Deducting Medical Savings Accounts

A health savings account (HSA) is a trust established for the exclusive purpose of paying for qualified medical expenses of the account beneficiary. HSAs can be established by employees through an employer’s cafeteria plan. (Note that a health savings account is different from an Archer Medical Savings account. No new Archer MSAs can be established, but eligible individuals can still participicate in an existing plan.)

High-Deductible Health Plan. A high-deductible health plan (HDHP) is defined as a plan with a minimum annual deductible of at least $1,200 for self-only coverage ($2,400 for family coverage) for 2011. (This amounts will remain the same for 2012.) In addition, the annual out-of-pocket expenses cannot exceed $5,950 for self-only coverage ($11,900 for family coverage) for 2011 ($6,050 and $12,100, respectively, for 2012.) Out-of-pocket expenses include deductibles, co-payments and other amounts (other than premiums) that must be paid for plan benefits.

Eligibility. To be eligible to establish an HSA in any month, an individual:

• must be covered by a high deductible health plan on the first day of the month,
• must not be covered by any other plan that is not a high deductible health plan (although there are a few exceptions for government insurance, such as workers' compensation),
• must not be enrolled in Medicare, and
• cannot be claimed as a dependent on another person's tax return.

Special rules apply for married individuals. More information can be found on the IRS website

HSA Contributions. Contributions to HSAs are deductible in determining adjusted gross income. Workers with high-deductible health insurance coverage can deduct up to $3,050 (for self-only coverage) or $6,150 (for family coverage) for 2011 contributions to their HSAs. (For 2012, the dollar limits are $3,100 and $6,250, respectively.) Contributions over those amounts are included in the employee's gross income. Excess contributions are also subject to a six-percent excise tax.

Individuals who reach age 55 by the end of the tax year can increase their annual contributions by $1,000 However, contributions cannot be made after the participant attains age 65 or is enrolled in Medicare, but withdrawals for qualified medical expenses continue to be excludable from gross income.

Contributions by Partnership or S Corporation. Contributions made by a partnership or S corporation to a partner's or shareholder's HSA are generally treated as payments to the partner or shareholder and are includible in gross income. The individual partner or shareholder may treat the contribution as an above-the-line deduction. However, a contribution to the partner's HSA by the partnership for services rendered is treated as a guaranteed payment, and the partnership may deduct the contribution as a business expense. Similarly, a contribution by the S corporation to a two-percent shareholder's HSA for services rendered is deductible by the S corporation and included in the shareholders income.