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June 15, 2008
How Health Savings Accounts are Taxed
Contributions by an individual to a Health Savings Account are deductible in calculating the individual's adjusted gross income (AGI) (that is, they are above-the-line deductions), whether or not he or she itemizes deductions. If an employee makes contributions to a Health Savings Account in the form of pretax salary reductions under a cafeteria plan, they are excluded from income for purposes of federal income and employment taxes. Contributions made by a family member to a Health Savings Account on behalf of an individual are also deductible in determining the individual's AGI, whether or not he or she itemizes deductions.
Hal's wife has given birth to twins and is no longer working. To help out, Hal's father contributes $500 to Hal's Health Savings Account (HSA). Hal can deduct the $500 on his own tax return, even though the money came from his father.Employer contributions to an HSA on behalf of an employee are treated as employer-provided coverage for medical expenses. They are excluded from the employee's income for purposes of income and employment taxes and are deductible by the employer.
Distributions
In general, an HSA participant may withdraw funds from the HSA at any time for any purpose. This contrasts with FSAs and HRAs, which only allow reimbursements for medical expenses. However, the use of HSA distributions, as well as the age of the participant and some other circumstances, determines how the money is taxed. Distributions used exclusively to pay for qualified medical expenses of the participant, or of his or her spouse or dependents, are excluded from gross income (that is, tax-free). On the other hand, any distribution or portion of a distribution not used exclusively to pay for qualified medical expenses is included in the participant's gross income and subject to an additional 10 percent penalty tax.
Molly has accumulated $6,000 in her HSA. She incurs $1,500 of dental expenses not covered by insurance, and she uses money from her HSA to pay them. Because this money is spent on qualified medical expenses, it is tax-free. Roger also has $6,000 in his HSA. He needs $1,500 to help cover college expenses for his daughter Becky. Roger can take this money from his HSA, but because he is not using it for qualified medical expenses, he must include it in his gross income and pay an additional $150 in penalty tax (10 percent of $1,500).
An exception applies to those 65 and older. Although Health Savings Account distributions not used for HSA qualified medical expenses are included in their income, such distributions are not subject to the 10 percent penalty tax.
Charlie, age 67, contributed to an HSA for several years before his retirement, and his account now holds $7,000. Charlie faces a series of expensive repairs to his home, and he withdraws $2,500 from his HSA to help pay for them. This money must be included in Charlie's income because it is used for nonmedical purposes, but since Charlie is over 64 he does not have to pay the 10 percent penalty tax.
To learn more about Health Savings Accounts, visit: http://www.health--savings--accounts.com
Posted by Wiley Long at June 15, 2008 05:30 PM