IRS provides guidance on Health Savings Accounts
Notice 2004-2, 2004-2 IRB
IRS has issued guidance on new tax-favored Code Sec. 223 Health
Savings Accounts (HSAs), which were created by the Medicare Act of
2003 (P.L. 108-173), which was signed into law on Dec. 8, 2003.
(See Special Study in Weekly Alert ¶ 1 11/26/2003 .) Using a
question and answer format, Notice 2004-2 explains what HSAs are,
who can establish them, and the basic rules for HSA contributions
and withdrawals. Key issues addressed in Notice 2004-2 follow:
... An HSA may be established by an “eligible individual”—an
individual, who, for any month: (1) is covered under a
high-deductible health plan (HDHP) on the first day of the
month; (2) is not also covered by any other non-HDHP health plan
(with certain exceptions); (3) is not entitled to benefits under
Medicare (generally, has not yet reached age 65); and (4) may
not be claimed as a dependent on another person's tax return.
... For self-only coverage, an HDHP must have an annual
deductible of at least $1,000 and annual out-of-pocket expenses
required to be paid not exceeding $5,000; for family coverage,
the minimum annual deductible is at least $2,000 and annual
out-of-pocket expenses required to be paid can't exceed $10,000.
For family coverage, a plan is an HDHP only if, under its terms
and without regard to which family member or members incur
expenses, no amounts are payable from it until the family has
incurred annual covered medical expenses in excess of the
minimum annual deductible. A plan does not fail to qualify as an
HDHP merely because it does not have a deductible (or has a
small deductible) for preventive care (e.g., first dollar
coverage for preventive care).
... A network plan (i.e., a plan that provides more
favorable benefits for services provided by its network of
providers than for services provided outside of the network)
doesn't fail to be an HDHP solely because the out-of-pocket
expense limit for out-of-network services exceeds the maximum
annual out-of-pocket expense limit allowed for an HDHP. In
addition, a network plan's annual deductible for out-of-network
services is not taken into account in determining the annual
contribution limit. Rather, the annual contribution limit is
determined by reference to the deductible for services within
... Generally, an individual is ineligible for an HSA if,
while covered under an HDHP, he is also covered under a health
plan (whether as an individual, spouse, or dependent) that is
not an HDHP.
... An individual doesn't fail to be eligible for an HSA
merely because, in addition to an HDHP, he has coverage for (1)
any benefit provided by “permitted insurance” (substantially all
coverage relates to liabilities incurred under workers'
compensation laws, tort liabilities, liabilities relating to
ownership or use of property, insurance for a specified disease
or illness, and insurance that pays a fixed amount per day of
hospitalization), or (2) accidents, disability, dental care,
vision care, or long-term care.
... A self-insured medical reimbursement plan sponsored by
an employer may be an HDHP.
Establishing an HSA
... Beginning Jan. 1, 2004, an eligible individual can
establish an HSA with a qualified HSA trustee or custodian, such
as an insurance company or bank. No permission or authorization
from IRS is necessary.
... An eligible individual who is an employee may establish
an HSA with or without his employer's involvement.
... An HSA can be established through a qualified trustee or
custodian who is different from the HDHP provider.
Contributions to HSAs
... The maximum annual contribution to an HSA is the sum of
the limits determined separately for each month, based on
status, eligibility and health plan coverage as of the first day
of the month. For 2004, the maximum monthly contribution for
eligible individuals with self-only coverage under an HDHP is
1/12 of the lesser of 100% of (1) the annual deductible under
the HDHP (minimum of $1,000) or (2) $2,600. For eligible
individuals with family coverage under an HDHP, the maximum
monthly contribution is 1/12 of the lesser of (1)100% of the
annual deductible under the HDHP (minimum of $2,000), or (2)
A taxpayer starts his self-only
coverage under an HDHP on April 1, 2004 and continues to be
covered under the HDHP for the rest of the year. The annual
deductible is $5,000 for the HDHP. The lesser of the
annual deductible and $2,600 is $2,600 so that the monthly
contribution limit is $216.67 ($2,600 ÷ 12). The annual
contribution limit is $1,950.03 (9 × $216.67).
RIA illustration :
... All HSA contributions made by or on behalf of an
eligible individual are aggregated for purposes of applying the
limit. The annual limit is decreased by the aggregate
contributions to an Archer MSA. Contributions may be made by or
on behalf of an eligible individual even if he has no
compensation or if the contributions exceed his compensation.
RIA observation: Thus, deductible
contributions can be used to shelter all forms of income from
tax including interest, pensions, dividends, stock gains and
... For individuals (and their spouses covered under the
HDHP) between ages 55 and 65, the HSA contribution limit is
increased by $500 in calendar year 2004. This catch-up amount
will increase in $100 increments annually, until it reaches
$1,000 in calendar year 2009. The catch-up contribution is also
computed on a monthly basis. After an individual has attained
age 65 (the Medicare eligibility age), contributions, including
catch-up contributions, cannot be made to an individual's HSA.
A taxpayer attains age 65 and
becomes eligible for Medicare benefits in October, 2004 and had
been participating in self-only coverage under an HDHP with an
annual deductible of $1,000. He can't make HSA contributions
(including catch-up contributions) after September, 2004. The
monthly contribution limit is $125 ([$1,000 ÷ 12] plus [$500 ÷
12 for the catch-up contribution]). Jones may make
contributions for January through September for a total of $1,125 (9 ×
... Both spouses are treated as having family coverage if
either one has it. If each spouse has family coverage under a
separate health plan, both are treated as covered under the plan
with the lowest deductible. The contribution limit for the
spouses is the lowest deductible amount, divided equally between
them unless they agree on a different division. The family
coverage limit is reduced further by any contribution to an
Archer MSA. However, both spouses may make the catch-up
contributions for individuals age 55 or over without exceeding
the family coverage limit.
... .Contributions made by a family member on behalf of an
eligible individual to an HSA are deductible by the eligible
individual in computing adjusted gross income.
Contributions made by family
members would be taxable gifts except to the extent they
qualify for the annual exclusion. The contributions wouldn't
qualify for the unlimited exclusion under Code Sec. 2503(e)
for payments for medical care.
... Employer contributions are treated as employer-provided
coverage for medical expenses under an accident or health plan
and are excludable from the employee's gross income. They aren't
subject to income tax withholding, FICA or FUTA. Contributions
through a cafeteria plan are treated as employer contributions.
An employee cannot deduct employer contributions as either HSA
contributions or medical expense deductions.
... Earnings on amounts in an HSA are not includable in
gross income while held in the HSA.
... Contributions for the tax year can be made in one or
more payments, at the convenience of the individual or the
employer, at any time before the due date (without extensions)
for filing the eligible individual's income tax return for that
year, but not before the beginning of that year.
... Contributions by individuals to an HSA, or if made on
behalf of an individual to an HSA, are not deductible to the
extent they exceed the limits discussed above. Employer
contributions are included in the gross income of the employee
to the extent that they exceed the limits or if they are made on
behalf of an employee who is not an eligible individual. In
addition, an excise tax of 6% for each tax year is imposed on
the account beneficiary for excess individual and employer
contributions. But the latter can be avoided if the excess
contributions and net income attributable to them are
distributed to the account beneficiary before the return due
date (including extensions). In such a case, the net income
would be taxed in the year of distributions.
... Rollover contributions from Archer MSAs and other HSAs
into an HSA are permitted. Unlike regular contributions,
rollover contributions need not be in cash.
... An individual may receive distributions from an HSA at
... Distributions used exclusively to pay for qualified
medical expenses of the account beneficiary, his or her spouse,
or dependents are excludable from gross income. However, the
portion of a distribution not used to pay for qualified medical
expenses of the account beneficiary, spouse or dependents is
includable in gross income of the account beneficiary and is
subject to an additional 10% tax. The penalty doesn't apply to
distributions made after the account beneficiary's death,
disability, or attaining age 65.
... Qualified medical expenses are expenses paid by the
account beneficiary, his or her spouse or dependents for medical
care as defined in Code Sec. 213(d) (including nonprescription
drugs described in Rev Rul 2003-102, 2003-38 IRB), but only to the extent the expenses are
not covered by insurance or otherwise.
distributions can be received tax-free
to pay for purchases of over-the-counter medicine or drugs, like
antacid, allergy medicine, pain reliever, or cold medicine even
though amounts paid for such items are not deductible medical
expenses under Code Sec. 213 .
The qualified medical expenses must be incurred only after
the HSA has been established. For purposes of determining the
itemized deduction for medical expenses, medical expenses paid
or reimbursed by distributions from an HSA are not treated as
expenses paid for medical care under Code Sec. 213 .
... Generally, health insurance premiums are not qualified
medical expenses except for the following: qualified long-term
care insurance, COBRA health care continuation coverage, and
health care coverage while an individual is receiving
unemployment compensation. In addition, for individuals over age
65, premiums for Medicare Part A or B, Medicare HMO, and the
employee share of premiums for employer-sponsored health
insurance, including premiums for employer-sponsored retiree
health insurance can be paid from an HSA. Premiums for Medigap
policies are not qualified medical expenses.
... Distributions used exclusively to pay for qualified
medical expenses are excludable from the account beneficiary's
gross income even if he is no longer an eligible individual
(e.g., he is over age 65 and entitled to Medicare benefits, or
no longer has an HDHP).
... HSA trustees or custodians, as well as employers, need
not determine whether HSA distributions are used for qualified
medical expenses. Individuals should maintain records to show
that distributions were made exclusively for qualified medical
... Upon death, any balance remaining in the account
beneficiary's HSA becomes the property of the individual named
in the HSA instrument as the beneficiary of the account. An
account passing to a spousal beneficiary becomes her HSA and she
is taxed only to the extent distributions from the HSA are not
used for qualified medical expenses. An account passing to a
nonspousal beneficiary ceases to be an HSA as of the date of the
HSA owner's death. The nonspouse beneficiary must include in
gross income the fair market value of the HSA assets as of the
date of death. For such a person (except the decedent's estate),
the includable amount is reduced by any payments from the HSA
made for the decedent's qualified medical expenses, if paid
within one year after death.
HSAs Offered by Employers
... An employer who makes HSA contributions must make
available comparable contributions on behalf of all “comparable
participating employees” (i.e., eligible employees with
comparable coverage) during the same period.
... Both an HSA and an HDHP may be offered as options under
a cafeteria plan. Thus, an employee may elect to have amounts
contributed as employer contributions to an HSA and an HDHP on a
... HSAs are not subject to COBRA continuation coverage.