TAX BREAK

Health Savings Accounts: IRS Provides Guidance

By Douglas E. McCash

 

Health Savings Accounts (HSAs) continue to be a hot topic of discussion. Since the winter issue of Tax Break, the IRS has published several rulings and issued additional guidance regarding the establishment of HSAs. Hailed as a possible key solution to the nation’s growing health insurance crisis, HSAs have gotten off to a relatively slow start. One important reason taxpayers are not establishing HSAs is that many taxpayers have been unable to locate a bank or financial institution to serve as trustee for their HSA. IRS officials are hopeful this additional guidance will stimulate and encourage the establishment of HSAs.

 

By way of review, an HSA is available only in conjunction with a high deductible health insurance plan (HDHP) and can be funded with up to 100% of the health plan’s deductible each year to a maximum of $2,600 for an individual and $5,150 for a family in 2004. Employers, as well as the employee, may contribute to an HSA account, which grows tax-free. Distributions are excluded from the account owner’s income if the amounts are used for qualified medical expenses and unused amounts can be rolled over for use in future years. Employer contributions are not subject to FICA taxes and employee contributions can be deducted on the employee’s tax return.

 

IRS Notice 2004-23 provides that an HDHP can now provide preventive care benefits without a deductible, or with a deductible below the minimum annual deductible and not run afoul of the HSA rules. Preventive care benefits that may be offered by an HDHP include: periodic health evaluations, routine prenatal and well-child care, immunizations for children and adults, smoking cessation programs, obesity weight-loss programs, and screening services. The “preventive care” safe harbor allows plans to provide preventive care benefits that will reduce health care costs in the long run.

 

IRS Notice 2004-25 states that eligible individuals who establish HSAs on or before April 15, 2005 may pay or reimburse, on a tax-free basis, any qualified medical expense that was incurred on or after January 1, 2004. This applies to 2004 expenses only. Originally, HSAs could pay or reimburse on a tax-free basis only qualified medical expenses incurred after the HSA had been established. This “transition relief” has been provided because of the difficulty taxpayers have had in finding institutions willing to act as trustee of their HSA as mentioned previously.

 

The IRS has also provided guidance regarding prescription drug coverage. In Revenue Ruling 2004-38, the IRS has stated that it will not allow HSAs to be used by taxpayers covered by both an HDHP and a separate plan or rider that provides prescription drug benefits at a lower deductible. However, Revenue Procedure 2004-22 provides that this prescription drug rule will not apply until 2006.

 

In addition, the Employee Benefit Security Administration has issued guidance which provides that, in general, HSAs will not be considered to constitute employee welfare benefit plans for purposes of ERISA. Therefore, employer contributions to an HSA will not result in ERISA coverage where employer involvement is limited, regardless of whether or not an employee’s high deductible health plan is sponsored by the employer or obtained as individual coverage by the employee. Limited employer involvement means that the establishment of an HSA is completely voluntary on the part of the employees, and that the employer does not: 1) limit the ability of eligible individuals to move their funds to another HSA; 2) impose conditions on utilization of HSA funds beyond those imposed by the code; 3) make or influence the investment decisions with respect to funds contributed to an HSA; 4) represent that the HSAs are an employee welfare benefit plan established or maintained by the employer; or 5) receive any payment or compensation in connection with an HSA.

 

While many questions still remain, the IRS has promised to issue additional guidance addressing the interaction between HSAs, FSAs, and HRAs in June 2004. Stay tuned … this guidance will be addressed in the fall issue of Tax Break.

 

 

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