What Church Treasurers Need to Know About Health Savings Accounts

An overview of the basic rules for these accounts.

Does your church provide health benefits to some or all of your employees? If so, you are not alone. Our surveys show that the overwhelming majority of churches provide some form of health benefits to at least some of their staff members.

Providing health benefits to employees has become far more complex in recent years because of the bewildering number of options. Late last year Congress added “health savings accounts” (HSAs) to the list. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 added section 223 to the tax code, which permits eligible individuals to establish Health Savings Accounts (HSAs) beginning in 2004.

Because HSAs will become more and more popular, it is important for church treasurers to be familiar with the basic rules. This article will review what you need to know.

Key point. The information in this article will assist you in responding to questions you receive from staff members who want to know more about HSAs. It also will assist you in evaluating HSAs as a possible fringe benefit for some or all of your church staff.

What are HSAs and who can have them?

An HSA is a tax-exempt account established exclusively for the purpose of paying qualified medical expenses of the account beneficiary. Any “eligible individual” can establish an HSA. An “eligible individual” is any person who: (1) is covered under a high-deductible health plan (HDHP); (2) is not also covered by any other health plan that is not an HDHP; (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.

Generally, for self-only coverage, an HDHP has an annual deductible of at least $1,000 and annual out-of-pocket expenses required to be paid (deductibles, co-payments and other amounts, but not premiums) not exceeding $5,000. For family coverage, an HDHP has an annual deductible of at least $2,000 and annual out-of-pocket expenses required to be paid not exceeding $10,000. In the case of family coverage, a plan is an HDHP only if no amounts are payable from the HDHP until the family has incurred annual covered medical expenses in excess of the minimum annual deductible. Amounts are indexed for inflation.

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). However, except for preventive care, a plan may not provide benefits for any year until the deductible for that year is met.

Example. A plan provides coverage for Jon and his family. The plan provides for the payment of covered medical expenses of any member of Jon’s family if the member has incurred covered medical expenses during the year in excess of $1,000 even if the family has not incurred covered medical expenses in excess of $2,000. If Jon incurred covered medical expenses of $1,500 in a year, the plan would pay $500. Benefits are potentially available under the plan even if the family’s covered medical expenses do not exceed $2,000. Because the plan provides family coverage with an annual deductible of less than $2,000, the plan is not an HDHP.

What kind of other health coverage makes an individual ineligible for an HSA?

Generally, an individual is ineligible for an HSA if the individual, while covered under an HDHP, is also covered under a health plan (whether as an individual, spouse, or dependent) that is not an HDHP.

An individual does not cease to be eligible for an HSA merely because, in addition to an HDHP, he or she has coverage for any benefit provided by “permitted insurance.” Permitted insurance is insurance under which substantially all of the coverage provided relates to liabilities incurred under workers compensation laws, tort liabilities, liabilities relating to ownership or use of property (e.g., automobile insurance), insurance for a specified disease or illness, and insurance that pays a fixed amount per day (or other period) for hospitalization.

In addition to permitted insurance, an individual does not cease to be eligible for an HSA merely because, in addition to an HDHP, he or she has coverage (whether provided through insurance or otherwise) for accidents, disability, dental care, vision care, or long-term care. If a plan that is intended to be an HDHP is one in which substantially all of the coverage of the plan is through permitted insurance or other coverage as described in this answer, it is not an HDHP.

A self-insured medical reimbursement plan sponsored by an employer can be an HDHP.

How can an HSA be established?

Beginning January 1, 2004, any eligible individual can establish an HSA with a qualified HSA trustee or custodian, in much the same way that individuals establish IRAs or Archer MSAs with qualified IRA or Archer MSA trustees or custodians. No permission or authorization from the IRS is necessary to establish an HSA.

Key point. An eligible individual who is an employee may establish an HSA with or without involvement of the employer.

Any insurance company or any bank can be an HSA trustee or custodian. In addition, any other person already approved by the IRS to be a trustee or custodian of IRAs or Archer MSAs is automatically approved to be an HSA trustee or custodian.

Who can contribute to an HSA, and in what amounts?

Any eligible individual may contribute to an HSA. For an HSA established by an employee, the employee, the employee’s employer or both may contribute to the HSA of the employee in a given year. For an HSA established by a self-employed (or unemployed) individual, the individual may contribute to the HSA. Family members may also make contributions to an HSA on behalf of another family member as long as that other family member is an eligible individual.

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 calendar year 2004, the maximum monthly contribution for eligible individuals with self-only coverage under an HDHP is 1/12 of the lesser of 100% of the annual deductible under the HDHP (minimum of $1,000) but not more than $2,600. For eligible individuals with family coverage under an HDHP, the maximum monthly contribution is 1/12 of the lesser of 100% of the annual deductible under the HDHP (minimum of $2,000) but not more than $5,150. In addition to the maximum contribution amount, catch-up contributions may be made by or on behalf of individuals age 55 or older and younger than 65. 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.

All HSA contributions made by or on behalf of an eligible individual to an HSA are aggregated for purposes of applying the limit. The annual limit is decreased by the aggregate contributions to an Archer MSA. The same annual contribution limit applies whether the contributions are made by an employee, an employer, a self-employed person, or a family member. Unlike Archer MSAs, contributions may be made by or on behalf of eligible individuals even if the individuals have no compensation or if the contributions exceed their compensation. If an individual has more than one HSA, the aggregate annual contributions to all the HSAs are subject to the limit.

In the case of married couples, if either spouse has family coverage, both are treated as having family coverage. If each spouse has family coverage under a separate health plan, both spouses 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 the spouses 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 to an HSA must be made in cash, or through a cafeteria plan.

Contributions made by an eligible individual to an HSA are deductible in determining adjusted gross income (i.e., “above-the-line”). The contributions are deductible whether or not the eligible individual itemizes deductions. However, the individual cannot also deduct the contributions as medical expense deductions. In addition, 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. The contributions are deductible whether or not the eligible individual itemizes deductions. An individual who may be claimed as a dependent on another person’s tax return is not an eligible individual and may not deduct contributions to an HSA.

In the case of an employee who is an eligible individual, employer contributions to the employee’s HSA are treated as employer-provided coverage for medical expenses under an accident or health plan and are excludable from the employee’s gross income. The employer contributions are not subject to withholding from wages for income tax or Social Security. Contributions to an employee’s HSA through a cafeteria plan are treated as employer contributions. The employee cannot deduct employer contributions on his or her federal income tax return as HSA contributions or as medical expense deductions.

Contributions can be made in one or more payments, at the convenience of the individual or the employer, at any time prior to the deadline of the individual’s federal income tax return for that year (April 15 of the following year). Although the annual contribution is determined monthly, the maximum contribution may be made on the first day of the year.

Example. Anne is a church employee who has self-only coverage under an HDHP with a deductible of $1,500 and also has an HSA. Anne’s employer contributes $200 to her HSA at the end of every quarter in 2004 and at the end of the first quarter in 2005. She can exclude from income in 2004 all of the employer contributions ($1,000) because her exclusion for all contributions does not exceed the maximum annual HSA contributions.

What about excess contributions?

What happens when HSA contributions exceed the maximum amount that may be deducted or excluded from gross income in a taxable 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 described above. Contributions by an employer to an HSA for an employee 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 taxable year is imposed on the account beneficiary for excess individual and employer contributions.

However, if the excess contributions for a taxable year and the net income attributable to such excess contributions are paid to the account beneficiary before the deadline for the account beneficiary’s federal income tax return for the taxable year, then the net income attributable to the excess contributions is included in the account beneficiary’s gross income for the taxable year in which the distribution is received but the excise tax is not imposed on the excess contribution and the distribution of the excess contributions is not taxed.

Can HSAs accept rollover contributions?

Rollover contributions from Archer MSAs and other HSAs into an HSA are permitted. Rollover contributions need not be in cash. Rollovers are not subject to the annual contribution limits. Rollovers from an IRA, from a health reimbursement arrangement (HRA), or from a health flexible spending arrangement (FSA) to an HSA are not permitted.

What is the tax treatment of an HSA?

An HSA is generally exempt from tax (like an IRA or Archer MSA), unless it has ceased to be an HSA. Earnings on amounts in an HSA are not includable in gross income while held in the HSA (i.e., inside buildup is not taxable).

Distributions from an HSA used exclusively to pay for qualified medical expenses of the account beneficiary, his or her spouse, or dependents are excludable from gross income. In general, amounts in an HSA can be used for qualified medical expenses and will be excludable from gross income even if the individual is not currently eligible for contributions to the HSA.

However, any amount of the distribution not used exclusively 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 on the amount includable, except in the case of 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 if those expenses could be deducted as an itemized deduction on Schedule A (Form 1040) and only to the extent that the expenses are not covered by insurance or otherwise. 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.

Generally, health insurance premiums are not qualified medical expenses except for 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.

If the account beneficiary is no longer an eligible individual (e.g., the individual is over age 65 and entitled to Medicare benefits, or no longer has an HDHP), distributions used exclusively to pay for qualified medical expenses continue to be excludable from the account beneficiary’s gross income.

HSA trustees or custodians are not required to determine whether HSA distributions are used for qualified medical expenses. Individuals who establish HSAs make that determination and should maintain records of their medical expenses sufficient to show that the distributions have been made exclusively for qualified medical expenses and are therefore excludable from gross income. Also, employers that make contributions to an employee’s HSA are not required to determine whether HSA distributions are used exclusively for qualified medical expenses.

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. If the account beneficiary’s surviving spouse is the named beneficiary of the HSA, the HSA becomes the HSA of the surviving spouse. The surviving spouse is subject to income tax only to the extent distributions from the HSA are not used for qualified medical expenses.

If, by reason of the death of the account beneficiary, the HSA passes to a person other than the account beneficiary’s surviving spouse, the HSA ceases to be an HSA as of the date of the account beneficiary’s death, and the person is required to 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.

What discrimination rules apply to HSAs?

If an employer makes HSA contributions, the employer must make available comparable contributions on behalf of all “comparable participating employees” (i.e., eligible employees with comparable coverage) during the same period. Contributions are considered comparable if they are either the same amount or same percentage of the deductible under the HDHP.

The comparability rule is applied separately to part-time employees (i.e., employees who are customarily employed for fewer than 30 hours per week). The comparability rule does not apply to amounts rolled over from an employee’s HSA or Archer MSA, or to contributions made through a cafeteria plan. If employer contributions do not satisfy the comparability rule during a period, the employer is subject to an excise tax equal to 35% of the aggregate amount contributed by the employer to HSAs for that period.

What reporting is required for an HSA?

Employer contributions to an HSA must be reported on the employee’s Form W-2 (box 12, code “W”). In addition, information reporting for HSAs will be similar to information reporting for Archer MSAs. The IRS will release forms and instructions, similar to those required for Archer MSAs, on how to report HSA contributions, deductions, and distributions.

This article first appeared in Church Treasurer Alert, May 2004.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

This content is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. "From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations." Due to the nature of the U.S. legal system, laws and regulations constantly change. The editors encourage readers to carefully search the site for all content related to the topic of interest and consult qualified local counsel to verify the status of specific statutes, laws, regulations, and precedential court holdings.

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