411 / How are amounts distributed from a Health Savings Account (HSA) taxed?

Any distribution that is includable in income because it was not used to pay qualified medical expenses is also subject to a penalty tax.³ The penalty tax is 20 percent of includable income for a distribution from an HSA.⁴ For distributions made prior to January 1, 2011, the additional tax on nonqualified distributions from HSAs was 10 percent of includable income.⁵

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.⁶

Qualified medical expenses are amounts paid by the account holder for medical care⁷ for the individual, his or her spouse, and any dependent to the extent that expenses are not compensated by insurance or otherwise.⁸ For expenses incurred after 2019, expenses incurred for menstrual care products are treated as paid for medical care.⁹ Over-the counter non-drug medical expenses (bandages, contact lenses cleaner, blood pressure monitors, etc.) are qualified without a prescription. (See Q 412.)

The 2025 OBBB classifies qualifying direct primary care arrangement (DPCA) fees as qualified medical expenses, so they could be paid with HSA funds on a tax-free basis (see Q 394).¹⁰ 

---

Planning Point: Perhaps the most common question asked of HSA professionals is whether or not a particular expense in a particular set of circumstances is qualified or not. Even though there is an abundance of interpretative material, the question is sometimes difficult to answer. The IRS definition below provides a helpful summary interpretation of the law.

“Medical expenses are the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body. These expenses include payments for legal medical services rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes.

Medical care expenses must be primarily to alleviate or prevent a physical or mental defect or illness. They do not include expenses that are merely beneficial to general health, such as vitamins or a vacation.”

This definition is helpful after you have exhausted the research for specific items where the IRS has already ruled, or in cases where items can have dual purposes (a massage given in a hospital to revive an atrophied muscle is different than a massage given on vacation for pleasure).

---

With a number of 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 contract ( Q 477),¹¹ a health plan paid for during a period in which the individual is receiving unemployment compensation,¹² or the payment of Medicare premiums (other than Medigap) after age 65 and, in some cases, the employee portion of employer provided health insurance premiums after age 65.

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 ( Q 487).

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.¹³

HSA trustees, custodians, and employers need not determine whether a distribution is used for qualified medical expenses. This responsibility falls on individual account holders.¹⁴