What is an HSA?
A Health Savings Account (HSA) is a tax-exempt trust or custodial account you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur. You must be an eligible individual to qualify for an HSA.
No permission or authorization from the IRS is necessary to establish an HSA. You set up an HSA 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 individual retirement arrangements (IRAs) or Archer MSAs. The HSA can be established through a trustee that is different from your health plan provider.
Your employer may already have some information on HSA trustees in your area.
TIP If you have an Archer MSA, you generally can roll it over into an HSA tax free.
What are the benefits of an HSA?
You may enjoy several benefits from having an HSA.
- You can claim a tax deduction for contributions you, or someone other than your employer, make to your HSA even if you don’t itemize your deductions on Schedule A (Form 1040).
- Contributions to your HSA made by your employer (including contributions made through a cafeteria plan) may be excluded from your gross income.
- The contributions remain in your account until you use them.
- The interest or other earnings on the assets in the account are tax free.
- Distributions may be tax free if you pay qualified medical expenses.
- An HSA is “portable.” It stays with you if you change employers or leave the work force.
How do you qualify for an HSA?
To be an eligible individual and qualify for an HSA, you must meet the following requirements.
- You are covered under a high deductible health plan (HDHP), described later, on the first day of the month.
- You have no other health coverage except what is permitted
- You aren’t enrolled in Medicare.
- You can’t be claimed as a dependent on someone else’s 2016 tax return.
TIP Under the last-month rule, you are considered to be an eligible individual for the entire year if you are an eligible individual on the first day of the last month of your tax year (December 1 for most taxpayers).
If you meet these requirements, you are an eligible individual even if your spouse has non-HDHP family coverage, provided your spouse’s coverage doesn’t cover you.
CAUTION If another taxpayer is entitled to claim an exemption for you, you can’t claim a deduction for an HSA contribution. This is true even if the other person doesn’t actually claim your exemption.
TIP Each spouse who is an eligible individual who wants an HSA must open a separate HSA. You can’t have a joint HSA.
Qualified medical expenses are those expenses that generally would qualify for the medical and dental expenses deduction. These are explained in Pub. 502, Medical and Dental Expenses.
Also, non-prescription medicines (other than insulin) aren’t considered qualified medical expenses for HSA purposes. A medicine or drug will be a qualified medical expense for HSA purposes only if the medicine or drug:
- Requires a prescription,
- Is available without a prescription (an over-the-counter medicine or drug) and you get a prescription for it, or
- Is insulin.
For HSA purposes, expenses incurred before you establish your HSA aren’t qualified medical expenses. State law determines when an HSA is established. An HSA that is funded by amounts rolled over from an Archer MSA or another HSA is established on the date the prior account was established.
If, under the last-month rule, you are considered to be an eligible individual for the entire year for determining the contribution amount, only those expenses incurred after you actually establish your HSA are qualified medical expenses.
Qualified medical expenses are those incurred by the following persons.
- You and your spouse.
- All dependents you claim on your tax return.
- Any person you could have claimed as a dependent on your return except that:
- The person filed a joint return,
- The person had gross income of $4,050 or more, or
- You, or your spouse if filing jointly, could be claimed as a dependent on someone else’s 2016 return.
TIP For this purpose, a child of parents that are divorced, separated, or living apart for the last 6 months of the calendar year is treated as the dependent of both parents whether or not the custodial parent releases the claim to the child’s exemption.
CAUTION You can’t deduct qualified medical expenses as an itemized deduction on Schedule A (Form 1040) that are equal to the tax-free distribution from your HSA.
Insurance premiums.
You can’t treat insurance premiums as qualified medical expenses unless the premiums are for:
- Long-term care insurance.
- Health care continuation coverage (such as coverage under COBRA).
- Health care coverage while receiving unemployment compensation under federal or state law.
- Medicare and other health care coverage if you were 65 or older (other than premiums for a Medicare supplemental policy, such as Medigap).
The premiums for long-term care insurance (item (1)) that you can treat as qualified medical expenses are subject to limits based on age and are adjusted annually. See Limit on long-term care premiums you can deduct in the instructions for Schedule A (Form 1040).
Items (2) and (3) can be for your spouse or a dependent meeting the requirement for that type of coverage. For item (4), if you, the account beneficiary, are not 65 or older, Medicare premiums for coverage of your spouse or a dependent (who is 65 or older) generally aren’t qualified medical expenses.
How do you contribute to an HSA?
Any eligible individual can contribute to an HSA. For an employee’s HSA, the employee, the employee’s employer, or both may contribute to the employee’s HSA in the same year. For an HSA established by a self-employed (or unemployed) individual, the individual can contribute. Family members or any other person may also make contributions on behalf of an eligible individual.
Contributions to an HSA must be made in cash. Contributions of stock or property aren’t allowed.
TIP For 2017, if you have self-only HDHP coverage, you can contribute up to $3,400. If you have family HDHP coverage, you can contribute up to $6,750.If you were, or were considered (under the last-month rule, discussed later), an eligible individual for the entire year and didn’t change your type of coverage, you can contribute the full amount based on your type of coverage. However, if you weren’t an eligible individual for the entire year or changed your coverage during the year, your contribution limit is the greater of:
- The limitation shown on the Line 3 Limitation Chart and Worksheet in the Instructions for Form 8889, Health Savings Accounts (HSAs), or
- The maximum annual HSA contribution based on your HDHP coverage (self-only or family) on the first day of the last month of your tax year.
TIP If you had family HDHP coverage on the first day of the last month of your tax year, your contribution limit for 2016 is $6,750 even if you changed coverage during the year.
Last-month rule. Under the last-month rule, if you are an eligible individual on the first day of the last month of your tax year (December 1 for most taxpayers), you are considered an eligible individual for the entire year. You are treated as having the same HDHP coverage for the entire year as you had on the first day of the last month.
Testing period. If contributions were made to your HSA based on you being an eligible individual for the entire year under the last-month rule, you must remain an eligible individual during the testing period. For the last-month rule, the testing period begins with the last month of your tax year and ends on the last day of the 12th month following that month (for example, December 1, 2016, through December 31, 2017).If you fail to remain an eligible individual during the testing period, for reasons other than death or becoming disabled, you will have to include in income the total contributions made to your HSA that wouldn’t have been made except for the last-month rule. You include this amount in your income in the year in which you fail to be an eligible individual. This amount is also subject to a 10% additional tax. The income and additional tax are calculated on Form 8889, Part III.
What if I take the wrong amount out of an HSA?
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. For example, the account beneficiary reasonably, but mistakenly, believed that an expense was a qualified medical expense and was reimbursed for that expense from the HSA. The account beneficiary then repays the mistaken distribution to the HSA.
Under these circumstances, the mistaken distribution is not included in gross income, is not subject to the additional 20% tax, and the repayment is not subject to the excise tax on excess contributions. Do not treat the repayment as a contribution on Form 5498-SA, HSA, Archer MSA, or Medicare Advantage MSA Information.
As the trustee or custodian, you do not have to allow beneficiaries to return a mistaken distribution to the HSA. However, if you do allow the return of the mistaken distribution, you may rely on the account beneficiary’s statement that the distribution was in fact a mistake. See Notice 2004-50, 2004-33 I.R.B. 196, Q/A-76, available at IRS.gov/irb/2004-33_IRB/ar08.html. Do not report the mistaken distribution on Form 1099-SA. Correct any filed Form 1099-SA with the IRS and the account beneficiary as soon as you become aware of the error. See Corrected Returns on Paper Forms in the 2018 General Instructions for Certain Information Returns for more information.
Health Savings Accounts and Other Tax-Favored Health Plans
For more information on Health Savings Accounts and other tax-favored health plan please feel free to contact us directly via email contact@MrSmartTax.com
