406 / What is the “testing period” for HSAs?

An HSA testing period is a rule that requires HSA account owners in some circumstances to maintain their HSA eligibility for a period of time after making an HSA contribution.¹ Congress created the testing period rules when it passed the Health Opportunity and Patient Empowerment Act of 2006, a law allowing HSA account owners to fully fund an HSA up to the IRS limits for a year even if they were not HSA eligible for the full year (this is commonly referred to as the “full contribution rule” or the “last month rule”).² The full contribution rule only applies to individuals eligible on the first day of the last month of the tax year (December 1 for calendar year taxpayers). The full contribution rule partially replaced the sum-of-the-months rule that limited HSA contributions to a pro-rata amount of the IRS maximum based on the number of months a person was eligible for an HSA (see Q 397). The testing period serves to plug a potential loophole that would have allowed individuals to make a full HSA contribution and then switch to traditional health insurance (i.e. allow individuals to benefit from the HSA tax deduction without being exposed to the high deductible required under an HDHP).

The testing period rules apply in two circumstances:³

(1)     HSA account owners that were HSA eligible on the first day of the last month of their tax year must meet a testing period (December 1 for calendar year taxpayers). This includes people that just started their HSA eligibility on the first day of the last month (December 1) as well as someone that started eligibility during the tax year and remained eligible on the first day of the last month. It does not include someone who was eligible for part of the year not including the first day of the last month of their tax year (i.e. an individual that lost HSA eligibility before the last month of the individual’s tax year).

(2)     An HSA account owner using a tax-free distribution from an IRA to fund an HSA must meet a testing period.

In other words, any calendar-year taxpayer who makes a regular HSA contribution and remains eligible on December 1 is subject to a testing period. Or, anyone who completes an HSA qualified funding distribution from an IRA is also subject to the testing period rules. This means that most participants in an HSA, those who make contributions every year and remain eligible year after year, are subject to the testing period rules. However, the impact of the rule only applies to individuals that start eligibility after the beginning of the tax year and remain eligible on the first day of the last month of the tax year or move money from an IRA to an HSA in an HSA qualified funding distribution. Individuals who are eligible every month of a year will not face any additional taxes or penalties based on a failed test period for that year. Individuals that are eligible during the year but lose eligibility prior to the first day of the last month of the tax year are not subject to the testing period rule because they are not granted the benefit of the full contribution rule.