8837 / How are amounts distributed from HSAs taxed?

If a distribution from an HSA is used exclusively to pay the qualified medical expenses of an account holder, the distributed amount is not includable in gross income.¹ In contrast, any distribution from an HSA that is not used exclusively to pay qualified medical expenses of an account holder must be included in the account holder’s gross income.²

In addition, a penalty tax applies to any distribution that is includable in income because it was not used to pay qualified medical expenses.³ The penalty tax is 20 percent of includable income for a distribution from an HSA.⁴ For distributions made prior to January 1, 2011, the additional tax on nonqualified distributions from HSAs was 10 percent of includable income.⁵

The penalty tax does not apply to includable distributions received after an HSA holder becomes disabled within the meaning of IRC Section 72(m)(7), dies, or reaches the age of Medicare eligibility.⁶

“Qualified medical expenses” are amounts paid by the account holder for medical care⁷ for the individual, his or her spouse, and any dependent to the extent that expenses are not compensated by insurance or otherwise.⁸ For tax years beginning after December 31, 2010 and before 2020, medicines constituting qualified medical expenses were limited to doctor-prescribed drugs and insulin. The 2020 CARES Act eliminated this restriction, so that over-the-counter medicines are once again qualified expenses even without a prescription.⁹

With several exceptions, the payment of insurance premiums is not a qualified medical expense. The exceptions include any expense for coverage under a health plan during a period of COBRA continuation coverage, a qualified long-term care insurance contract¹⁰ or a health plan paid for during a period in which the individual is receiving unemployment compensation.¹¹

An account holder may pay qualified long-term care insurance premiums with distributions from an HSA even if contributions to the HSA were made by salary reduction through a cafeteria plan. Amounts of qualified long-term care insurance premiums that constitute qualified medical expenses are limited to the following age-based limits in 2025, which are adjusted annually: ¹²

(1)  for persons age 40 or less, the limit is $480,

(2)  for ages 41 through 50, the limit is $900;

(3)  for ages 51 through 60, the limit is $1,800;

(4)  for ages 61 through 70, the limit is $4,810; and

(5)  for those over age 70, the limit is $6,020.

The age is the individual’s attained age before the close of the taxable year.

An HSA account holder may make tax-free distributions to reimburse qualified medical expenses from prior tax years as long as the expenses were incurred after the HSA was established. There is no time limit on when a distribution must occur.¹³

HSA trustees, custodians, and employers need not determine whether a distribution is used for qualified medical expenses. This responsibility falls on individual account holders.¹⁴