HSAs.

• Author: Laffie, Lesli S.
• Position: From The IRS

The IRS and Treasury have provided guidance on health savings accounts (HSAs) established under Sec. 223, as added by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, for tax years beginning after 2003. HSAs are designed to help individuals save for qualified medical and retiree health expenses. Tax-favored contributions may be made by, or on behalf of, eligible individuals; amounts in an HSA can be accumulated over time or distributed tax free to pay or reimburse qualified expenses.

An HSA is a tax-exempt trust or custodial account established exclusively to pay qualified medical expenses of the account beneficiary who, for the months for which contributions are made to an HSA, is covered under a high-deductible health plan that satisfies certain requirements as to deductibles and out-of-pocket expenses. HSA funds can be used to cover health insurance deductibles and any co-payments for medical services, prescriptions or products; they can also be used to purchase both over-the-counter drugs and long-term care insurance and to pay health insurance premiums during any period of unemployment. However, distributions not used for qualified expenses will be taxable; a 10% penalty will be imposed to deter the use of an HSA for nonmedical purposes. HSA contributions may be made by:

1. An individual and family members, even if the individual does not itemize deductions;

2. An individual's employer (contributions are not taxed to either the employer or the employee); and

3. Employees who participate in cafeteria plans, through a salary reduction plan.

   HSA distributions are not subject to tax if used to pay qualifying medical expenses. To encourage saving for health expenses after retirement, HSA owners between age 55 and 65 can make additional catch-up contributions ($500 for 2004). By 2009, an additional $1,000 can be added to the HSA.

   Notice 2004-2 contains guidance, in question-and-answer format, explaining what HSAs are, who can have them, how to create them and the basic rules for contributions and withdrawals. The notice clarifies the following:

   * Employer contributions to employee HSAs are not subject to FICA taxes.

   * HSAs are allowed for employees covered by employer self-insured medical reimbursement plans with qualifying high deductibles.

   * Like medical savings accounts (MSAs), HSA trustees or custodians do not have to determine if withdrawals are used for medical costs.

   * Special rules cover determining the...