Health Savings Account Tax Increased Under New Health Care Act

6/24/2010

By Mark Corey, CPA

If you have a Health Savings Account (HSA) and take distributions after December 31, 2010, you had better make sure that they are for qualified medical expenses. The Health Care and Education Reconciliation Act of 2010 (the companion law to the Patient Protection and Affordable Care Act, better known as the Health Care Act) requires that there be imposed a 20% tax on any distribution that is includable in gross income because it was not distributed for a qualified medical expense. This tax (which is double the prior tax of 10% on non-medical distributions) is imposed in addition to the distribution for nonqualified medical expenses being included in your gross income.

If you are not familiar with HSAs, they are trust accounts set up to pay qualified medical expenses for the participant. To be eligible to set up an HSA you must be covered under a high deductible health plan and not covered by any other non-high deductible plan.

According to the IRS website, the benefits of an HSA include:

• The ability to claim a tax deduction for contributions you, or someone other than your employer, make to your HSA even if you do not itemize your deductions on Form 1040.
• Contributions to your HSA made by your employer (including contributions made through a cafeteria plan) may be excluded from your gross income.
• The contributions remain in your account from year to year until you use them.
• The interest or other earnings on the assets in the account are tax free.
• Distributions may be tax free if you pay qualified medical expenses.
• An HSA is “portable” so it stays with you if you change employers or leave the work force.

For purposes of this tax, a “Qualified Medical Expense” is generally any expense that would qualify for the medical and dental expense deduction on Schedule A of Form 1040. There are some notable exceptions to this general rule, including non-prescription drugs which are qualified under the HSA rules but not eligible as an itemized medical expense deduction. Insurance premiums are not qualified medical expenses unless they are premiums for long-term care insurance, COBRA coverage, health coverage for the unemployed, and Medicare if you are 65 and older (but not for a Medicare supplemental policy).

You cannot take an itemized deduction on Schedule A for a qualified medical expense accounted for under an HSA distribution.