Basics of Health Savings Accounts

Tax Tips

 

The IRS has come up with the health savings account for qualifying taxpayers to receive a tax benefit for medical expenses paid whether you itemize or not. Since the IRS did design this program, you might guess it is a little complicated! But once you figure out how it works, the plan does offer some real benefits and is actually growing in popularity.


Basically, a health savings account (HSA) allows you to save money for future qualified health expenses on a tax-free basis. In a nutshell, this is how it works. You set up the HSA account with an approved institution. You contribute to the plan annually on a tax-free basis through your employer, or you contribute on your own and receive a tax deduction on Form 1040, line 25. As you need the funds to pay medical expenses, you receive distributions from the account. As long as the distributions are used to pay medical expenses, there is no tax effect. The beauty of the plan is that you get the tax benefit up-front when you contribute to the plan. Any unused funds carry over from year-to-year until you need them.

You can set up a health savings account (HSA) with a financial institution, insurance company, or another approved company. Your employer can set up an HSA for you as well. Here are some more details about HSA’s…


  • Benefits of an HSA
    • You can claim a deduction for contributions you make that are not pre-tax or made by your employer even if you don’t itemize your deductions on Schedule A.
    • Contributions made on your behalf by your employer, including any pre-tax contributions you make through a cafeteria plan, are generally not taxable.
    • Unused contributions remain in your account from year to year
    • Interest earned on the account is usually tax free
    • Distributions used to pay for qualified medical expenses are tax free.
    • Your account stays with you even if you leave your employer

  • Qualifying for an HSA
You must have a high deductible health plan (HDHP). An HDHP has a higher deductible than most health plans, and a maximum limit on the sum of the annual deductible and out-of-pocket medical expenses that you pay. You can set up a self-only (one person) or a family (more than one person) coverage plan. For 2008, the limits are as follows for self-only and family coverage plans:

Minimum Annual Deductible Maximum Annual Deductible Plus Out-of -Pocket Expenses
Self $1,100 $5,600
Family $2,200 $11,200

    • You generally can’t be covered under another insurance plan
    • You can’t be enrolled in Medicare
    • You can’t be a dependent on someone else’s return

· Contributions

o As we discussed earlier, contributions to your HSA can be made by you, your employer, or both.

o Pre-tax contributions made by you through a cafeteria plan or by your employer are both considered employer contributions, and are reported on Form W-2, line 12, code W.

o You can also make contributions to your account on your own – these contributions usually result in an HSA deduction on Form 1040, line 25.

o You can contribute up to your annual plan deductible amount each year if you had the account all year. The limits are detailed in the table above. If you have a self-coverage plan, you can contribute up to $2,900 for 2008 annually; if you have a family coverage plan, you can contribute up to $5,800 annually.

o The deductible amount must be allocated based on the number of months you held the account if you didn’t have it the entire year.

o If you are 55 years or older, your contribution limit increases by $900 in 2008.

o Any contributions over the deductible limit are considered excess contributions and are not deductible.

o Excess contributions made by your employer or made by you through a cafeteria plan are taxable income and may be subject to a 6% excise tax.

o An excess contribution can be withdrawn by the due date of the return, including extensions, to avoid the additional tax.

· Multiple Coverage Situations

o This is where it can get dicey!! As discussed earlier, you can have a plan with self coverage or family coverage. However, if you and your spouse are filing jointly and either of you have a family coverage plan, you are both considered to have the family coverage plan (even if one of you has a self-only plan).

o If both you and your spouse have family coverage plans at the same time, you are both considered to have the family coverage plan with the lowest deductible. You and your spouse would both complete a Form 8889, and the deductible limit must be allocated between the two of you as you choose.


· Distributions

o A distribution is money that you receive from your HSA to pay qualified medical expenses during the year.

o These distributions will be reported to you on Form 1099-SA at the end of the year.

o If the distributions are used for a purpose other than to pay qualified medical expenses, the amount will be taxable income and also may be subject to an additional 10% tax.


So, there you have it…the basics of health savings accounts! Hope this helps clear up a lot of the confusion around HSA’s. As you can see, it can be a little complicated, but can also provide a great tax break to certain taxpayers. TurboTax can help you wade through some of the complications. All you have to do if answer the questions in TurboTax related to HSA’s, and it will calculate your deduction, if applicable, and accurately report your HSA activity for the year.


For additional information on HSA’s:

IRS Publication 969


Comments (2) Leave your comment

  1. I have an HSA which started July 1, 2008. Our employer gave each employee $1,000 direct deposited into each employees HSA account. They did not include it on the W-2. On which line do I report the $1,000. Thank you for your help.

  2. I have an HSA plan and contributed $2,900 for 2008. I see on my 1040 that it is being added in as “other income” however I don’t see it being deducted out (which is should since the dollars in the HSA are deemed to be non-taxable). On top of this I am paying a surtax on the amount of HSA I have. This appears to be calculating incorrect in TurboTax. I am basically paying tax on my HSA funds according to TurboTax. After using a rival software I was able to come up with a different answer. Please explain this to me. I have already filed my return and am now looking at having to file an amended return.

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