HSA Trojan Horse

[Snaggletooth]

A local employer started HSA plans for its employees, and gloated about all the tax savings it was going to benefit employees.

No special instructions or tutelage for the employees. Or if there was, there was precious little, or the employees didn't want to listen.

Have run into several 1099-SAs this year from this employer. Appears the people are paying their entire deductibles out of the plan. [doesn't dawn on anyone what a "deductible" is really for I suppose]

Typical tax "benefit": employee contributions are subtracted from their W-2. Employees generally keep their "account" spent down to zero. Employee's W-2 is less by $3500, but the 1099-SA is for appx $3500, so tax falls upon filing at end-of-year. Plus 10% penalty.

I've been telling clients if they can't pay their deductibles themselves, the tax-favored HSA becomes a Trojan Horse.

Anyone having this experience?

[ToledoEd]

Why is the employees use of the HSA for their Medical Deductable not a qualified medical expenses of the account holder and or family? The 1099SA is only income to the extent it was spent onthings other than qualified medical expenses. Put the 1099SA on Form 8889 or Form 8853(depending on the type of HSA) and put the qualified medical expenses on the form as well. Assuming the deductable are for medical doctors and prescriptions, then they are qualified medical expenses.

From the instructions on the back of the 1099SA
Distributions from a health savings account (HSA), Archer MSA, or Medicare
Advantage (MA) MSA are reported to you on Form 1099-SA. File Form 8853 or
Form 8889, with your Form 1040 to report a distribution from these accounts
even if the distribution is not taxable. The payer is not required to compute the
taxable amount of any distribution.
Box 1. Shows the amount received this year. The amount may have been a
direct payment to the medical service provider or distributed to you.

Box 5. Shows the type of account that is reported on this Form 1099-SA.

An HSA or Archer MSA distribution is not taxable if you used it to pay
qualified medical expenses of the account holder and family or you rolled it
over.

[Snaggletooth]

Deductible the problem

Jeepguy the problem is when they invade the account to pay deductibles.

An HSA plan has a minimum $2400 deductible for a family plan and by design the taxpayer is supposed to pay this out of his own pocket before paying for any medical expense out of the HSA account.

These employees are paying EVERYTHING out of the account, including the deductible.
Defeats the entire purpose of having the high-deductible plan.

[AJsTax]

I think you have it totally backwards.

Snags,
The main purpose of having the HSA is to cover medical expenses that occur BEFORE the coverage of the high deductible insurance kicks in. You are defeating the ENTIRE reason for doing an HSA.

[ToledoEd]

Please cite where you see that deductables are not a valid medical expenses to be paid by a HSA.

[Golden Rocket]

Interesting

Snags,
The main purpose of having the HSA is to cover medical expenses that occur BEFORE the coverage of the high deductible insurance kicks in. You are defeating the ENTIRE reason for doing an HSA.

Interesting AJ. Had a client a couple days ago with a 1099-SA for $3100. She said she paid her $2400 deductible from the HSA account.

Software took the 1099-SA and taxed her on $3100 plus a $310 penalty.

Can you read enough into this to tell me what's going on??

[Lion]

Yes, Backwards

The employee is supposed to pay their deductible from their own funds, including their HSAs, before the high deductible insurance plan pays benefits.

You must file Form 8889 or form corresponding to the type of savings account to net the qualified medical expenses from the otherwise taxable distribution. Most people will not have any tax implications on their returns. And, they saved on their withholding, so come out ahead.

If they add after-tax money of their own, it's a deduction to income on their return.

And, the employer pays less in payroll taxes and probably smaller health insurance premiums.

It really is win-win. Even YOU get to charge for an extra form on their returns!

[abby]

medical premiums

I believe what they can't pay for are the premiums for the high deductible plan. Is this, perhaps, what you're thinking of? The copays etc they pay are qualified medical expenses.

[AJsTax]

Interesting AJ. Had a client a couple days ago with a 1099-SA for $3100. She said she paid her $2400 deductible from the HSA account.

Software took the 1099-SA and taxed her on $3100 plus a $310 penalty.

Can you read enough into this to tell me what's going on??

Sounds as though you did not enter qualified medical expenses paid for with the HSA funds into your software on the HSA page. If you entered a total of $3100 paid with those funds there would be no taxable amount. Usually they have to show expense in order to draw from that fund so they would not get it if they did not already have the medical expense.

[Burke]

See Instructions for Form 8889. This details "Qualifed Medical Expenses." The insurance premiums for the HDHP are not part of this category. Premiums for LTC, COBRA, health care coverage while receiving unemployment compensation, and Medicare are. Medicare supplemental plan premiums are not. Any other medical expense that could normally be deducted on Schedule A is. So this would include any deductibles under the HDHP or co-pays, as well. In 2009, non-prescription medicines also qualified, but I am thinking that changed last year. Expenses incurred BEFORE the plan was established by the TP are not.

[Gretel]

The employee is supposed to pay their deductible from their own funds, including their HSAs, before the high deductible insurance plan pays benefits.

You must file Form 8889 or form corresponding to the type of savings account to net the qualified medical expenses from the otherwise taxable distribution. Most people will not have any tax implications on their returns. And, they saved on their withholding, so come out ahead.

If they add after-tax money of their own, it's a deduction to income on their return.

And, the employer pays less in payroll taxes and probably smaller health insurance premiums.

It really is win-win. Even YOU get to charge for an extra form on their returns!

Until last week I thought that this is a win-win for employer and employee. Then I got an employee who had a cafeteria plan before. It's a looser for her!

[ToledoEd]

For 2010 over the counter medicines were allowed expenses for HSA, but after December 31, 2010 they are no longer allowed.

Golden Rocket, I agree with AJ that it sounds tlike you did not enter the Qualified Medical Expenses on the form 8889. From what you posted, I would expect $700 added to income and a $70 penalty. Again this is based on what you posted.

[Lion]

Cafeteria Plan

But, a Cafeteria Plan is use it or lose it. An HSA can carry over from year to year, from employer to employer, etc., as long as a HDHP is in place. And, eventually (after 59.5?) it becomes like an IRA, taxable if distributions are not for medical but no penalty, and still non-taxable distributions for medical. Since most of us expect more medical expenses as we age, being able to save for them now while we're working tax-deferred is nice. If your client is too high income for a deductible IRA or even for a Roth, then this is a legal way to defer tax on an IRA-like savings. Maybe it's a win-win-win-win.

[Snaggletooth]

Here's the Scoop

I'm really dense. After reading all the comments, the only thing of which I am certain is that I've treated this wrong. Probably 2-3 times.

1099-SA is for $3100. Family coverage. Deductible was $2400. Employee contributions to HSA was $2900. I'm assuming this is what is meant by "W" in Box 12.

Conversation with taxpayer indicates she spent appx $3100 from the account, and did not pay the deductible $2400 separately.

My calculation was the $3100 was taxable income (or else there would be no purpose for issuing the 1099-SA). Additionally, there would be a $310 penalty for 10%.

[Gary2]

1099-SA is for $3100. Family coverage. Deductible was $2400. Employer contributions to HSA was $2900.

Conversation with taxpayer indicates she spent appx $3100 from the account, and did not pay the deductible $2400 separately.

My calculation was the $3100 was taxable income (or else there would be no purpose for issuing the 1099-SA). Additionally, there would be a $310 penalty for 10%.

That's like saying there's no purpose in issuing a 1099-R for a perfectly legitimate, total indirect rollover.

The 1099-SA simply says that $3100 was taken out of the account. It's up to the taxpayer to prove the number that they put down on line 15 of the 8889. I'm not sure what you mean by "did not pay the deductible $2400 separately." Either they had other medical expenses or they didn't. Did they go to the doctor, dentist, optometrist at all? Any prescription drugs, eyeglasses, etc?

In this economy, people may dip into their HSAs just like others dip into the 401k plans or IRAs, but unlike those, it's extremely rare that the entire HSA distribution would be taxable.