Contributions by your employer up to the above limit are tax free and are not subject to withholding for income tax or FICA (Social Security and Medicare) purposes. All employer contributions to an HSA are reported in Box 12 of Form W-2 with Code W. Contributions exceeding the excludable limit are also reported in Box 1 of Form W-2 as taxable wages. If you do not remove an excess contribution (and any net income) by the due date for your return (including extensions), the excess is subject to a 6% penalty; see the instructions to Forms 8889 and 5329.
If your employer contributes less than the limit, you may contribute to your HSA but the same overall limit applies to the aggregate contributions. Contributions you make are reported on Form 8889 and deductible “above the line” from gross income on Line 25 of Form 1040. You must attach Form 8889 to your Form 1040.
Archer MSAs
Most employers have replaced Archer MSAs (medical savings accounts) with HSAs. However, an Archer MSA that is not rolled over to a new HSA may continue to be funded.
To contribute, you must have coverage under a high-deductible health plan and must work for a
“small employer,” one that had an average of 50 or fewer employees during either of the two preceding years. For 2015, the minimum deductible for self-only coverage was $2,200 and the maximum deductible could be no more than $3,300. For 2015 family coverage, the deductible had to be at least
$4,450 and no more than $6,650. Th e high-deductible plan limit on out-of-pocket expenses (other than premiums) for 2015 was $4,450 for self-only coverage and $8,150 for family coverage. All of these limits are subject to an infl ation adjustment for 2016; see the e-Supplement at jklasser.com.
Generally, you are not eligible for an Archer MSA if you have any other health insurance in addition to the high-deductible plan coverage, except for policies covering only disability, vision or dental care, long-term care, or accidental injuries, or plans that pay a fl at amount during hospitalization.
Employer contribution limits. Your employer’s contributions to your Archer MSA are tax free up to an annual limit of 65% of the plan deductible if you have individual coverage and 75% of the deductible for family coverage. Th e limit is reduced on a monthly basis if you are not covered for the entire year. For example, if for all of 2015 you were covered by a qualifying family coverage high-deductible plan with a $6,650 annual deductible (this is the maximum deductible for 2015), the maximum tax-free contribution is $4,988 (75% of $6,650). If you had coverage for only 10 months, the limit would be $4,157 (10/12 × $4,988). All employer contributions to your Archer MSA are reported in Box 12 of Form W-2 (Code R). If the contributions exceed the tax-free limit, the excess is reported in Box 1 of Form W-2 as taxable wages. You must report all employer contributions on Form 8853, which you attach to your Form 1040.
If your employer makes any contributions to your account, you may not make any contributions for that year. In addition, if you and your spouse have family coverage under a high-deductible plan and your spouse’s employer contributes to his or her Archer MSA, you cannot contribute to your Archer MSA. If your employer (or spouse’s employer) does not contribute, you may make deduct- ible contributions up to the above employer contribution limits. You report your contributions on Form 8853 and claim your deduction on Line 36 of Form 1040; label it “MSA.” Contributions exceeding the annual limit are subject to a 6% penalty.
3.3 Reimbursements and Other Tax-Free Payments From Employer Health and Accident Plans
Several types of payments from a health or accident plan are tax free to you even if your employer paid the entire cost of your coverage:
1. Reimbursements of your medical expenses; see below.
2. Payments for permanent physical injuries; see below.
3. Distributions from a health savings account (HSA) or Archer MSA if they are used to pay for qualifi ed medical expenses; see below.
4. Payments you receive when you are chronically ill from a qualifying long-term- care insurance contract; but if payments are made on a per diem or other periodic basis, the exclusion may be limited. For 2015, payments of up to $330 per day are tax free regardless of actual expenses. If the payments exceed $330 per day, you are only taxed to the extent that the payments exceed your qualifying long-term-care expenses. See 17.15 for further details.
Planning Reminder
One-Time Transfer From IRA to HSA
You can make a one-time tax-free transfer from your IRA or Roth IRA to your HSA. A qualifying transfer is not taxable or subject to the 10% penalty for distributions before age 59ẵ. Generally, only one IRA/Roth IRA transfer to an HSA is allowed during your lifetime, but if a transfer is made to a self-only HDHP, and later in the same year you obtain family HDHP coverage, a second transfer from an IRA or Roth IRA may be made in that year. Th e transfer (or transfers) count towards the annual HSA contribution limit for that year, so if the transfer exceeds the annual HSA contribution limit, the excess is taxable (and possibly subject to the pre-59ẵ penalty). If you want to transfer amounts from more than one IRA or Roth IRA to an HSA, you have to fi rst roll the funds into a single IRA/Roth IRA and then make the transfer from that account.
To be tax free, the transfer must be directly to the HSA trustee or custodian. Furthermore, you must remain HSA-eligible (have qualifying HDHP coverage) for 12 months following the date of the distribution; otherwise, the distribution is taxable (and possibly subject to the pre-59ẵ penalty) in the year that you cease to be eligible. Changing from family-HDHP coverage to a self-only HDHP during the 12-month testing period is not considered a cessation of HSA eligibility.
Reimbursements and Other Tax-Free Payments From Employer Health and Accident Plans • 3.3 Payments that are not within the above tax-free categories, such as disability benefi ts, are not
taxable to you if you paid all of the premiums with after-tax contributions. If your contributions were made on a pre-tax basis, benefi ts received from the plan are taxable. For example, disability benefi ts are taxable if you paid premiums paid under a cafeteria plan (3.14) with pre-tax contribu- tions that were excluded from your income. If your employer paid all the premiums and you were not taxed on your employer’s payment, any benefi ts you receive from the plan are fully taxable.
If both you (with after-tax contributions) and your employer contributed to the plan, only the amount received that is attributable to your employer’s payments is taxable.
Tax-Free Reimbursements for Medical Expenses
Reimbursements of medical expenses (17.2) that you paid for yourself, your spouse, or any de- pendents and your children under age 27 are tax free, provided you incurred the expenses after the plan was established. Payment does not have to come directly to you to be tax free; it may go directly to your medical care providers.
Tax-free reimbursements may be from a health-care fl exible spending arrangement (FSA) (3.16).
Reimbursements made under a qualifying health reimbursement arrangement (HRA) also qualify for tax-free treatment; see below.
Tax-free treatment applies only for reimbursed expenses, not amounts you would have received anyway, such as sick leave that is not dependent on actual medical expenses. If your employer reimburses you for premiums you paid, the reimbursement is tax free so long as your payment was from after-tax funds. If you paid premiums with pre-tax salary reductions, a “reimbursement” from the employer will be taxable to you because the salary reductions are treated as your employer’s payment, not yours.
Reimbursements for cosmetic surgery do not qualify for tax-free treatment, unless the surgery is for disfi gurement related to congenital deformity, disease, or accidental injury.
Reimbursements for your dependents’ medical expenses are tax free. Th is exclusion applies not only to reimbursed expenses of persons claimed as dependents (21.1) on your return, but also to expenses of qualifying children or relatives who cannot be claimed as your dependents because: (1) they are claimed by the other parent under the special rules for divorced/separated parents (21.7), (2) their gross income exceeds the limit for qualifying relatives ($4,000 for 2015), (3) they fi le a joint return with their spouse, or (4) you are the dependent of another taxpayer and thus are barred from claiming any dependents on your return.
A qualifying dependent does not include a live-in mate where the relationship violates local law.
If the reimbursement is for medical expenses you deducted in a previous year, the reimbursement may be taxable. See 17.4 for the rules on reimbursements of deducted medical expenses.
If you receive payments from more than one policy and the total exceeds your actual medical expenses, the excess is taxable if your employer paid the entire premium; see the Examples in 17.4.
Health Reimbursement Arrangements (HRAs). Employers can set up health reimburse- ment arrangements (HRAs) to reimburse out-of-pocket medical expenses of employees, their spouses, children under age 27 and their dependents. Former employees including retired employees, and spouses and dependents of deceased employees can be covered. Self-employed individuals are not eligible. An HRA must be funded solely by employer contributions and not by salary reductions or after-tax contributions from employees.
Employees are not taxed on HRA reimbursements for medical expenses that may be claimed as itemized deductions (17.2), including premiums. Over-the-counter medicines or drugs other than insulin do not qualify for tax-free reimbursement from an HRA unless they are prescribed by a physi- cian. For contributions and reimbursements (3.1) to be tax free, employees must not receive cash or any benefi t (taxable or nontaxable) from an HRA other than reimbursement for medical expenses. If the reimbursement limit is not fully used up by the end of a coverage year, the unused limit can be carried forward to a subsequent year. Nondiscrimination rules apply to self-insured HRAs.
Self-employed health plan that includes spouse. If a self-employed person hires his or her spouse and provides family coverage under a health plan purchased in the name of the business, the employee-spouse may be reimbursed tax-free for medical expenses incurred by both spouses and their dependent children.
Executives taxed in discriminatory self-insured medical reimbursement plans. Although reimbursements from an employer plan for medical expenses of an employee and his or her spouse and dependents are generally tax free, this exclusion does not apply to certain
Caution
Reimbursed Cosmetic Surgery An employer’s reimbursement of expenses for cosmetic surgery is taxable unless the employee had surgery to correct disfi gurement from an accident, disease, or congenital deformity.
3.3 • Reimbursements and Other Tax-Free Payments From Employer Health and Accident Plans highly compensated employees and stockholders if the plan is self-insured and it discriminates on their behalf. A plan is self-insured if reimbursement is not provided by an unrelated insurance company. If coverage is provided by an unrelated insurer, these discrimination rules do not apply.
If a self-insured plan is deemed discriminatory, rank-and-fi le employees are not aff ected; only highly compensated employees are subject to tax.
Highly compensated participants subject to these rules include employees owning more than 10%
of the employer’s stock, the highest paid 25% of all employees (other than employees who do not have to be covered under the law), and the fi ve highest paid offi cers.
If highly compensated employees are entitled to reimbursement for expenses not available to other plan participants, any such reimbursements are taxable to them. For example, if only the fi ve highest paid offi cers are entitled to dental benefi ts, any dental reimbursements they receive are taxable. However, routine physical exams may be provided to highly compensated employees (but not their dependents) on a discriminatory basis. Th is exception does not apply to testing for, or treatment of, a specifi c complaint.
If highly compensated participants are entitled to a higher reimbursement limit than other participants, any excess reimbursement over the lower limit is taxable to the highly compensated participant. For example, if highly compensated employees are entitled to reimbursements up to
$5,000 while all others have a $1,000 limit, a highly compensated employee who receives a $4,000 reimbursement must report $3,000 ($4,000 received minus the $1,000 lower limit) as income.
A separate nondiscrimination test applies to plan eligibility. Th e eligibility test requires that the plan benefi t: (1) 70% or more of all employees or (2) 80% or more of employees eligible to participate, provided that at least 70% of all employees are eligible. A plan not meeting either test is considered discriminatory unless proven otherwise. In applying these tests, employees may be excluded if they have less than three years of service, are under age 25, do part-time or seasonal work, or are covered by a union collective bargaining agreement. A fraction of the benefi ts received by a highly compensated individual from a nonqualifying plan is taxable. Th e fraction equals the total reimbursements to highly compensated participants divided by total plan reimbursements;
benefi ts available only to highly compensated employees are disregarded. For example, assume that a plan failing the eligibility tests pays total reimbursements of $50,000, of which $30,000 is to highly compensated participants. A highly compensated executive who is reimbursed $4,500 for medical expenses must include $2,700 in income:
30,000
× 4,500 = 2,700 50,000
Taxable reimbursements are reported in the year during which the applicable plan year ends.
For example, in early 2015 you are reimbursed for a 2014 expense from a calendar-year plan. If under plan provisions the expenses are allocated to the 2014 plan year, the taxable amount should be reported as 2014 income. If the plan does not specify the plan year to which the reimbursement relates, the reimbursement is attributed to the plan year in which payment is made.
Tax-Free Payments for Permanent Physical Injuries
Payments from an employer plan are tax free if they are for the permanent loss of part of the body, permanent loss of use of part of the body, or for permanent disfi gurement of yourself, your spouse, your children under age 27, or your dependent. An appeals court held that severe hypertension does not involve loss of a bodily part or function and thus does not qualify for the exclusion.
To be tax free, the payments must be based on the kind of injury and have no relation to the length of time you are out of work or prior years of service. If the employer’s plan does not spe- cifi cally allocate benefi ts according to the nature of the injury, the benefi ts are taxable even if an employee is in fact permanently disabled.
EXAMPLE
After he loses a foot in an accident, Marc Jones receives $50,000 as specifi ed in his employer’s plan. The payment is tax free as it does not depend on how long Jones is out from work.
Filing Tip
Permanent Physical Injuries An employer’s payment for permanent disfigurement or permanent loss of bodily function is tax free if the payment is based solely on the nature of the injury. Whether or not you qualify for this exclusion, you may deduct as an itemized deduction any unreimbursed medical expense you have in connection with these injuries subject to the adjusted gross income fl oor(17.1).
Group-Term Life Insurance Premiums • 3.4 Disability payments from profi t-sharing plan. Th e Tax Court has held that a profi t-sharing
plan may provide benefi ts that qualify for the exclusion for permanent disfi gurement or permanent loss of bodily function. Th e plan must clearly state that its purpose is to provide qualifying tax-free benefi ts, and a specifi c payment schedule must be provided for diff erent types of injuries. Without such provisions, payments from the plan are treated as taxable retirement distributions.
HSA or Archer MSA Payments
Tax-free distributions from a health savings account (HSA). Distributions from an HSA (3.2) are tax free if used to pay qualifi ed medical expenses for you, your spouse, or your dependents. Qualifi ed medical expenses are unreimbursed costs eligible for the itemized deduc- tion (17.2) on Schedule A of Form 1040. Over-the-counter medicines other than insulin that do not require a prescription qualify for HSA purposes if they are actually prescribed by a physician.
Medical expenses are “qualifi ed” only if incurred after the HSA has been established. A distribution is taxable to the extent it is not used to pay qualifi ed medical expenses. A taxable distribution is also subject to a 20% penalty unless you are disabled or are age 65 or older. Distributions will be reported to you on Form 1099-SA and you must report them on Form 8889, which you attach to Form 1040. On Form 8889, you determine if any part of the distribution is taxable and, if it is, that amount must be included as “Other income” on Line 21 of Form 1040. Th e 20% penalty from Form 8889, if any, is entered on Form 1040, Line 62.
A non-spouse benefi ciary who inherits an HSA after the death of the account owner generally must include in income the fair market value of the assets as of the date of death. However, the benefi ciary is not subject to the 20% penalty for taxable distributions. If the benefi ciary is the account owner’s spouse, he or she becomes the owner of the HSA and will be taxed only on distributions that are not used for qualifi ed medical expenses.
Tax-free distributions from Archer MSA. If you work for a small-business employer and have a qualifying Archer MSA (3.2), earnings accumulate in the account tax free. Withdrawals are tax free if used to pay deductible medical costs for you, your spouse, or dependents. Withdrawals used for a non-qualifying purpose are taxable and a taxable distribution before age 65 or becoming disabled is also subject to a 20% penalty. See 41.13 for further details.