Contributions to HSAs.

• Author: Ellentuck, Albert B.
• Position: Health savings accounts

Contributions to a health savings account (HSA) can be made by or on behalf of (for example, by a family member) any eligible individual and are deductible by the eligible individual "above the line" in arriving at adjusted gross income (AGI) (Sec. 62(a)(19)). Thus, eligible individuals can benefit regardless of whether they itemize deductions. However, the individual cannot also deduct the contributions as a medical expense under Sec. 213 (Sec. 223(f) (6)), and the deduction will not reduce a self-employed person's self-employment tax. Also, contributions can be made by or on behalf of an eligible individual even if the individual has no compensation or if the contributions exceed his or her compensation.

[ILLUSTRATION OMITTED]

Observation: Deductible HSA contributions can be used to offset all forms of income including interest, dividends, retirement plan income, capital gains, and other items.

The maximum annual contribution to an HSA is the sum of the limits determined separately for each month, based on status, eligibility, and health plan coverage as of the first day of the month (Sec. 223(b)(1)). For 2017, the maximum monthly contribution for eligible individuals is one-twelfth of $3,400 for single coverage or $6,750 for family coverage (Sec. 223(b)(2); Rev. Proc. 2016-28). Also, HSA contribution eligibility is based on the individual's eligibility status as of the first day of the last month of the year. Therefore, if the taxpayer establishes the HSA in the middle of the year (and is still eligible on the first day of December), he or she will be treated as eligible during each of the months in the tax year and as having been enrolled in the same high-deductible health plan (HDHP) that currently qualifies him or her for an HSA (Sec. 223(b)(8)(A)). However, if the taxpayer ceases to be eligible (except by reason of death or disability) for an HSA during a testing period that begins on the first day of the last month of the year the taxpayer becomes eligible and ends on the last day of the 12th month following that month (i.e., Dec. 1 of current year through Dec. 31 of following year), he or she must recapture the amount contributed for the period he or she was ineligible, as income, plus pay a 10% penalty tax (Sec. 223(b)(8)(B)).

It is not necessary to distribute this amount from the HSA, and earnings on this amount are not included in gross income or subject to the additional 10% penalty tax as long as the earnings remain in the HSA or are used for qualified medical expenses. This amount is also not considered an excess contribution to the HSA and is therefore not subject to the Sec. 4973 6% excise tax for excess contributions to HSAs. However, if an individual who fails the testing period leaves the recaptured funds in the HSA and later makes a nonqualified HSA distribution (one that is not used for qualified medical expenses), the distribution is taxable and subject to penalty without regard to the previous inclusion in income and penalty (Notice 2008-52).

Example 1: W is a self-employed sole proprietor. He begins self-only coverage under an HDHP on Aug. 1,2017, and continues to be covered throughout the remainder of the year. He continues this coverage beyond Dec. 31,2018. The annual deductible is $4,000 under the plan. For 2017, W can contribute (and deduct) a maximum amount of $3,400 to an HSA.

Example 2: Assume the same facts as Example 1 and that W accepts a new position with Z Inc. in June 2018. Z Inc. provides comprehensive medical coverage as part of its compensation package. Since W ceased being an eligible individual prior to Dec. 31, 2018, he must report $1,983 ($3,400 x [7 / 12] related to January--July 2017) recapture income on his 2018 return, plus pay $198 ($1,983 x 10%) in penalty tax.

All HSA contributions made by or on behalf of an eligible individual are aggregated for purposes of applying the limit (Sec. 223(a)). The same annual contribution limit applies whether an employee, an employer, a self-employed person, or a family member makes the contributions (Notice 2004-2). (Family members may make contributions to an HSA on behalf of another family member as long as that other family member is an eligible individual.) The annual limit is also...