There are different types of health-care savings programs that offer certain income tax advantages in order to save for, and offset the cost of health-care.  These programs may be sponsored by employers, and are generally also available to self-employed individuals.

Tax-Favored Health Plans

These plans include:

• Health Savings Accounts (HSAs),
• Medical Savings Accounts (MSAs, including Archer MSAs),
• Health Flexible Spending Arrangements (FSAs), and
• Health Reimbursement Arrangements (HRAs).

Who Can Make Contributions?

There are some differences among these programs regarding who can make contributions to the account:

• Health Savings Accounts:  The eligible individual or any other person, including the employer or a family member, can make contributions.  Contributions, except those made by the employer, are deductible on the eligible individual’s income tax return, without having to itemize deductions.  Employer contributions are not included in the person’s income.
• Archer Medical Savings Accounts:  The eligible individual and the employer can both make contributions, but not in the same year.  Contributions by the individual are deductible without having to itemize, and employer contributions are not included in income.
• Health Flexible Spending Arrangements:  Contributions can be made by both the eligible individual and the employer.  The individual’s contributions are deducted from his or her salary and while they are not deductible, they are not subject to income tax or payroll taxes. The employer’s contributions are not included in income.
• Health Reimbursement Arrangements: Only the employer can make contributions, and these are not included in the eligible individual’s income.

For all these programs, distributions from the accounts that are used to pay qualified medical expenses are not taxable.

Health Savings Accounts

A Health Savings Account (HSA) can be set up with a bank, insurance company, or a trustee authorized to set up Individual Retirement Arrangements (IRAs) or Archer Medical Savings Accounts (MSAs).  An HSA can be set up separately from your health care provider, and in this sense provides you with an additional source of funds to cover medical expenses.

Benefits of an HSA

There are tax and other benefits of having an HSA:

• You can deduct the contribution you or someone else makes on your behalf, without having to itemize deductions on your tax return.  You need to file Form 8889, Health Savings Accounts (HSAs) and can take the deduction as an adjustment to income on Form 1040.
• Contributions that your employer makes to the account (such as through a cafeteria plan) are excluded from your taxable income.
• The contributions remain in your account and earnings on the balance accumulate tax-free.
• Withdrawals, or distributions from your HSA are tax-free if you use them to pay qualified medical expenses.
• An HSA is not tied to your employer, so you can take it with you if your change jobs or stop working.

Who Qualifies for an HSA?

In order to qualify for an HSA, you must meet the following requirements:

• You must have a high deductible health plan (defined below).   
• You cannot have other health care coverage, except for certain plans that provide specific benefits (described below). 
• You cannot be enrolled in Medicare.
• If you can be claimed as a dependent by someone else, even if that person does not actually claim the exemption, you cannot open an HSA.
• Spouses who are both eligible must open separate HSAs.  You cannot have a joint HSA.

High Deductible Plan, for HSA Purposes

This is a plan that has a higher annual deductible than typical health plans, and has a maximum annual limit on the total of the annual deductible and the out-of-pocket medical expenses you must pay, including co-payments and other amounts.  The high deductible health plan can cover preventive care health services, subject to the annual limit on the deductible and out-of-pocket expenses.

For purposes of qualifying for an HSA, the annual deductible has to be more than a certain minimum amount, and there are maximum limits defined for the amount of the annual deductible plus out-of-pocket expenses.  These limits may change periodically and are published by the Internal Revenue Service (IRS).  They can be found in IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.

The limit established as the maximum annual amount for the deductible and out-of-pocket expenses is for in-network services, if the plan has a network of health care providers.  Out-of-network services would not be included in the maximum annual amount allowable.  That is, if your deductible and out-of-pocket expenses are under the maximum amount defined, you could still qualify for an HSA, even if your expenses for out-of-network services put you over the limit.

Other Health Coverage You Can Have, and Still Qualify for an HSA

Health coverage plans you can have, and still qualify for an HSA, include workers’ compensation insurance, insurance for a specific illness or disease, insurance that provides a fixed amount per day for hospitalization, and other coverage for accidents, disability, dental care, vision care, or long-term care.  You can have a prescription drug plan, either as part of your high deductible plan or as a rider or separate policy and still qualify for an HSA, provided you do not receive benefits until the annual deductible has been met.

Coordination of HSAs with Other Health Plans

Generally, if you are covered by a high deductible plan and also a Health Flexible Spending Arrangement (FSA) or a Health Reimbursement Arrangement (HRA), you cannot make contributions to a Health Savings Account (HSA).  But there are certain cases in which an employee can make contributions to an HSA while being covered by a high deductible plan and one of the following:

• Limited purpose FSAs or HRAs that only cover the items indicated under other health coverage above.
• An HRA that you suspended.  Before the HRA coverage period begins, you can elect to suspend it.  During this suspension period, the HRA does not pay or reimburse you for expenses except for preventive expenses and others indicated under other health coverage above.  During the period the HRA is suspended, you can make contributions to an HSA. Once the suspension period ends, you can no longer make contributions to an HSA.
•  FSAs or HRAs that pay for expenses only after the minimum annual deductible has been met.  This does not have to be the same deductible that applies for the high deductible plan.

Contributions to an HSA

If you are an employee, both you and your employer can make contributions to the HSA in the same year.  If you are self-employed or unemployed, you can make contributions to an HSA you set up for yourself.  Family members or any other person can also make contributions on your behalf.  The contributions must be in cash, not stock or other property.

Limit on Contributions

The amount you or someone else can contribute to your HSA depends on whether your high deductible plan is for self-only coverage or for family coverage.  The amount you can contribute also depends on your age (whether you are 55 or older).  You can contribute (to your HSA) up to the amount of your annual deductible (for your high deductible plan), subject to maximum amounts defined by the IRS.  These dollar-amount limits are subject to change periodically, and can be found in IRS Publication 969.

In order to be able to claim the maximum deduction for the year, you must have had the same coverage all year.  If you did not, and cannot claim the maximum deduction, there is a worksheet in the instructions for Form 8889 to figure your contribution limit.  By using this worksheet, you are calculating your average deductible for the year.  If you are married with family coverage and both you and your spouse are eligible for an HSA, you will need to allocate the deductible for family coverage between you.  You can allocate the deductible any way you agree upon, but if you do not agree, you have to allocate the deductible equally between you.

If you are age 55 or older, your contribution limit is increased.  The amount by which it increases can also be found in IRS Publication 969 and in the instructions for Form 8889.

If you had more than one HSA during the year, the total contributions to all your HSAs are subject to the same maximum limit.

Contribution Deductions

You will have to reduce your contribution limit by the following:

• Any contributions that are made to an Archer MSA that you have, including employer contributions, and
• Any contributions that your employer makes to your HSA that are not included in your income.  In other words, the total contributions you and your employer make cannot exceed the maximum amount.

Special Rules for Married Persons

If either you or your spouse has family coverage, both of you are treated as having family coverage.  And if either of you has family coverage under separate plans, each of you is treated as having family coverage under the plan with the lower deductible.  This limit must be reduced by any amounts contributed to both spouses’ Archer MSAs, if applicable.  The remaining amount is then allocated between you.  If either or both of you are age 55 or older and not enrolled in Medicare, you can add the additional contribution amount for being 55 or older to your allocable portions of the family deductible limit to determine your individual maximum contribution limits.

For example, assuming the following:

• You and your spouse both have family coverage under separate high deductible health care plans.
• You are age 57 and your spouse is age 52.
• The annual deductible under your plan if $3,000, and the deductible under your spouse’s plan is $2,000.

You are both treated as being covered by the $2,000 deductible plan.  If you split the deductible evenly, you can contribute $1,500 to your HSA (half of $2,000 plus $500 additional contribution for being 55 or older (the $500 is subject to change each year), and your spouse can contribute up to $1,000 (half the deductible).

Embedded Deductibles

In a high deductible health care plans with family coverage, there may be a deductible for the family as a whole (referred to as the umbrella deductible) and a deductible for each family member (referred to as the embedded deductible).  In this case, the limit on your contribution to your HSA is the least of the following amounts:

• The maximum annual contribution limit (defined by the IRS),
• The umbrella deductible, or
• The embedded deductible times the number of family members covered under the plan.

But, the health care plan will not qualify as a high deductible plan (and therefore you will not qualify for an HSA) if either the umbrella deductible or the embedded deductible is less than the minimum annual deductible required for family coverage under a high deductible plan.  If no umbrella deductible is defined, the maximum amount for the total of the deductible plus out-of-pocket expenses for family coverage applies.  The deductible for each family member times the number of family members covered cannot exceed this maximum amount.

Reporting HSA Contributions

You can make contributions to your HSA at any time during the applicable tax year, and until the due date for filing your tax return for the year (April 15th of the following year).  Contributions are reported on Form 8889.  You should receive Form 5498-SA, HSA, Archer MSA, or Medicare+Choice MSA Information, from the trustee of the account, showing the amount contributed to your HSA during the year.  Any contributions your employer makes to your HSA should be reported in box 12 of your Form W-2, with code W.

Excess Contributions

Any amounts you contribute that exceed the maximum amount allowable are not deductible.  Excess contributions by your employer should be included in your gross wages.  If they are not included in box 1 of your W-2 as wages, you should report the excess contributions as Other Income on Form 1040.

Excise Tax 

Generally, you will have to pay a 6% excise tax on the excess contributions.  This tax is reported on Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts.  You can avoid this excise tax by withdrawing the excess contributions and reporting any earnings on them in Other Income on your tax return.

Distributions from an HSA

Distributions from your HSA will be tax free if you use them to pay for qualified medical expenses.  With a high deductible health care plan, you will not be reimbursed for medical expenses until you reach the annual deductible amount.  You can withdraw funds from your HSA to cover these un-reimbursed medical expenses.

Taxable Distributions

If you receive a distribution and use it for a purpose other than paying medical expenses, the amount you receive will be subject to income tax at the normal rate, plus an additional 10% tax.  The trustee of your HSA will report distributions made to you on Form 1099-SA.

If you have an HSA but are no longer eligible to make contributions (because of the qualifying rules regarding a high deductible plan, and not being on Medicare, for example), you can still receive tax-free distributions from your HSA to pay qualified medical expenses.

Qualified Medical Expenses

To be considered qualified for purposes of a tax-free distribution from your HSA, the medical expenses must generally meet the same requirements as they would in order to qualify as an itemized deduction.  But medical expenses you pay with a tax-free deduction from your HSA cannot be claimed as an itemized deduction.

Medical insurance premiums are generally not a qualified medical expense for HSA purposes.  But premiums for long-term care coverage, health care coverage while you are unemployed, or health care continuation coverage required under federal law are considered qualified medical expenses.  Also, medical insurance premiums you pay if you are 65 or older (other than Medicare supplemental policies) are qualified medical expenses.

You will need to keep your own records to show that:

• Distributions from your HSA were used exclusively for qualified medical expenses.
• The medical expenses had not been previously paid or reimbursed from another source.
• You have not taken an itemized deduction for the same medical expenses.

Reporting Distributions

If you use a distribution from your HSA to pay qualified medical expenses, you do not have to pay tax on the distribution, but you have to report it on Form 8889 and file it with your annual income tax return.

If you do not use the distribution to pay qualified medical expenses, you will owe income tax on the distribution.  You will still report it on Form 8889 and must report the distribution as “Other Income” on your Form 1040.  You include the amount of the distribution on the line for Other income on Form 1040, and write “HSA” on the dotted line alongside the amount.  You may owe an additional 10% tax on distributions or the portion of a distribution that is not used to pay qualified medical expenses.  This additional tax is calculated on Form 8889.  Any distributions made after you become disabled, reach age 65, or die, are not subject to the additional 10% tax.

Rollovers and the Balance in an HSA

The balance in your HSA can be carried forward from one year to the next, and earnings on the balance that remain in your account are not subject to income tax.

Rollovers

You can roll over amounts from an Archer MSA or from other HSAs  into your HSA.  The rollovers do not have to be in cash – they could be in securities or other property.  But you cannot roll over amounts from an IRA, an HRA or a health  FSA into an HSA.

Rollovers are not subject to the annual contribution limits.  You can make one rollover to an HSA per year, and it must be made within 60 days of the date of receipt.

When you set up an HSA, you should name a beneficiary in the event of your death. Your HAS will become your spouse’s HSA after your death.  If you name a beneficiary other than your spouse, the account ceases to be an HSA upon your death, and the fair market value of the HSA is taxable to the beneficiary in the year of your death.  In this case, the amount subject to tax can be reduced by any qualified medical expenses the beneficiary pays for the decedent within one year from the date of death.