As part of AdvisorOne’s Special Report, 20 Days of Tax Planning Advice for 2013, throughout the month of March, we are partnering with our Summit Business Media sister service, Tax Facts Online, to take a deeper dive into certain tax planning issues in a convenient Q&A format. In this fourth article, we look at how health savings account distributions are taxed.
Q. How are amounts distributed from a health savings account (“HSA”) taxed?
A distribution from an HSA used exclusively to pay qualified medical expenses of an account holder is not includable in gross income. In contrast, any distribution from an HSA that is not used exclusively to pay qualified medical expenses of an account holder must be included in the account holder’s gross income.
In addition, any distribution that is includable in income because it was not used to pay qualified medical expenses also is subject to a penalty tax. The penalty tax is 10 percent of includable income for a distribution from an HSA. For distributions made after December 31, 2010, the additional tax on nonqualified distributions from HSAs is increased to 20 percent of includable income.
Includable distributions received after an HSA holder becomes disabled within the meaning of IRC Section 72(m)(7), dies, or reaches the age of Medicare eligibility are not subject to the penalty tax.
Qualified medical expenses are amounts paid by the account holder for medical carefor the individual, his or her spouse, and any dependent to the extent that expenses are not compensated by insurance or otherwise. For tax years beginning after December 31, 2010, medicines constituting qualified medical expenses will be limited to doctor-prescribed drugs and insulin. Consequently, over-the counter medicines will no longer be qualified expenses unless prescribed by a doctor after 2010.
With several exceptions, the payment of insurance premiums is not a qualified medical expense. The exceptions include any expense for coverage under a health plan during a period of COBRA continuation coverage, a qualified long term care insurance contractor a health plan paid for during a period in which the individual is receiving unemployment compensation.
An account holder may pay qualified long term care insurance premiums with distributions from an HSA even if contributions to the HSA were made by salary reduction through an IRC Section 125 cafeteria plan. Amounts of qualified long term care insurance premiums that constitute qualified medical expenses are limited to the age-based limits found in IRC Section 213(d)(10) as adjusted annually.
An HSA account holder may make tax free distributions to reimburse qualified medical expenses from prior tax years as long as the expenses were incurred after the HSA was established. There is no time limit on when a distribution must occur.
HSA trustees, custodians, and employers need not determine whether a distribution is used for qualified medical expenses. This responsibility falls on individual account holders.
See all the articles from Tax Facts Online, part of AdvisorOne's Special Report, 20 Days of Tax Planning Advice for 2013.
You might also be interested in a related product, Healthcare Reform Facts, a publication from The National Underwriter Company, another Summit Business Media company.