Health Savings Accounts And Health Care Reform Law

<div class="Section1">No. An employer cannot sponsor a stand-alone health FSA. An employer may only offer a health FSA if it also offers a major medical plan to the health FSA participants, who are not required to accept the offer of coverage in the employer’s major medical plan.</div>

<div class="Section1">Section 9003 of the ACA adds IRC Section 106(f), which revises the definition of medical expenses for employer-provided accident and health plans, including health flexible spending arrangements (health FSAs) and health reimbursement arrangements (HRAs). Section 9003 also revises the definition of qualified medical expenses for health savings accounts and Archer medical savings accounts.</div><br /> <div class="Section1"><br /> <br /> Prior to 2020, over-the-counter drugs were not eligible for reimbursement by these plans unless a physician issued a prescription. The requirement was removed in 2020. Prior to that, for example, if a physician were to prescribe aspirin, this expense could be reimbursed but the purchase of aspirin without a prescription could not be reimbursed.<br /> <br /> Other changes in health FSAs and HRAs are discussed in the following Q&amp;As.<br /> <br /> </div>

<div class="Section1">An HSA generally is exempt from income tax unless it ceases to be an HSA.<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> In addition, rules similar to those applicable to individual retirement arrangements (IRAs) regarding the loss of the income tax exemption for an account where an employee engages in a prohibited transaction<a href="#_ftn2" name="_ftnref2">²</a> and those regarding the effect of pledging an account as security<a href="#_ftn3" name="_ftnref3">³</a> apply to HSAs. Any amounts treated as distributed under these rules will be treated as not used to pay qualified medical expenses ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3649">3649</a>).<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 223(e)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 408(e)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 408(e)(4).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 223(e)(2).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Under IRC Section 106(f), expenses incurred for medicines or drugs may be paid or reimbursed by an employer-provided plan, including a health FSA or HRA, only if the medicine or drug:<br /> <blockquote>(1)     requires a prescription;<br /> <br /> (2)     is available without a prescription, that is, is an over-the-counter medicine or drug, (before 2020, the individual was required to obtain a prescription); or<br /> <br /> (3)     is insulin.</blockquote><br /> These rules generally apply to expenses incurred for taxable years beginning on or after January 1, 2011. Congress removed the prescription requirement for over-the-counter drugs in 2020.<br /> <br /> Additionally, for plan years beginning in 2013 and thereafter, contributions to flexible savings accounts are limited to $3,300 in 2025 ($3,200 in 2024, $3,050 in 2023, $2,850 in 2022, $2,750 for 2020-2021 and $2,700 for 2019), as indexed for inflation in subsequent years.<a href="#_ftn1" name="_ftnref1">¹</a> Flexible spending accounts are those accounts, typically in cafeteria plans, that may be used to reimburse medical or dependent care expenses.<br /> <br /> Further, the IRS has modified the cafeteria plan use it or lose it rule for health FSAs. Health FSAs may now be amended so that $660 in 2025 ($640 in 2024, $610 in 2023, $570 in 2022 and $550 in 2021) of unused amounts remaining at the end of the plan year may be carried forward to the next plan year.<a href="#_ftn2" name="_ftnref2">²</a> However, plans that incorporate the carry forward provision may not also offer the two-month grace (run-out) period that would otherwise allow FSA participants an additional two-month period after the end of the plan year to exhaust account funds.<br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.    Rev. Proc. 2019-44, Rev. Proc. 2020-45, Rev. Proc. 2021-45, Rev. Proc. 2022-38, Rev. Proc. 2023-34.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.    Notice 2013-71.<br /> <br /> </div>

<div class="Section1">HSA law provides special treatment for spouses in the following areas:<br /> <blockquote><strong>Tax-Free Distributions.</strong> An HSA owner can use his or her HSA tax-free to pay the qualified medical expenses of spouses. This benefit does not extend to domestic partners (in limited circumstances a domestic partner could be a tax dependent and an HSA owner can use an HSA for a tax dependent).<br /> <br /> <strong>Beneficiary Treatment.</strong> A spouse beneficiary can treat the HSA as his or her own upon the death of the HSA owner. Non-spouse beneficiaries must take a full distribution of the money remaining in the HSA.<br /> <br /> <strong>Divorce Transfer.</strong> An HSA owner can transfer assets into an HSA of former spouse in the case of a divorce.<br /> <br /> <strong>Estate Tax Treatment.</strong> If a spouse is named as the beneficiary of the HSA, the treatment of the HSA may change for estate tax purposes.<br /> <br /> <strong>Family HDHP Treatment.</strong> Spouses covered under a family HDHP are capped at the combined HSA family limit. Also, if one spouse has a family HDHP, then both spouses are deemed to have family HDHPs. This rule closes a loophole that allowed each partner in a same-sex couple to contribute the family HSA maximum in certain circumstances.<br /> <br /> <strong>Child of Former Spouse.</strong> An HSA owner can use the HSA to pay for medical expenses of his or her child that is claimed as a tax dependent by a former spouse (this is helpful in cases of divorce and legal separation).</blockquote><br /> </div>

<div class="Section1">For amounts paid after December 31, 2010 and before 2020, a distribution from an HSA or Archer MSA<a href="#_ftn1" name="_ftnref1">¹</a> for a medicine or drug was a tax-free qualified medical expense only if the medicine or drug (1) required a prescription, (2) was an over-the-counter medicine or drug and the individual obtained a prescription, or (3) was insulin. The prescription requirement for over-the-counter drugs was eliminated beginning in 2020.</div><br /> <div class="Section1"><br /> <br /> If amounts are distributed from an HSA or Archer MSA for any medicine or drug that does not satisfy these requirements, the amounts are distributions for nonqualified medical expenses, which are includable in gross income and generally are subject to a 20 percent additional tax. This change does not affect HSA or Archer MSA distributions for medicines or drugs made before January 1, 2011, nor does it affect distributions made after December 31, 2010, for medicines or drugs purchased on or before that date.<br /> <br /> IRS guidance reflecting these statutory changes makes it clear that the rules in IRC Sections 106(f), 223(d)(2)(A), and 220(d)(2)(A) do not apply to items that are not medicines or drugs, including equipment such as crutches, supplies such as bandages, and diagnostic devices such as blood sugar test kits. These items may qualify as medical care if they otherwise meet the definition of medical care in IRC Section 213(d)(1), which includes expenses for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body.<br /> <br /> Expenses for items that are merely beneficial to the general health of an individual, such as expenditures for a vacation, are not expenses for medical care.<br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 223(d)(2)(A), IRC § 220(d)(2)(A).<br /> <br /> </div>

<div class="Section1">For tax years beginning after December 31, 2010, health care reform originally required that employers disclose the value of benefits provided for each employee’s health insurance coverage on employee W-2 forms. This reporting was to give the federal government statistical information and did not change the income tax treatment for employers or employees.</div><br /> <div class="Section1"><br /> <br /> The required reporting rules were delayed twice. Health care reform required W-2s for the 2011 year to provide the cost of health coverage. That requirement was delayed and made applicable for W-2s issued for the 2012 year. Additionally, IRS Notice 2011-28 (as modified by Notice 2012-9) provides an exemption for this delayed reporting requirement. Until further notice from the IRS, an employer is not subject to the reporting requirement for any calendar year if the employer was required to file fewer than 250 Forms W-2 for the preceding calendar year. The IRS has advised that any guidance expanding the reporting requirements will apply to calendar years that begin at least six months after the date that such guidance is issued.<br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> If employees talk to one another, the new W-2 reporting may mean that employees can discover that their employer pays nothing for some employees and thousands for others, especially in grandfathered plans that are not subject to nondiscrimination rules so long as they retain their grandfathered status. It has been quite common for small employers to provide family coverage for owners and key employees, to provide single employee coverage often with less than 100 percent of cost for other employees, and to exclude employees who have health insurance through another source, such as a spouse’s employment.<br /> <br /> <hr /><br /> <br /> </div>

<div class="Section1">HSA account owners that mistakenly take distributions from their HSAs have an opportunity to fix the mistake through special rules for the return of mistaken distributions.<a href="#_ftn1" name="_ftnref1">¹</a> The HSA account owner has to make the mistake due to a reasonable cause and be able to support that with clear and convincing evidence. The HSA account owner should save the evidence along with other tax documents in case of an IRS audit. The HSA custodian will generally not request any evidence as the custodian can rely on the representation of the HSA account owner that the distribution was a reasonable mistake supported by evidence.</div><br /> <div class="Section1"><br /> <br /> The HSA account owner must repay the mistaken distribution amount to the HSA prior to the tax filing due date for the year the HSA account owner knew or should have known of the mistake. Custodians generally provide a form for this purpose. Failure to notify the HSA custodian that the reason for the contribution is the return of mistaken distribution will result in incorrect IRS reporting. HSA custodians are not required to accept the return. In that case, the HSA account owner would have to pay taxes plus a 20 percent penalty on the amount of the mistaken distribution.<br /> <br /> HSA account owners generally do not report the mistaken distribution on their income tax return and the HSA account owner correspondingly also does not report the return of the amount to the HSA. If the mistaken distribution is corrected in the same year as it is made, no reporting is necessary. The HSA custodian will not include the original mistaken distribution as a distribution on the 1099-SA or the return of the money as a contribution on the IRS form 5498-SA. If the custodian already filed the 1099-SA, the custodian will need to file a corrected 1099-SA.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     Notice 2004-50, A37.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.     IRS Instructions for Form 1099-SA and 5498-SA.<br /> <br /> </div>

<div class="Section1">Each year employers must report on the Form W-2 to each employee the amount contributed to an HSA for the employee or the employee’s spouse. The report must be received by the employee by January 31 of the following year.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 6051(a); Notice 2004-2, 2004-1 CB 269, A-34.<br /> <br /> </div>

<div class="Section1">The definition of wages for purposes of the federal unemployment tax (FUTA) does not include any payment made to or for the benefit of an employee if it is reasonable to believe that the employee will be able to exclude the payment from income under IRC Section 106(d), which deals with contributions to HSAs.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> Unfortunately, a similar change was not made to IRC Section 3121(a) with respect to FICA. The IRS has stated, however, that employer contributions to an HSA are not subject to withholding from wages for income tax or subject to the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA), or the Railroad Retirement Tax Act.<a href="#_ftn2" name="_ftnref2">²</a> A similar statement has been made by the Joint Committee on Taxation.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 3306(b)(18).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.     Notice 2004-2, 2004-1 CB 269, A-19.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.     General Explanation of Tax Legislation Enacted in the 104th Congress (JCT-12-96), n. 1642, p. 324.<br /> <br /> </div>