One of the most common IRS notices my clients receive relates to distributions from their health savings accounts.
It is important to properly report these distributions from HSA accounts to ensure that the IRS knows that these were non-taxable distributions. Without properly reporting these distributions at the time of filing, the IRS has no way of knowing the tax status of these distributions.
An HSA is a tax-advantaged savings account linked to a high-deductible health insurance plan. The savings account can be used to pay deductibles, coinsurance, and other eligible tax-free healthcare expenses. An HSA is an individual account and is used to cover current and future medical expenses for the taxpayer, their spouse, and any dependents.
Unlike other types of employee benefit savings plans, HSA contributions and earnings can be carried forward from year to year, allowing the account holder to build up the savings account balance over time. HSA accounts are also portable and remain with the employee regardless of employment status.
To be eligible to contribute to your HSA, you must be covered by a high-deductible health insurance plan and have no medical coverage other than the authorized coverage. If you are eligible, individual contributions to your HSA can be made by you or your employer. However, you cannot be enrolled in Medicare or claimed on another person’s tax return.
The annual contribution limit for a single person for 2022 is $3,600 and for a family $7,200. An additional catch-up contribution of $1,000 is allowed for single and family coverage for people over age 55. If a person is covered by HDHP for part of the year, the allowable deduction is calculated on a proportional basis based on the number of months they were covered by HDHP.
Unlike claiming medical expenses as an itemized deduction on Schedule A, where you can deduct medical expenses over 7.5% of your adjusted gross income, no portion of your HSA distribution used for medical expenses is taxable. Medical expenses generally eligible for HSA purposes are non-reimbursed medical expenses, these items include but are not limited to co-payments, medical deductibles, prescriptions, optical expenses including prescription glasses, and dental expenses.
It is essential that a taxpayer receives their Form 1099-SA from the financial institution where the HSA is located, as this information is also transmitted to the IRS. The information reported on Form 1099-SA is used in the preparation of the tax return to complete IRS tax form 8889 titled Health Savings Accounts. Without properly reporting these distributions, the IRS assumes that they were not used for qualifying medical expenses.
It is the taxpayer’s responsibility to maintain adequate records to prove that the distribution was made for eligible medical related expenses.
Distributions for non-medical expenses are subject to an additional 20% penalty, with exceptions, so make sure your distributions are for eligible medical expenses only.
Exceptions to the 20% penalty include if the account beneficiary turns 65, becomes disabled, or dies. So there are ways to withdraw money from these HSA accounts for non-medical purposes, but the owner must be over 65.
So if you haven’t already signed up for an HSA account, this can be a way to save money on your existing health insurance by increasing your deductibles. You can then also save tax-free money for current and future medical expenses.
Simply keep proper supporting documentation and report distributions correctly to avoid receiving a discrepancy from the IRS that you will need to respond to.
Paul Pahoresky is a partner in the accounting firm of CPA JLP. He can be reached at 440-974-1040×14 or at firstname.lastname@example.org. Consult your tax advisor for your particular situation for additional information and advice on these matters.