A Qualified High Deductible Health Plan (QHDHP) coupled with a Health Savings Account (HSA) offers an opportunity for individuals to be more involved in and responsible for managing their own healthcare costs while enjoying advantageous tax treatment. HSA contributions, investment earnings, and distributions for qualified medical expenses are free of federal income taxes, FICA taxes and most state income taxes. In exchange for this tax-favored status, certain requirements apply to HSAs. This Benefit Minute provides a reminder about those requirements.
Eligibility & Contributions
To be eligible to contribute to an HSA, an individual must be covered under a QHDHP on the first day of the month, have no other health coverage that is not a QHDHP (with some exceptions such as dental, vision, limited purpose FSAs and hospital indemnity coverage), not be enrolled in Medicare, and not be claimed as a dependent on someone else’s tax return. The HSA is an individually owned trust or custodial account.
For 2017, the IRS has set the annual HSA contribution limits to $3,400 for single coverage and $6,750 for family coverage. While contribution amounts are determined monthly (1/12th for each month of QHDHP coverage), a special last month rule allows a full year contribution if an individual is covered on the first day of the last calendar month of the tax year and remains covered for an additional 12 months (called the testing period). Individuals age 55 and older may also contribute up to an extra $1,000 per year.
Excess Contributions
Any contribution to a HSA that exceeds the contribution limits above (determined on a month-by-month basis) is an excess contribution. Excess contributions lose their tax-favored treatment and must be included in gross income. In addition, excess contributions not withdrawn by the due date, including extensions, of the individual’s tax return are subject to a 6% annual excise tax penalty. When calculating the total HSA contributions for the tax year, employer contributions, employee salary reduction contributions and individual post-tax contributions (taken as an above-the-line tax deduction) must be included. Employer and employee salary reduction contributions are reported annually in Box 12 of the Form W-2.
Failure to Maintain QHDHP Coverage
Under the special last month rule, an individual who fails to maintain QHDHP coverage throughout the testing period must include in income in the next tax year the pro-rata contribution amount that would not have been made except for the rule. This amount is also subject to an additional 10% tax. However, the amount included in income remains in the account and can be used for tax-free distributions to pay qualified medical expenses.
Distributions
Tax-free distributions from an HSA may be taken to pay or reimburse the qualified medical expenses of an individual, a spouse and tax dependents, as long as the expenses are incurred after the HSA has been established. Distributions for other reasons are subject to income tax and may be subject to an additional 20% tax. An individual who is no longer eligible to contribute to an HSA may still receive tax-free distributions for qualified medical expenses.
Nondiscrimination & Comparability Rules
Under the general comparable contribution rules, employer contributions to an HSA must be either the same dollar amount or the same percentage of the deductible for all similarly situated employees. However, as long as employees have the opportunity to make salary reduction contributions to an HSA through the employer’s cafeteria plan, employer HSA contributions are not subject to the strict comparability rules and instead are tested under the cafeteria plan nondiscrimination rules. This allows employers additional flexibility in designing a non-discriminatory contribution strategy, such as contributing more to the HSAs of lower income employees, providing a matching HSA contribution or offering HSA contributions as a wellness plan reward.
Medicare and HSA Eligibility
Enrollment in Medicare Part A will make an individual ineligible to contribute to an HSA. Premium-free Part A coverage begins the month an individual turns age 65, provided he or she files an application for Part A (or for Social Security retirement benefits) within 6 months of attaining age 65. If the application is filed more than 6 months after turning 65, Part A coverage will be retroactive for 6 months. This will impact an individual’s HSA contribution limit in the tax year of Medicare enrollment (or the prior tax year or both) since HSA eligibility is determined monthly. In addition, an individual already receiving Social Security retirement benefits cannot disenroll from Medicare Part A to gain HSA eligibility without also losing retirement benefits and having to repay retirement benefits already received.
Future Outlook
The President-elect and the Republican majority have stated that Health Savings Accounts are an important facet of their plan to reshape the existing healthcare system. Republicans have advocated for increasing contribution limits to mirror out-of-pocket maximums, allowing reimbursable expenses to be incurred prior to establishment of an HSA, allowing both spouses to make catch-up contributions to a single HSA, providing greater portability of HSAs through estate transfers and repealing the Cadillac tax. Employers should continue to monitor future legislative and regulatory developments that may impact QHDHPs and HSAs.
