Tax Benefits of Health Savings Accounts

A Health Savings Account (HSA) is a tax-exempt account that a taxpayer can set up with a qualified HSA trustee (usually a bank or an insurance company) to pay or reimburse certain medical expenses. The only stipulation for setting up this account is that you must have a High Deductible Health Plan (HDHP). No other permission or authorization from the IRS is necessary to establish an HSA.

A plan that has a higher-than-traditional deductible can be considered an HDHP, but the IRS does have specific requirements for the plan to qualify for favorable tax treatment. We won’t try in this article to cover all the tricky details for figuring out which HDHP plans qualify and which don’t. Your PRO-TAX professional can provide the latest information on these limits and requirements.

HDHP premiums are usually lower than traditional health insurance plans because the cover less items. The purpose of the HSA is to pay expenses during the year that are not reimbursed by the HDHP (deductibles, copays, dental, orthodontic, and vision care, and other non-covered items). If you take money from the HSA to pay for these expenses, the distribution is tax-free. If you take a distribution for any other reason, the distribution will be taxable, and may be subject to an additional 20% tax (unless other factors are met).

HSA Benefits

• New for 2011: For HSA, MSA, FSA and HRA purposes, a medicine/drug will be a qualified medical expense ONLY if it (a) requires a prescription, (b) is available without a prescription and you get a prescription for it, or (c) it is insulin.
• You can still claim a tax deduction for contributions made by you, or someone other than your employer, even if you don’t itemize.
• Contributions made to an HSA by your employer may be excluded from your gross income.
• Contributions are rolled over in the HSA account from year to year until they are used (no “use it or lose it”).
• Interest and other earnings in the account are tax-free.
• Distributions are tax-free, if used for qualified medical expenses.
• It’s portable, so it stays with you even during employment changes or if you leave the work force.

Examples of qualified medical expenses include amounts paid for doctors’ fees, prescription medicines and necessary hospital services not paid for by insurance. Expenses are qualified if they are incurred by you, your spouse, or any dependents claimed on your tax return.

In addition to the HSA, there are other tax-favored, medically-related accounts – namely, the MSA, FSA, and HRA. Each one is slightly different than the other, but if you have one of these accounts, you should become familiar with the rules.

To get the most benefit from your HSA, or other tax-favored account, bring any questions you may have, and ask your tax preparer while you are having your return prepared at your local PRO-TAX office.

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