- Recent IRS Guidance on Health Savings Accounts
- October 28, 2008
- Law Firm: Krieg DeVault LLP - Indianapolis Office
The Internal Revenue Service ("IRS ") has had a busy summer in the employee benefits area, issuing three separate notices related to health savings accounts ("HSAs"). HSAs, which grew out of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, are accounts established by eligible individuals, designed to help those individuals save for and pay for qualified medical expenses incurred by account holders and their eligible dependents on a tax-free basis. Since the inception of these accounts, the IRS has issued formal technical guidance on several occasions on a wide range of HSA-related issues. This summer's guidance is no exception in its wide-ranging scope.
Notice 2008-51: Qualified Distributions from IRAs to HSAs. As part of the Health Opportunity and Empowerment Act of 2006, Congress enacted Section 408(d)(9) of the Internal Revenue Code (the "Code"), and created a "qualified HSA funding distribution" from certain Individual Retirement Accounts ("IRAs"). Qualified HSA funding distributions are permissible by HSA eligible individuals for tax years beginning after December 31, 2006. On June 23, 2008, the IRS published Notice 2008-51 detailing the rules applicable to these distributions.
A qualified HSA funding distribution is a direct trustee-to-trustee transfer from either a traditional IRA or a Roth IRA (but not a SIMPLE IRA or a SEP IRA) to an individual HSA. This type of distribution is excluded from gross income and is not subject to the 10% additional tax for early distribution ordinarily imposed on IRA distributions that occur prior to a specified event, as long as the individual remains eligible to contribute to an individual HSA for a "testing period." The testing period is 13 months in duration, beginning on the first day of the month in which the qualified funding distribution is made, and ending on the last day of the 12th month following that month. Fortunately, HSA account holders are responsible for tracking whether an individual remains eligible during the testing period; employers are not required to do so. If an individual fails to remain HSA eligible during the testing period, the entire amount of the qualified HSA funding distribution is taxable and subject to the 10% additional tax.
The maximum amount of a qualified funding distribution from an individual IRA to an HSA is limited by the HSA account holder's maximum annual HSA contribution for the tax year in which the distribution is made. In 2008, this maximum annual contribution for an HSA account holder with qualifying self-only coverage is $2900, and for an account holder with qualifying family coverage is $5,800. In addition, an HSA account holder age 55 or over by the end of the tax year may make an additional $900 "catch up" contribution to his HSA. Any qualified funding distribution to an HSA is applied against these maximum annual contribution limitations. Again, HSA account holders are responsible for ensuring that the maximum annual contribution limit is not exceeded.
Generally, an individual is limited to one qualified HSA distribution during his lifetime. The only exception to this limitation is if the distribution occurs when the individual has self-only coverage, and later in the taxable year, the individual changes to family coverage. A second qualified HSA distribution is permissible in these circumstances if that distribution is made in the same tax year as the first distribution, subject to the HSA annual contribution limits. Individuals wishing to distribute funds from multiple IRAs must combine those accounts prior to making the one-time qualified HSA distribution.
IRS Notice 2008-52: The Full Contribution Rule. Also on June 23, 2008, the IRS published Notice 2008-52, describing rules related to HSA contribution limits and the "full contribution rule" set forth in the Tax Relief and Health Care Act of 2006 ("TRHCA"). Prior to January 1, 2007, the maximum annual HSA contribution was limited by an individual's deductible under his high deductible health plan ("HDHP"). TRHCA repealed this limitation, and established that the maximum annual HSA contribution of an eligible individual with HDHP coverage is equal to the applicable annual statutory maximum, which in 2008 is $2,900 for self-only coverage and is $5,800 for family coverage. In addition, TRHCA established the full contribution rule.
Notice 2008-52 sets forth how to calculate the maximum annual contribution for an eligible individual under the full contribution rule. The full contribution rule provides that an individual who is an HSA eligible individual on the first day of the last month of the tax year (December 1 for calendar year taxpayers) is treated like an eligible individual for the entire year. That individual may increase his contribution to an HSA to the annual maximum for his type of coverage (self-only v. family), and may determine that annual maximum based on the type of coverage that he has in place on the first day of the last month of the tax year. This rule also applies to catch up contributions for individuals age 55 and older.
The benefit of the full contribution rule is that it applies regardless of whether the individual was an HSA eligible individual for the entire tax year, and will apply to mid-year entrants under an employer's HDHP. The individual's eligibility and type of HDHP coverage on the first day of the last month of the tax year (usually December 1) controls his maximum HSA contribution for that year, regardless of the type of coverage in place prior to that date.
The full contribution rule is subject to a testing period similar to qualified funding distributions. The testing period is 13 months long, beginning on the first day of the last month of the tax year and ending on the last day of the 12th month following that month. For calendar year taxpayers making 2008 HSA contributions and taking advantage of this rule, the testing period begins on December 1, 2008and ends on December 31, 2009 . It is important to note that if an individual takes advantage of the full contribution rule and makes an HSA contribution greater than the monthly contribution limits under Code Section 223(b), but fails to remain an HSA eligible individual during the entire testing period, then the amount of the excess contributions is included in the individual's gross income and subject to an additional 10% tax. Fortunately, the individual is not required to maintain the same level of HDHP coverage during the testing period, and may change from family to self-only HDHP coverage during the testing period without penalty.
IRS Notice 2008-59: The "Grab Bag" Guidance. On July 21, 2008, the IRS published Notice 2008-59, commonly referred to as the "grab bag" HSA guidance. This latest guidance is intended to "amplify" prior guidance, and provide answers to a myriad of questions related to HSAs that have arisen since issuance of prior guidance. This Notice does not address any new law. The text sets forth seven broad categories of HSA-related issues, and provides questions and answers related thereto.
Eligible Individuals. The IRS clarified several issues related to determining HSA eligible individuals. Key clarifications include the fact that an individual is considered to be HSA eligible when covered by a limited-purpose health reimbursement arrangement (HRA) that reimburses premiums for accident or health coverage (in addition to dental, vision, and preventive care expenses). An individual is not ineligible to contribute to an HSA merely because he is eligible for Medicare; however, if an individual is both eligible for and enrolled in any Medicare benefit, he is not an HSA eligible individual. Similarly, an individual who has received medical benefits from the Veterans Administration at any time in the previous 3 months is not an HSA eligible individual, unless those benefits consisted solely of preventive care, permitted coverage, or permitted insurance. Coverage that is not an HDHP, but does have a deductible that exceeds the statutory minimum HDHP deductible, will not disqualify an otherwise eligible individual. An individual does not lose HSA eligibility due to access to free or reduced-charge health care at an employer's on-site clinic, as long as the clinic does not provide significant benefits in the nature of medical care. Finally, an individual with family HDHP coverage does not lose HSA eligibility solely because a family member covered under the HDHP also has disqualifying coverage. In fact, that individual remains eligible to contribute the annual statutory maximum for family coverage to his HSA.
High Deductible Health Plans. The IRS devoted a good deal of analysis to the calculation of deductibles under HDHPs, and concluded that when an individual makes a mid-year change from family to self-only HDHP coverage, amounts applicable to the family deductible may be allocated to the self-only deductible in any manner that is "reasonable and consistent" over a 12 month plan year. With the exception of COBRA continuation coverage, each expense must be allocated to a single individual. HDHPs are subject to annual out-of-pocket maximums, and the IRS made clear that when an HDHP contains a higher deductible for specific benefits, the additional amounts paid toward the higher specific benefit deductible do not count toward the statutory out-of-pocket maximum. Finally, the IRS reiterated that an HDHP must provide significant medical benefits, and plans providing only limited coverage such as hospitalization or in-patient care do not meet this requirement.
Contributions. The IRS addressed certain issues related to HSA contributions. An individual who ceases to be an eligible individual during a year may still contribute to an HSA, as long as he only makes contributions for the months during which he was eligible. Both employers and employees may contribute to employees' HSAs after December 31 and prior to April 15 of a subsequent tax year, and allocate those contributions to the prior tax year. If an employer chooses to do so, it must provide notice of the allocation to the HSA custodian. In addition, the IRS described the limited circumstances in which employers may recoup erroneous contributions to employees' HSAs. Specifically, employers may recoup their contributions in two circumstances: 1) when the employee was never an HSA eligible individual and as a result, no HSA exists, and 2) when the employer's contribution exceeds the annual statutory maximum. In either case, if the employer does not recoup the contribution prior to the end of the tax year, the amounts contributed in error must be reported as gross income to the employee. An employer cannot recoup contributions from an HSA under any other circumstances. Finally, any employer contribution to the HSA of a non-employee (such as an employee's spouse) must be included in the gross income of the employee.
Distributions. Although employers generally may not control employees' access to funds in HSAs, an employer may offer an HSA account with a debit card that restricts payments and reimbursements to health care expenses. An employer may do so if the funds in the HSA are otherwise readily available to the account holder, and the employer notifies the employee that other access to the funds is available. An HSA account holder may authorize other individuals to make withdrawals from his HSA, and those distributions are not subject to tax as long as they are for qualified medical expenses of the account holder, his spouse, or dependents. Medicare Part D premiums for the account holder, his spouse, or dependents are qualified expenses as long as the account holder is at least age 65. However, Medicare premiums for an account holder's spouse or dependents are not qualified expenses when the account holder has not attained age 65. The qualified nature of other types of medical expenses was also clarified. COBRA premiums, expenses for a spouse or dependent's health coverage during a period of unemployment, and qualified medical expenses for an account holder's child who is claimed as a dependent by the account holder's former spouse were all determined to be HSA qualified expenses.
Prohibited Transactions. The IRS addressed issues related to prohibited transactions under Code Section 4975, making clear that an account beneficiary may not borrow funds from his HSA, cause the HSA trustee to lend money or otherwise extend credit to his HSA, or pledge his HSA as security for a loan without entering into a prohibited transaction. If an account holder engages in a prohibited transaction with his HSA, the sanction is disqualification of the account, and the HSA ceases to be an HSA as of the first day of the tax year of the prohibited transaction. The assets of the HSA are deemed distributed, and all appropriate taxes, including the 10% additional tax for distributions not used for qualified medical expenses, are assessed.
Establishing HSAs. This guidance makes clear that state trust law determines when an HSA is established. An HSA that is funded by transfers from an Archer MSA or another HSA is considered to be established as of the date the prior account was established. However, qualified HSA distributions from health flexible spending accounts and health reimbursement arrangements, and qualified HSA funding distributions from IRAs do not effect the HSA establishment date.
Administration. Finally, the IRS stated that HSA administration and maintenance fees that are withdrawn from an individual HSA by the trustee are reported on the Form 5498 in the fair market value of the HSA at the end of the tax year, and are not reported as distributions from the HSA.