The Tax Advantages of Having a Health Savings Accounts

Medical Expense Tax Deductions

A Health Savings Account, or HSA, is a plan designed to help individuals pay their healthcare costs while receiving favorable HSA tax advantages from the Internal Revenue Service. Unlike most other reimbursement accounts that require participants to use the money within a specific time or forfeit it, funds remain in an HSA until they are withdrawn. They are also not employer-dependent, meaning that the owner can change employers without losing his funds. Although each state has the option to treat contributions to and distributions differently, most follow the same rules as the IRS and provide the same tax benefits for state income tax.

Health Savings Account Tax Benefits

Contributions are tax-deductible, and itemizing deductions is not required to claim contributions. The owner may also deduct contributions made to his account by another individual, such as a spouse or parent, but cannot deduct contributions made by his employer.

Contributions made by the employer of an HSA owner are typically excluded from the employee's gross income. This includes contributions made under a cafeteria plan (a type of benefit plan offered by employers).

If the funds can earn dividends or interest, these additional earnings are tax-free. The earnings are subject to the same rules regarding qualified distributions as deposits of principal.

Distributions are only tax-free if used to pay qualified medical expenses.

The IRS sets the annual contribution limit and revises it every year. For 2020, if the account owner has family coverage under a high deductible health plan, the maximum is $7,100, and the maximum is $3,550 for individual coverage. These limits are increased by $1,000 if the account owner is at least 55 years of age.

Qualifications for HSA Tax Advantages

The IRS has specific qualifications that an individual must meet to establish an HSA. Most of the trade-offs to the advantages involve meeting these qualifications:

  • Account owners cannot be enrolled in Medicare.
  • Account owners cannot qualify as another taxpayer's dependent.
  • Account owners must be covered by a high deductible health plan and it has a higher yearly deductible and out-of-pocket limit than typical plans. These limits change annually.
  • Married couples must establish separate health savings accounts even if they file a joint return.
  • Account owners cannot have coverage under another health plan that is not a high deductible health plan. For example, an owner cannot be covered under his spouse's plan. However, exceptions exist; account owners may have insurance offering tax benefits for workers' compensation; specific illnesses or diseases; tort liabilities; disability; long-term care; dental care; accidents; vision care; or flat-rate benefits paid while hospitalized.

Other Health Savings Account Tax Benefits & Considerations

Contributions are paid to a trustee, who administers the account. The trustee may manage the investments and determine the method of distributions, such allowing account owners to use a debit card to pay expenses or require account owners to accept a check from the trustee.

Qualifying is determined on a 12-month basis that begins when the account is established. If the account owner does not remain eligible for the entire 12 months, contributions may become taxable.

Contributions that exceed the limits are not tax deductible, and the excess amounts are subject to a 6-percent excise tax.

Quiz: Health Insurance and Your Taxes

The type of health insurance coverage you have may impact your taxes. Lacking health coverage can affect the outcome of your tax return. Obtaining health coverage privatly versus through an employer can also affects your taxes. See if you're up-to-date on health care rules and taxes with this quiz:

Which of the following health plans would not be considered minimum essential coverage in terms of avoiding the penalty for being uninsured or underinsured? Answer

A. Bronze plans
C. Dental insurance

C. Private insurance of any caliber available through an employer, bought on the marketplace, or bought through a private broker is considered minimum essential coverage. The same is true of government programs like Medicaid, CHIP, and TRICARE. Having dental, long-term care, or disability coverage by itself is not minimum essential coverage.

True or False: You don't have to make a shared responsibility payment if buying health insurance is unaffordable and you have no other options. Answer
True. You're exempt from the shared responsibility payment if you lack access to a government program because your state didn't expand Medicaid, you don't have access to a spouse's plan, you've aged out of your parents' plan, or the amount you must pay for minimum essential coverage represents more than 8.13% of your household income (not just yours if other people live in your household.)

True or False: If you are self-employed and receive health coverage through your spouse's employer-sponsored plan, you can take your half of the premiums for the self-employment health insurance deduction. Answer
False. You can only take the self-employment health insurance deduction if the policy is in your or your business' name. Your spouse's coverage is a condition of employment, not self-employment, and the portion paid out of pocket can be deducted as a medical expense.

What is the maximum number of months you can go without having minimum essential coverage before the shared responsibility payment kicks in, assuming you don't meet any other exceptions? Answer

A. 2
B. 3
C. 4
D. 6

B. If you lack coverage for three months or less and don't meet any other exceptions, you don't have to make the shared responsibility payment.

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