Be Sure Your Clients Understand HSA Distributions
Health savings accounts (HSAs) continue to be a great way to help offset the rising costs of healthcare. If you have clients who own an HSA, they may have questions about using their HSA money to pay or reimburse themselves for medical expenses that they’ve incurred. Do they understand the tax advantages—and any tax consequences—of HSA distributions? Educating your clients about HSA distributions can help them get the most from their HSA savings.
HSA Distributions May Be Tax-Free
An HSA allows your clients who are covered by high deductible health plans (HDHPs) to save on a pretax basis for medical expenses not covered by their health insurance. A key benefit of an HSA is that distributions may be taken out tax free if used for qualified medical expenses incurred by either
the HSA owner,
the HSA owner’s spouse (even if the spouse is not HSA-eligible),
the HSA owner’s dependents, or
any person that the HSA owner could have claimed as a dependent, except that the person filed a joint return, the person had gross income of $4,300 or more (for 2020), or the HSA owner, or HSA owner’s spouse if filing jointly, could be claimed as a dependent on someone else’s tax return.
Qualified Medical Expenses Are Key
Qualified medical expenses must be incurred after the HSA is established and generally must be eligible for the income tax medical and dental expense deduction. Qualified medical expenses include doctor’s fees, prescriptions, and certain dental and vision care (excluding most insurance premiums). IRS Publication 502, Medical and Dental Expenses, provides a detailed list and can be a great resource for your clients when they have questions about what constitutes a qualified medical expense. Note that in 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act repealed the Affordable Care Act’s restriction that nonprescription, over-the-counter medications (other than insulin) have to be prescribed by a physician in order to be a qualified medical expense. HSA owners should also refer to a competent tax advisor or to IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, for specific details about qualified medical expenses.
Distributions not used for qualified medical expenses are taxed as gross income and subject to an additional 20 percent penalty tax. Exceptions to this penalty tax include distributions payable to
an HSA owner who is disabled,
an HSA owner who is age 65 or older, or
a nonspouse death beneficiary after the HSA owner’s death.
Up to HSA Owner to Monitor
The responsibility for determining qualified medical expenses, and thus, whether a distribution qualifies for tax-free treatment rests solely with the HSA owner. It is not up to you as the HSA trustee or custodian to determine whether HSA distributions are being used for qualified medical expenses. Your primary responsibility as an HSA trustee or custodian is to report HSA distributions to the IRS on Form 1099-SA, Distributions From an HSA, Archer MSA, or Medicare Advantage MSA, and to also send a copy of this form to the HSA owner (or HSA beneficiary) by January 31 of the year following the year of distribution.
In addition to understanding the basics of HSA distributions, your clients should see a competent tax advisor for more complex questions. With the abundance of tax law changes that occur every year—especially with tax-advantaged savings accounts—the value of good advice cannot be overstated.
