| In an attempt to deal with the high cost of medical care in the United States, Congress has passed a tax law allowing certain taxpayers to set up a health savings account (HSA), a tax-exempt trust or custodial account for the payment or reimbursement of medical expenses.
There are many benefits resulting from the establishment of a HSA. These include the fact that a qualified taxpayer can claim a deduction for contributions to his HSA even if he does not itemize deductions and that contributions to the HSA made through an employer may be excluded from gross income. In addition, the contributions remain in the HSA from year to year until they are used, and the earnings of the assets in the account are tax-free. Distributions from the HSA for qualified medical expenses are tax free, and the HSA stays with the taxpayer when he changes jobs or even leaves the work force.
Qualified Taxpayers
In order to set up a HSA, a taxpayer must already participate in a high deductible health plan (HDHP). A HDHP has a higher annual deductible than typical health plans and a maximum limit on the sum of annual deductible and out-of-pocket medical expenses that the member must pay for covered expenses.
In addition, a taxpayer who is eligible for an HSA must not be entitled to Medicare benefits, nor can he be claimed as a dependent on someone else's tax return. Finally, he can have no other health insurance except plans covering accidents, disability, dental or vision care, long-term care, benefits relating to workers' compensation laws, tort liabilities, or ownership or use of property, or a fixed per diem amount for hospitalization.
Amount of Contributions
The total amount that can be contributed to an HSA by a taxpayer, his family members, or his employer depends upon the type of existing HDHP coverage and the age of the taxpayer. Generally, contributions are limited to the amount of the annual deductible for the HDHP with a maximum set by statute.
Distributions from an HSA
When a taxpayer pays medical expenses that are not reimbursed by his HDHP, he is entitled to a tax-free distribution from the HSA. However, if the taxpayer makes withdrawals for other reasons, the amount withdrawn will be subject to income tax and may be subject to an additional 10 percent penalty.
Expenses that qualify for a medical or dental income tax deduction are qualified medical expenses resulting in a tax-free distribution from an HSA. The taxpayer seeking a tax-free distribution must accrue the qualified medical expenses after the HSA has been set up.
Generally, a taxpayer cannot treat insurance premiums as qualified medical expenses for HSAs. However, an exception is made for premiums for long-term care coverage, health care coverage while receiving unemployment benefits, or health care continuation coverage required under any federal law. A taxpayer who is over the age of 65 can treat insurance premiums other than for a Medicare supplemental policy as qualified medical expenses.
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