HSA Rules

HSA Rules For Employer Contributions

Health Savings Account Issues for Employers and Employees

HSA Rules For Employer Contributions Must Be Fair for Employees! 

First, and perhaps most importantly, employer need to know that HSA rules require that contributions to employees must be “comparable” for all employees participating in the HSA.  If they are not comparable, or fair in terms of the IRS code, there will be an excise tax equal to 35% of the amount that the employer contributed to employees’ HSA’s.  Comparable contributions are contributions to all HSA’s of an employer, which are:

1.    The same amount, or
2.    Which are the same percentages of the annual deductible.

When it comes to testing for comparability, an employer may only count employees who are “eligible individuals” covered by the employer under the high-deductible health plan and who have the “same category of coverage” (i.e., self-only or family).  No other classifications of employees are currently permitted.

Part-time employees can, and should, be tested separately from full-time employees.  “Part-time” means customarily employed fewer than 30 hours per week.   

Employer matching contributions to the HSA through a cafeteria plan are not subject to the comparability HSA rules, but cafeteria plan non-discrimination rules apply. Non-discrimination rules typically look to make sure that contributions aren’t greater for higher paid employees than they are for lower paid employees.  (However, contributions that favor lower paid employees are generally considered allowable.)  

Employer contributions into employee’s HSA accounts are always excluded from employees’ income (pre-tax), and distributions are tax-free if taken for “qualified medical expenses”, which now includes over-the-counter drugs.

Timing Issues Regarding the Setup of HSA’s 

HSA rules for qualified medical expenses must be incurred on or after the account was established. If the high-deductible health plan coverage becomes effective on first day of the month, the HSA can be established as early as first day of same month.  Conversely, if the high-deductible health insurance coverage is effective any day other than first day of month, HSA cannot be established until first day of following month.  

Can Medically-Related HSA Distributions be Taken for Someone Other than the Owner? 

Tax-free distributions can be taken for qualified medical expenses of the:

  •  Person covered by the high deductible.
  • Spouse of the individual (even if not covered by the high-deductible health plan).
  • Any dependent of the individual (even if not covered by the high-deductible health plan).

How Much Tax Do I Pay if my Distribution is not Used for Qualified Medical Expenses? 

If an account distribution is not used for qualified medical expenses, the amount of the distribution is included in taxable income for 1040 Federal Tax purposes, and an additional 10% tax is applied except when taken after:

  • Individual dies or becomes disabled, or
  • Individual is age 65.

“Qualified medical expenses” do not include other health insurance (including premiums for dental or vision care).  The exception to these HSA rules include:

  • COBRA continuation coverage.
  • Any health plan coverage while receiving unemployment compensation.
  • For individuals enrolled in Medicare: Medicare premiums and out-of-pocket expenses (Part A, Part B, Medicare HMOs, and prescription drug coverage).
  • The employee’s share of premiums for employer-based coverage.
  • Cannot pay Medigap premiums.
  • Qualified long-term care insurance premiums.

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Should the HSA account holder keep receipts?

YES!  Here is why:

  • The account-owner may need to prove to IRS that distributions from an HSA were for medical expenses and not otherwise reimbursed, and
  • He or she may be required by an insurance company to prove that a high-deductible health plan deductible was met.

Not all medical expenses paid out of the HSA have to be charged against the deductible (e.g. dental care, vision care), and health savings account distributions can be used to reimburse prior years’ expenses as long as they were incurred on or after the date the HSA was established.  There is no time limit on when a distribution must occur, but the individual must keep sufficient records to prove that:

  • the expenses were incurred,
  • they were not paid for or reimbursed by another source, or
  • they were taken as an itemized deduction on a previous tax return.

Mistaken HSA distributions can be returned to the HSA. It should be noted that clear and convincing evidence must be shown that the distribution was a mistake of fact.

The original distribution must be repaid by April 15 of the year following the year in which the individual knew or should have known the distribution was a mistake.

What happens to an HSA when the HSA owner dies? 

If the spouse is the beneficiary of the health savings account, the spouse inheriting the HSA is treated as the owner.  To the extent the spouse is not the beneficiary, the account will no longer be treated as an HSA upon the death of the individual. 

The account will then become taxable to the decedent in the decedent’s final tax return if the estate is the beneficiary, otherwise, it will be taxable to the recipient.

The taxable amount will be reduced by any qualified medical expenses incurred by the deceased individual before his or her death and paid by the recipient of the account.  Also, the taxable amount will be reduced by the amount of estate tax paid due to inclusion of the HSA into the deceased individual’s estate.

HSA Rules: Who Owns the HSA?  The Employer?  The Individual? 

Accounts are owned by the individual (not an employer). The individual decides:

  • Whether he or she should contribute,
  • How much to use for medical expenses,
  • Which medical expenses to pay from the account,
  • Whether to pay for medical expenses from the account or save the account for future use,
  • Which company will hold the account,
  • What type of investments to grow account,

The employer cannot restrict:

The health savings account custodian or trustee can put reasonable limits on accessing the money in the account because of:

  • Frequency of distributions, or
  • The size of the distributions.

Who can be an HSA Trustee or Custodian?

  • Banks,
  • Credit unions,
  • Insurance companies,
  • Entities already approved by the IRS to be an IRA or Archer MSA trustee or custodian,
  • Other entities can apply to the IRS to be approved as a non-bank trustee or custodian.

Trustee, investment, or custodian fees can be paid from the assets in the HSA account without being subject to tax or penalty.

There are no “use-it-or-lose-it rules” like Flexible Spending Arrangements (FSAs).  All amounts in the HSA are fully vested.

Unspent balances in accounts remain in the account until spent.  In this, HSA’s encourages account holders to spend their funds more wisely on their medical care without the “use-it-or-lose-it” hurdles.  HSA’s also encourage account holders to shop around for the best value for their health care dollars.

  • Accounts can grow through investment earnings, just like an IRA. Same investment options and investment limitations as with IRAs.
  • Same restrictions on self-dealing as with IRAs.
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