Health Savings Account Rules You Should Know

This post provides a summary of the main rules for HSA’s, for both their creation and use. Following these rules, you can understand 90% of what HSA’s are all about and avoid major pain points. Of course, due to the complicated nature of the IRS there exist corner cases you may encounter based on your situation, for which hopefully this site is a good resource.

Rule #1: You must have qualifying health insurance

You can only open a health savings account if you have a High Deductible Health Plan (HDHP). This is an IRS tax guideline, the definition of which changes each year based on inflation and other adjustments. Basically what this means is that HSA’s are an advantage only allowed to a certain subset of health insurance accounts that fall under the HDHP umbrella.

For 2017, the requirements that define HDHP insurance are below. Thus to open an HSA, your health insurance must conform to the following:

Self Only Coverage 2016 2017
Maximum annual deductible for HDHP $1,300 $1,300
Maximum annual out of pocket limit for HDHP $6,550 $6,550
Maximum annual HSA contribution $3,350 $3,400
Family Coverage
Maximum annual deductible for HDHP $2,600 $2,600
Maximum annual out of pocket limit for HDHP $13,100 $13,100
Maximum annual HSA contribution $6,750 $6,750

Note: besides having HSA eligible insurance, there are 3 other requirements for opening an HSA that you should be aware of but we not be covered here: 1) you cannot be enrolled in Medicare, 2) cannot be claimed as a dependent on someone else’s tax return, 3) do not have any other health insurance.

Rule #2: You must open a Health Savings Account

You must actually apply for an open an HSA account from the banking institution of your choice. Perhaps your employer helps you do this, or perhaps you open the HSA yourself. Either way, the Health Savings Account must be open before you can any expenses incurred qualify for payment from (future) HSA funds. Per IRS form 969 (2015 PDF):

You can (only) receive tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA.

So the actual HSA contributions do not need to be in your account, but any medical costs you incur before opening the account are not qualified and cannot be paid with (tax free) HSA dollars.

Rule #3: Know your HSA contribution limit for the year

There is a maximum amount you can contribute to your HSA each year called your contribution limit. This amount varies based on a number of factors that may apply to your situation. The simple case is if you had health insurance all year, the contribution limit for 2017 for self only insurance is $3,400 and for family insurance is $6,750. If you are 55 or older, you can add an additional $1,000 to that. If you are married and both have HSA’s, you have to share the $6,750.

If you had partial year coverage, more complicated rules apply. Generally a pro rata (by month) allocation of the contribution limit for your insurance occurs. If you began HSA coverage this year, you may take advantage of the Last Month Rule. This optionally allows you to contribute up to the contribution limit for the year, even if you had partial year coverage. However, do so with caution: if you fail to maintain the Testing Period, these contributions will be considered excessive and taxes and penalties attached.

Rule #4: Spend your HSA only on Qualified Medical Expenses

In order to receive tax benefits of HSA’s, you must play by the IRS’s rules regarding how they are spent. They detail these as Qualified Medical Expenses which include a wide variety of medical items such as prescription drugs, copay’s, doctor’s visits, dental work, eye care, child care, surgeries, tests, hospital fees, acupuncture, etc. For HSA contributions to be spent tax free, they must be spent on qualified medical expenses. If HSA funds are spent on anything other than qualified medical expenses, they will be taxed and penalized.

This tax/penalty calculation occurs when you file HSA tax Form 8889 for your yearly taxes, as you will be asked two questions regarding your HSA.

  1. How much was spent from your HSA during the year?
  2. How much was spent was spent on qualified medical expenses during the year?

Any difference noticed above (amount not spent on QME) will be taxed and penalized.

TrackHSA logo

Rule #5: Record all of your HSA transactions

So how does the IRS know that you spent your HSA funds on qualified medical expenses? For one, they require that you maintain proof regarding all of your purchases made with your HSA. While they do not ask for it each year, they reserve the right to audit your HSA tax filings at any time. In this scenario, the burden is on you to substantiate all of your HSA spending for a given year(s). You are required to provide proof that the amounts you deducted for your HSA were spent entirely on qualified medical expenses, and likely show receipts that this spending occurred. Not being able to prove this could result in your HSA spending being reclassified as “non qualified” and taxes and penalties assessed.

There are a number of ways you can store this information, from the simple file or shoebox to the high tech excel file or custom website such as TrackHSA.com. Whatever method you choose, be sure that you maintain this information to protect yourself from the tax man.

Rule #6: Account for your HSA taxes correctly

The best laid HSA plans are all for not if you file your taxes incorrectly. Imagine if you save in your HSA for years, use the funds correctly, and diligently record all of your medical expenses and maintain records. If this activity fails to make it to your 1040 tax form in the proper manner, it does not matter and the whole effort has been wasted. In this scenario, you will find yourself paying excessive taxes which could have been avoided.

Form 8889 is the crucial link to insure that the HSA’s tax advantages make there way to Form 1040 in the correct manner. I recommend the use of EasyForm8889.com to accurately complete your HSA tax form 8889, no matter what your HSA situation for the year. With Form 8889 being the main HSA input, the main output on Form 1040 will be your tax liability, which hopefully your HSA has helped reduce.

How to Open an HSA if your Employer Doesn’t Offer One

This was a reader question submitted by HSA Edge reader Alice. If you have a question get in touch and we’ll try to help. Email us at evan@hsaedge.com.

Our health insurance is through my husband’s work. We have a HDHP and an HSA account. Our oldest child is now 22 and out of college, employed full time, and we will not be declaring him a dependent on 2016 taxes. He is still on our health insurance plan, as it was the same cost to us.

My understanding is we cannot pay for his medical expenses with our HSA account, since he is not our dependent. I believe he is allowed to open his own HSA account. However, his work says he cannot open it through them, since he’s not on their health plan. My husband’s employer has told us he can open his own HSA but he can only contribute post-tax dollars, completely negating the purpose of the HSA account. What is the law and where/how does he open his own HSA account and contribute pre-tax earnings?

Thanks for your email. I only recently learned about the adult child HSA and it is a great benefit. Everything you say is true: your son has HSA eligible insurance, he can have his own HSA, his employer does not offer an HSA, and you cannot pay for his medical expenses using your HSA. There is just one key part missing that provides the tax benefit.

Your son does not need to have an employer open a Health Savings Account for him, he can do this on his own at whatever banking institution he likes. The only requirement is that you have HDHP eligible health insurance, which he does. All he has to do is some research on banks that offer HSA’s and go online and click “Open HSA Account” and fill out the forms. When selecting a provider, I would look at the fee structure because that can vary; I have had success with HSAbank.com.

In fact, many people establish HSA’s without their employer’s help. Employer’s that offer actual Health Savings Accounts (via a 3rd party banking institution) are likely also making contributions to the employee’s HSA. So in that regard it makes sense that they help you open the account as they will be directing their (and possibly your) contributions there. However, this is not at all required. There are many people (for example, the self employed) who have HSA eligible insurance and open up their own HSA account. Totally legit and acceptable, all the law states that you need is HSA eligible insurance.

As for tax benefits, it is true that your son will contribute post tax dollars to the HSA. However, this amount will be deducted from his income when he files his yearly taxes (see: Automatic vs. Manual Contributions), reducing the amount of tax he owes then. Specifically, when he completes HSA Form 8889, the amount he contributes to the HSA will flow down to Line 13, which will make its way onto Form 1040 and reduce his taxes.

So in summary, he does not need to contribute pre-tax earnings. Instead, his post-tax contributions will be converted into pre-tax contributions once he files his taxes, so he can enjoy all of the benefits of the HSA.

————————————

Note: if you have an HSA, please consider using my service EasyForm8889.com to complete Form 8889. It is fast and painless, no matter how complicated your HSA situation.


EasyForm8889.com - complete HSA Form 8889 in 10 minutes!

How Do Employer Contributions Affect My HSA Limit?

A common question readers have is how employer contributions to a Health Savings Account work and how they affect their HSA contribution limit for a year. HSA’s are very flexible in that basically anyone can contribute to your HSA (see: Who Can Contribute to a Health Savings Account), including yourself, your family, others on your behalf, and your employer. However, some differences exists for those contributions made by your employer in terms of taxation, reporting, and contribution limit.

Do employer contributions to HSA count towards maximum?

The short answer is yes, employer contributions count towards your HSA maximum contribution limit for the year. Looking at HSA tax Form 8889 shows you how this occurs:

form_8889_line_9_employer_contributions


The above Form 8889 was prepared quickly using EasyForm8889.com.

HSA Employer Contributions are entered on Line 9 of IRS Form 8889, so whatever your employer contributes to your HSA goes there. Line 12 is where the employer contribution actually affects your HSA contribution limit, since it subtracts the employer contribution from Line 8 which is a “running total” of your contribution limit up until that point. The result is compared to Line 2, your actual HSA contribution, and the smaller is reported on Line 13 which carries over as your deduction to Form 1040. So the net effect of this comparison is that employer contributions reduce your contribution limit from Line 3.

Are employer HSA contributions taxable?

For the account holder, if made directly to your HSA, Employer Contributions are not taxable to you. As you can see above, the amount flows into Form 8889 on Line 9 and then onto Form 1040 Line 25, which is in fact a deduction. So the employer contributions are reducing the possible tax deduction, but of course, this is free money. You can’t receive an employer contribution and then take a deduction for it. How the employer contributes matters, though. If your employer were to simply write a check and say “here is your HSA contribution”, this would be treated as a “bonus” or regular income and taxed. It would be wise to coordinate with the employer as it would be to both of your benefits.

For employers managing a corporation, HSA contributions are a deductible expense so are treated preferentially and reduce your tax liability. For S-Corps and Partnerships, the contribution is treated as a distribution which is claimed by the recipient, but not the business.


EasyForm8889.com - complete HSA Form 8889 in 10 minutes!

HSA Employer contributions found on W2

HSA contributions from your employer are shown on Box 12 of your W2 with code “W”. They will take one of the available Box 12 spaces, mark a “W” to indicate HSA, and enter the amount in the box to the right. If only your employer contributed to your HSA, this is easy and you are done.

w2_hsa_employer_contributions_box_12

However, one confusing aspect of this is that your personal contributions made to your HSA may show here if they were withheld from your paycheck. These are called “cafeteria plan” contributions and should in fact be put on Form 8889 on Line 9, not Line 2. This is a common mistake, but looking at Form 8889 Line 2 you can see that these cafeteria plan contributions are excluded and instead go on Line 9 (employer contributions):

form_8889_line_2_cafeteria_plan_contributions


The above Form 8889 was prepared quickly using EasyForm8889.com.

HSA contributions: employee vs. employer

The main difference between employee and employer contributions is who is paying for them. Of course, free money is free money, so if you can get employer contributions, do it! Another difference is how they get into your Health Savings Account: employer contributions should be directly deposited, whereas you will contribute your HSA contributions manually. Note the exception here is if you make cafeteria plan contributions, which are withheld from your paycheck (see above). Additionally, employer contributions go on Line 9 of IRS tax form 8889, whereas personal contributions go on Line 2.

On the other hand, there are many similarities between employee and employer contributions. Both types of contribution count toward your HSA maximum contribution limit. This occurs in different sections of Form 8889, but eventually they make there way to Line 13 which is your HSA deduction that flows to Form 1040. Both types of contribution go into your Health Savings Account and are yours forever, and you may spend them on whatever qualified medical expense you want. Your employer will never see how they were spent and cannot claw back those contributions.

HSA employer contribution limits for 2016

The maximum amount your employer can contribute to your HSA is calculated in the same manner as your personal contribution limit. For 2016, the HSA maximum contribution limit is $3,350 / $6,750 for single / family coverage. In addition there is a $1,000 catch up limit applied to those over 55 years old. So between your personal and employer contributions, you cannot exceed this limit. If you are on single coverage and your employer contributes $3,350 to your HSA, you can make $0 in personal contributions for the year without over contributing. However, if you are 56 years old with single coverage and your employer contributes $3,350, you could make a personal $1,000 contribution for a total of $4,350 as part of the 55+ additional catch up contribution.