The Basics of Health Savings Accounts
While we generally cover information in this blog primarily related to payroll and HR matters, we have chosen to post on Health Savings Accounts (HSAs). The basics of HSAs are covered here to lay the ground work for structuring HSAs for S corporation owners to take advantage of tax savings. We’ll cover this topic in a later post.
Healthcare and education costs have been among the fastest rising costs to Americans over the past several years. Individually there’s not a lot that we can do to affect these costs, but there are a few things that we can do individually to help manage our costs. When it comes to healthcare, Health Savings Accounts (HSAs) are a great tool for eligible individuals.
HSAs offer a tax-favorable way for individuals (and their employers) to set aside funds to meet future medical needs. Here are the key tax-related elements:
- Individual HSA contributions are tax deductible,
- Employer HSA contributions are tax-exempt employee benefits,
- Earnings on HSAs are not taxed, and
- Qualified HSA distributions are not taxed.
To be eligible for an HSA, individuals must be covered by a “high deductible health plan” or HDHP. HDHPs are just like they sound – Health plans with a High Deductible. And while you may consider your health plan deductible as “high”, a heath plan must meet certain IRS rules to be considered an HDHP. You’ll probably know if you have an HDHP, but if there is a question, ask your benefits manager, health insurance agent or broker.
If you have additional coverage that is not a HDHP that provides coverage for any benefit covered by your HDHP, you may not be eligible. However, separate coverage through insurance or otherwise, for accidents, disability, or dental, vision, or long-term care is generally acceptable.
The deductibles for HDHPs are set annually by the IRS. For 2019, the deductible for single coverage and family coverage HDHPs is $1,350 and $2,700, respectively. Contributions are limited to $3,500 and $7,000 for individual and family coverage, respectively and participants age 55 or older can make an additional $1,000 contribution per year.
Once an individual reaches full retirement age and enrolls in Medicare, contributions to an HSA can no longer be made.
Employer Contributions to HSAs
From a payroll perspective, here’s where HSAs start to get interesting.
Employer contributions to employee HSAs are treated as employer-provided coverage for medical expenses and excludable from the employee’s gross income. This also saves on payroll taxes for the employer as the contributions are not subject to payroll taxes.
To avoid costly penalties, the employer needs to make comparable contributions for al all participating employees or risk significant penalties.
For owners of S Corporations, correct reporting of the HSA on the owner’s W-2 is critical to taking advantage of tax savings. We’ll cover this specifically in an upcoming post.
Earnings on HSAs
Any earnings from the investments made in an HSA are generally exempt from taxation. However, taxes may apply if contribution limitations are exceeded.
Distributions from HSAs
Distributions from the HSA to cover an eligible individual's qualified medical expenses, or those of his spouse or dependents, are not taxed. Qualified medical expenses for these purposes generally mean those that would qualify for the medical expense itemized deduction.
However, if funds are withdrawn from the HSA for other reasons, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it is made after reaching age 65, or in the event of death or disability.
HSAs offer a very flexible option for providing health care coverage, but the rules are somewhat involved.
Look for an upcoming follow up post that covers the tax treatment and payroll setup for S corporation owners.