review of hsas for employers

Review of HSAs for EmployersLarry Grudzien

Attorney at Law

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HSAs represent a significant improvement over MSAs and offer an impressive list of attractive features:

• Funding flexibility - employer contributions, pre-tax employee salary reduction contributions and tax-deductible contributions are all permissible within specified limits

• No “Use-It-or-Lose-It” rule - participants may accumulate funds and self-direct investments in a tax-exempt trust or custodial account

• The ability to transfer amounts from your Health FSA and HRA (before January 1, 2012) or IRA to the HSA

• The ability to use funds for non-medical purposes without any effect on the tax-free character of amounts remaining in the individual’s HSA

• Account portability for participants - monies can be transferred to another HSA at any time without limitation

• Any employer may offer and contribute to employees’ HSAs

• Participant self-substantiation of expenses is required

• The tandem high-deductible health plan (HDHP) that is required is a mainstream design

• Family members, employers and any other third parties may make contributions to a HSA on behalf of the eligible individual

Why should an employer consider establishing HSAs for its employees?

Copyright 2016 – Not to be reproduced without express permission of Benefit Express Services, LLC

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HSAs provide employees with a tax-free basis for paying current medical expenses, as well as the ability to save on a tax-favored basis for future medical expenses.

In general, HSAs use tax-exempt trusts or custodial accounts to store contributions and earnings to pay for the qualified medical expenses of an employee and his or her spouse and dependents that are subject to rules similar to those applicable to individual retirement arrangements (“IRAs”).

In general, what is required?


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• Within limits, contributions to HSAs are deductible if made by or for an eligible individual and are excludable from such individual’s income and wages for employment tax purposes if made by the employer of an eligible individual or made by the employee in the form of pre-tax salary reduction contributions (through a cafeteria plan).

• Distributions from HSAs for qualified medical expenses are not includible in the eligible individual’s gross income.

• Distributions that are not for qualified medical expenses are includible in an eligible individual’s gross income and are subject to an additional 20% tax.

• The additional tax does not apply for distributions made after death, disability, or when the individual attains the age of Medicare eligibility (i.e., age 65).

In general, what is required?


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For any month, an eligible individual is defined as any individual who:

• is covered only by a high-deductible health plan (“HDHP”) as of the first day of such month

• is not also covered by any other health plan that is not a HDHP (with certain exceptions for plans providing certain limited types of coverage

• is not enrolled in benefits under Medicare

• may not be claimed as a dependent on another person’s tax return

To be eligible to make or receive HSA contributions for any month, an employee must meet all of the requirements, including HDHP coverage as of the first day of the month.

Which employees are eligible to make or receive contributions to a HSA?


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An employee may not make or receive a contribution to a HSA if he or she is covered under:

• a spouse’s or dependent’s employer’s health plan that is not a HDHP

• a Health FSA or HRA unless coverage under such Health FSA or HRA is limited to “permitted coverage” or “permitted insurance” or other benefits

Which employees are not eligible to make or receive contributions to a HSA?


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No, unless the employee’s situation is one of the following:

• The employee’s expenses reimbursed under a Health FSA and/or a HRA are limited to dental, vision and/or preventive care benefits (“Limited Purpose Health FSA or HRA”)

• The employee suspends participation in a HRA for the year (“Suspended HRA”)

• The Health FSA or HRA pays expenses above the deductible of the HDHP (“Post-Deductible Health FSA or HRA”)

• The HRA pays or reimburses the employee’s expenses incurred after the employee retires (“Retirement HRA”)

Can an employee participate in either a Health FSA or a HRA in the same month and still be eligible to make or receive contribution to a HSA?


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• A high deductible health plan (HDHP) is an insured or self-insured health plan that satisfies certain requirements with respect to deductibles and out-of-pocket expenses.

• In the case of individual coverage, the plan must have an annual deductible of not less than $1,300 for 2015, 2016 and 2017; and in the case of family coverage, the plan must have an annual deductible of not less than $2,600 for 2015, 2016 and 2017.

• In addition, the plan's annual deductible for out-of-network services is not taken into account in determining the annual contribution limit.

• Rather, the annual contribution limit is determined by reference to the deductible for services within the network.

What is a high-deductible health plan (HDHP)?

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In the case of individual coverage, the maximum out-of-pocket expense limit on covered expenses cannot exceed $6,650 for 2016 and 2017. In the case of family coverage, the maximum out-of-pocket expense limit on covered expenses cannot exceed $13,100 for 2016 and 2017.

Out-of-pocket expenses include deductibles, co-payments, and other amounts (other than premiums) that the individual must pay for covered benefits under the plan.

What is a high-deductible health plan (HDHP)?


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• Any eligible individual can establish a HSA with a qualified HSA trustee or custodian, in much the same way that individuals establish IRAs or MSAs with qualified IRA or MSA trustees or custodians.

• No permission or authorization from the IRS is necessary to establish a HSA.

• An eligible individual who is an employee may establish a HSA with or without involvement of the employer.

How is a HSA established?


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In addition, if an employer wants to permit pre-tax employee-made HSA contributions, it must amend its cafeteria plan to provide for such contributions.

The making of these pre-tax HSA contributions must be voluntary on behalf of eligible employees, but the employer may provide for these HSA contributions through a “negative” election.

How is a HSA established?


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• An employee may invest in any vehicle approved for IRAs (e.g., bank accounts, annuities, certificate of deposit, stocks, mutual funds, or bonds).

• HSAs may not invest in life insurance contracts or in collectibles.

• HSAs may, however, invest in certain types of bullion or coins.

• The trust or custodial agreement may restrict investments to certain types of permissible investments.

• HSA trust assets may only be commingled in a common trust fund or common investment fund.

• No other arrangement is permitted.

Are there any restrictions on the types of investments available under a HSA?


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• Contributions to a HSA must be made in cash and may be made by an eligible individual, the employer, family member or any other third person.

• Contributions made by a family member or any other third person are deductible (within limits) in determining adjusted gross income (i.e., “above-the-line”) of the eligible individual.

What contributions are permitted under a HSA and how are they treated for tax purposes?


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• Contributions made by an eligible individual’s family members or any other person are deductible by the eligible individual to the extent the contributions would be deductible if made by that individual.

• The individual making the contribution cannot also deduct the contributions as medical expense deductions under Code § 213.

• Employer contributions to a HSA (including pre-tax salary reductions or employer matching contributions made through a cafeteria plan) are excludable from gross income and wages for employment tax purposes to the extent the contribution would be deductible if made by the employee.

• The employee cannot deduct employer contributions on his or her federal income tax return as HSA contributions or as medical expense deductions under Code § 213.

What contributions are permitted under a HSA and how are they treated for tax purposes?


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• Yes. An employee may make pre-tax salary reduction contributions under a HSA, but these contributions must be made to a cafeteria plan.

• They are treated as employer contributions and are not subject to income and employment taxes.

• Code §125 has been amended to allow HSAs to be offered under cafeteria plans.

Can pre-tax salary reduction contributions be made to a HSA?


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The following requirements do not apply to HSA contributions if made to cafeteria plans:

• “Use-it-or-Lose-it” Rule

• Uniform Coverage Rule

• Mandatory 12 month period of coverage

• Change in status requirements for changing elections – An eligible employee may start or stop his or her election or increase or decrease his or her

election at any time as long as the change is effective prospectively.

An employer is not required to allow all changes and can restrict the employee’s ability to make or change elections, but must allow an employee to change his or her election monthly.

Can pre-tax salary reduction contributions be made to a HSA?


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The maximum annual contribution to a HSA is the sum of the limits determined separately for each month, based on status, eligibility and health plan coverage as of the first day of the month.

Any individual who begins HDHP coverage in mid-month would not be eligible to make a HSA contribution until the beginning of the following month.

What are the limits for contributions to a HSA?


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• An individual who becomes covered under a HDHP in a month other than January and who is covered by a HDHP in December of that year, may make a full deductible HSA contribution for the year if he or she has HDHP coverage for the entire “testing period”.

• The testing period is the period beginning with the last month of the taxable year and ending on the last day of the 12th month following such month.

• If an individual does not remain an eligible individual during the testing period, the amount of the contributions attributable to months preceding the month in which the individual was not an eligible individual (which could not have been made but for the provision) will be includible in the individual’s gross income.

• The amount is includible for the taxable year of the first day during the testing period that the individual was not an eligible individual.

• A 10% additional tax also applies to the amount includible.

• An exception applies if the individual ceases to be an eligible individual by reason of death or disability.



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• The maximum aggregate annual contribution that an individual can make to a HSA is $3,350 for 2015 and 2016 and $3,400 for 2017 in the case of individual coverage and $6,650 for 2015 and $6,750 for 2016 and 2017 in the case of family coverage.

• If an employee has reached age 55 by the end of the taxable year, the HSA annual contribution limit is increased by $1,000 for 2016, 2017 and thereafter.

• As with the annual contribution limit, the catch-up contribution is also computed on a monthly basis for tax years.



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• All HSA contributions made by or on behalf of an eligible individual to a HSA are aggregated for purposes of applying the limit.

• The annual limit is decreased by the aggregate contributions to a MSA.

• The same annual contribution limit applies whether the contributions are made by an employee, an employer, a self-employed person, or a family member.



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• Contributions for the taxable year can be made in one or more payments, at the convenience of the individual or the employer, at any time prior to the time prescribed by law (without extensions) for filing the eligible individual's federal income tax return for that year, but not before the beginning of that year.

• For calendar year taxpayers, the deadline for contributions to a HSA is generally April 15th following the year for which the contributions are made.

• Although the annual contribution is determined monthly, the maximum contribution may be made on the first day of the year or any other time during the year.

When must contributions be made for a taxable year?


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An individual may also establish a HSA for any taxable year at any time prior to the time prescribed by law (without extensions) for filing the eligible individual's federal income tax return for that year, (April 15th for calendar year taxpayers).

When must contributions be made for a taxable year?


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• If an individual contributes over the stated limits for the taxable year, these contributions are not deductible.

• Contributions made by an employer over the limits are included in the employee’s income, but not returned to the employer.

• An excise tax applies to contributions in excess of the maximum contribution amount.

• The excise tax is generally equal to 6% of the cumulative amount of excess contributions that are not distributed from the HSA to the contributor.

What are the consequences if either the employer or the employee over contributes to a HSA for any year?


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If the excess contributions for a taxable year and the net income attributable to such excess contributions are paid to the individual before the last day prescribed by law (including extensions) for filing the individual's federal income tax return for the taxable year, then the net income attributable to the excess contributions is included in the individual’s gross income for the taxable year in which the distribution is received, but the excise tax is not imposed on the excess contribution and the distribution of the excess contribution is not taxed.

If the eligible individual is under age 65 and is not dead or disabled, he or she will be subject to the 20% penalty tax on the earnings.

What are the consequences if either the employer or the employee over contributes to a HSA for any year?


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• Yes. Amounts can be rolled over into a HSA from a MSA or another HSA on a tax-free basis.

• Rollovers need not be made in cash.

• Amounts transferred from another HSA or a MSA are not taken into account under the annual contribution limits.

• An individual may make only one rollover contribution to a HSA during a one-year period.

• To qualify as a rollover, any amount paid or distributed from a HSA to an eligible individual must be paid over to a HSA within 60 days after the date of receipt of the payment or distribution.

Can amounts be rolled over to another HSA?


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No. There is no limit on the number of trustee-to-trustee transfers allowed during any year.

Are transfers of HSA amounts from one HSA trustee directly to another HSA trustee subject to the rollover restrictions?


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• Yes. Amounts can be distributed from a IRA and then transferred to a HSA.

• An individual is allowed to make a one-time contribution to a HSA of an amount distributed from his or her IRA.

• The contribution must be made in a direct trustee-to-trustee transfer.

• Amounts distributed from the IRA are not includible in the individual’s income to the extent that the distribution would otherwise be includible in income.

• Such distributions are not subject to the 20% additional tax on early distributions.

Can amounts distributed from a IRA be directly transferred to a HSA?


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The employer must satisfy the following “comparability rules” or be subject to an excise tax.

If an employer makes contributions to employees’ HSAs, the employer must make available comparable contributions (e.g. the same amount or the same percentage of deductible) on behalf of all employees with comparable coverage during the same period (e.g. single/family) with certain exceptions.

Does an employer have to meet any nondiscrimination rules if it makes contributions to its employees’ HSAs?


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• An employer is now allowed to make larger HSA contributions for nonhighly compensated employees than for highly compensated employees.

• Highly compensated employees are defined under Code Section 414(q) (5% or greater owners and employees earning in excess of $120,000 for 2015 and 2016).

• The comparable contribution rules will continue to apply to the contributions made to nonhighly compensated employees so that the employer must make available comparable contributions on behalf of all nonhighly compensated employees with comparable coverage during the same period.

• This means that an employer can make a contribution to just the nonhighly compensated employees, but all the nonhighly compensated employees must receive the same contribution based on coverage.



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Family coverage has now been subdivided into additional categories of family HDHP coverage: self-plus-one, self-plus-two, and self-plus-three or more.

An employer may contribute different amounts for each of these new categories of family coverage, but its contribution for the self-plus-three or more categories must be greater than or equal to the contribution for employees in the self-plus-two-or-more category, and its contribution with respect to the self-plus-two category must be greater than or equal to the contribution in the self-plus-one category.



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• Any employer HSA contributions to a cafeteria plan are not subject to the comparability rule.

• An employer is able to make matching HSA contributions through a cafeteria plan.

• These contributions are subject to the cafeteria nondiscrimination rules.

• If an employer makes contributions to an employee’s HSA on condition of an employee’s participation in health assessments, disease management programs, wellness programs or any other conditions and makes the same contributions to all employees who participate in the programs, its contributions will not satisfy the comparability rule unless all eligible employees receive that payment in currently taxable cash rather than having a nontaxable contribution to the HSA.



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• If employer contributions do not satisfy the comparability rules during a period, then the employer is subject to an excise tax equal to 35% of the aggregate amount contributed by the employer to HSAs of the employer for that period.

• The excise tax is designed as a proxy for the denial of the deduction for employer contributions.

• In the case of a failure to comply with the comparability rule due to reasonable cause and not to willful neglect, the IRS may waive part or all of the tax imposed to the extent that the payment of the tax would be excessive relative to the failure involved.

• For purposes of the comparability rule, employers under common control are aggregated.

What happens if the employer does not comply with the above comparability rules?


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• Distributions from a HSA for “qualified medical expenses” of the individual and his or her spouse or dependents generally are excludable from gross income and can be made at anytime.

• In general, amounts in a HSA can be used for “qualified medical expenses” even if the individual is not currently eligible for contributions to a HSA.

• In addition, administrative and account maintenance fees withdrawn from HSAs are treated as non-taxable distributions.

When can distributions be made from a HSA and what is the tax treatment of such distributions?


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Qualified medical expenses generally are defined under Code § 213(d) (including nonprescription drugs prior to January 1, 2011) and include expenses for diagnosis, cure, mitigation, treatment, or prevention of disease, including prescription drugs, transportation primarily for and essential to such care, and qualified long term care expenses but only to the extent that the expenses are not covered by insurance or otherwise.

What are “qualified medical expenses”?


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Qualified medical expenses do not include expenses for insurance coverage except for:

• long-term care insurance

• premiums for COBRA coverage

• premiums for health care coverage while an individual is receiving unemployment compensation under Federal or State law

For purposes of determining the itemized deduction for medical expenses, distributions from a HSA for qualified medical expenses are not treated as expenses paid for medical care under Code § 213(d).



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• In addition, qualified medical expenses include health insurance premiums for individuals eligible for Medicare, other than premiums for Medigap policies.

• Qualified health insurance premiums include, for example, Medicare Part A, Part B or Part D premiums, Medicare HMO premiums, and the employee’s share of premiums for employer-sponsored retiree health insurance for individuals age 65 or older.

• Generally, a HSA may only reimburse expenses incurred after the HSA has been established.



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If an individual is no longer an eligible individual (e.g., the individual is over age 65 and enrolled in Medicare benefits, or no longer covered by a HDHP), distributions used exclusively to pay for qualified medical expenses continue to be excludable from the individual’s gross income.

How are distributions from a HSA taxed after an employee is no longer an eligible individual?


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Distributions from a HSA that are not for qualified medical expenses are includible in the employee’s gross income.

Distributions includible in gross income are also subject to an additional 20% tax unless made after death, disability, or after the individual attains the age of Medicare eligibility (i.e., age 65).

If distributions are made from the HSA for reasons other than the reimbursement of qualified medical expenses, what are the consequences?


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• Upon death, any balance remaining in the decedent’s HSA is includible in his or her gross estate.

• If the HSA account holder’s surviving spouse is the named beneficiary of the HSA, then, after the death of the HSA account holder, the HSA becomes the HSA of the surviving spouse and the amount of the HSA balance may be deducted when computing the decedent's taxable estate, pursuant to the estate tax marital deduction.

• The surviving spouse is not required to include any amount in gross income as a result of the death; the general rules applicable to the HSA apply to the surviving spouse’s HSA (e.g., the surviving spouse is subject to income tax only on distributions from the HSA for nonqualified expenses).

• The surviving spouse can exclude from gross income amounts withdrawn from the HSA for expenses incurred by the decedent prior to death, to the extent they otherwise are qualified medical expenses.

What happens to an employee’s HSA upon his or her death?


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• If, upon death, the HSA passes to a named beneficiary other than the decedent’s surviving spouse, the HSA ceases to be a HSA as of the date of the decedent's death, and the beneficiary is required to include the fair market value of HSA assets as of the date of death in gross income for the taxable year that includes the date of death.

• The amount includible in income is reduced by the amount in the HSA used, within one year after death, to pay qualified medical expenses incurred by the decedent prior to the death.

• As is the case with other HSA distributions, whether the expenses are qualified medical expenses is determined as of the time the expenses were incurred.

• In computing taxable income, the beneficiary may claim a deduction for that portion of the federal estate tax on the decedent’s estate that was attributable to the amount of the HSA balance.



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If there is no named beneficiary of the decedent’s HSA, the HSA ceases to be a HSA as of the date of death, and the fair market value of the assets in the HSA as of such date is includible in the decedent’s gross income for the year of the death.

This rule applies in all cases in which there is no named beneficiary, even if the surviving spouse ultimately obtains the right to the HSA assets (e.g., if the surviving spouse is the sole beneficiary of the decedent’s estate).



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• Eligible individuals must report contributions to their HSAs, contributions to their spouse’s HSAs, any employer contributions, and distributions on Form 8889. Form 8889 is an attachment to an eligible individual’s Form 1040.

• Employer contributions are required to be reported in Box 12 of the Form W-2 of an employee, using code W.

• In addition, HSA trustees and custodians must report contributions to a HSA for a year on Form 5498-SA and distributions for the year on Form 1099-SA.

What reporting is required for HSAs?


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Questions?


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Larry Grudzien

Attorney at Law

(708) 717-9638

[email protected]

www.larrygrudzien.com

Contact Information


mailto:[email protected]

http://www.larrygrudzien.com/

review of hsas for employers

Recruiting & HR