Individuals:

In the case of married individuals, each spouse who is an eligible individual who wants to have an HSA must open a separate HSA. Married couples cannot have a joint HSA, even if they are covered by the same HDHP; however, distributions can be used to cover the qualified expenses of the other spouse. In the event of the death of one of the married individuals, the HSA will be treated as the surviving spouse’s HSA if the spouse is the designated beneficiary of the HSA.

Rules for Married People:

The rules for married people apply only if both spouses are eligible individuals. If either spouse has family HDHP coverage, the family contribution limit applies; both spouses are treated as having family HDHP coverage.

If both spouses are 55 or older and not enrolled in Medicare: • Each spouse is entitled to increase his or her contribution limit with an additional contribution. • Their maximum total contributions under family HDHP coverage would include a catch-up contribution for each spouse. • The contribution limit is divided between the spouses by agreement. If there is no agreement, the contribution limit is split equally between the spouses. • Any additional contribution for age 55 or over must be made by each spouse to his or her own HSA.

Limit on Contributions:

While many taxpayers do not contribute the maximum amount allowed to their HSA, you may need to explain these limits to taxpayers. The amount that can be contributed to an HSA depends on the: • Type of HDHP coverage (self-only or family coverage) • Taxpayer’s age • Date the taxpayer became an eligible individual, and • Date the taxpayer ceases to become an eligible individual.

If the taxpayer is an eligible individual on the first day of every month with the same coverage for the entire year, the full contribution amount is allowed.

If the taxpayer was not an eligible individual for the entire year or changed his or her coverage during the year, the contribution limit is: • Last-month rule allows eligible individuals to make a full contribution for the year even if they were not an eligible individual for the entire year.

They can make the full contribution for the year if: – They are eligible individuals on the first day of last month of their taxable year. For most people, this would be December 1, and – They remain eligible individuals during the testing period. The testing period runs from December 1 of the current year through December 31 of the following year (for calendar taxpayers). – If the taxpayer does not qualify to contribute the full amount for the year, the contribution is determined by using the sum of the monthly contribution limits rule. OR • Sum of the monthly contribution limits rule (use Limitation Chart and Worksheet in Form 8889 Instructions). This is the amount determined separately for each month based on eligibility and HDHP coverage on the first day of each month plus catch-up contributions. For this purpose, the monthly limit is 1/12 of the annual contribution limit, as calculated on the Limitation Chart and worksheet. A taxpayer who cannot use the last-month rule must use the sum of the monthly contribution limits rule to determine the maximum HSA contribution.

Distributions from an HSA / Distributions for Qualified Medical Expenses:

Generally, taxpayers will pay medical expenses during the year without being reimbursed by the HDHP until the plan’s annual deductible is reached. When the taxpayer pays these medical expenses that are not reimbursed by the HDHP, the taxpayer can request a distribution from the HSA trustee. The taxpayer can receive tax-free distributions from an HSA to pay or be reimbursed for qualified medical expenses incurred after the taxpayer establishes the HSA.

Qualified medical expenses are expenses that generally would qualify for the medical and dental expenses deduction. Examples include unreimbursed expenses for doctors, dentists, and hospitals.

“The CARES Act of 2020 expanded allowable medical expenses to include the purchase of over-the-counter medical products, including those needed in quarantine and social distancing, without a prescription from a physician. This applies to amounts paid and expenses incurred after December 31, 2019. ” See Publication 502, Medical and Dental Expenses, for more information.

Taxpayers must keep records to show that HSA distributions were used to pay or reimburse qualified medical expenses and the medical expense had not been taken as an itemized deduction in any year. For recordkeeping requirements on HSA distributions see Publication 969, Distributions from an HSA.

Taxpayers are not required to take annual distributions from their HAS. However, taxpayers who have taken HSA distributions will receive Form 1099-SA, Distributions from an HSA, Archer MSA, or Medicare Advantage MSA, from their HSA trustee and must provide it before the return can be completed.

Expenses incurred before establishing an HSA are not qualified medical expenses. If a taxpayer is considered to be an eligible individual for the entire year under the last-month rule, only those expenses incurred after actually establishing the HSA are qualified expenses.

12 Health Savings Accounts (HSA) Mistaken Distributions

If amounts were distributed during the year from an HSA because of a mistake of fact due to reasonable cause, the account beneficiary may repay the mistaken distribution no later than April 15 following the first year the account beneficiary knew or should have known the distribution was a mistake. See the instructions for Form 1099-SA for further information.

This information is attributed to the IRS Publication 4942 (Rev. 10-2022) at https://www.irs.gov/pub/irs-pdf/p4942.pdf

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