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.