1. What exactly is an HSA and how can one be established?

An HSA is a trust created exclusively for the purpose of paying qualified medical expenses of an account beneficiary.

HSAs are available to any employer or individual for an account beneficiary who has high deductible health insurance coverage. An eligible individual or an employer may establish an HSA with a qualified HSA custodian or trustee. No permission or authorization is needed from the IRS to set up an HSA.

Contributions to an HSA generally may be made either by an individual, by an individual's employer, or by both. If contributions are made by an individual taxpayer, they are deductible from income. If contributions are made by an employer, they are excluded from employee income.Although an HSA is similar to an IRA in some respects, a taxpayer cannot use an IRA as an HSA, nor can a taxpayer combine an IRA with an HSA.

An HSA itself is exempt from income tax as long as it remains an HSA.

Contributions may be made through a cafeteria plan under IRC Section 125.

Distributions from HSAs are not includable in gross income if they are used exclusively to pay qualified medical expenses. Distributions used for other purposes are includable in gross income and may be subject to a penalty, with some exceptions.

An employer's contributions to an HSA are not considered part of a group health plan subject to COBRA continuation coverage requirements. Therefore, a plan is not required to make COBRA continuation coverage available with respect to an HSA.

The IRS has stated that a levy to satisfy a tax liability under IRC Section 6331 extends to a taxpayer's interest in an HSA. A taxpayer is liable for the additional 10 percent tax (20 percent after Dec. 31, 2010, under PPACA 2010) on the amount of the levy unless, at the time of the levy, the taxpayer had attained the age of sixty-five or was disabled.

Additionally, an HSA must be created by a written governing instrument that states: 

• no contribution will be accepted except in the case of a rollover contribution unless it is in cash or to the extent that the contribution, when added to previous contributions for the calendar year, exceeds the contribution limit for the calendar year;
   
• the trustee is a bank, an insurance company, or a person who satisfies IRS requirements;
   
• no part of trust assets will be invested in life insurance contracts;
   
• trust assets will not be commingled with other property, with certain limited exceptions; and
   
• the interest of an individual in the balance of his or her account is non-forfeitable.

2. Who's eligible – and who's not – to enroll in an HSA?

Certain kinds of insurance are not taken into account in determining whether an individual is eligible for an HSA. Specifically, insurance for a specific disease or illness, hospitalization insurance paying a fixed daily amount, and insurance providing coverage that relates to certain liabilities are disregarded.

In addition, coverage provided by insurance or otherwise for accidents, disability, dental care, vision care, or long term care will not adversely impact HSA eligibility.

Eligible individuals include anyone who, for any month, is covered under a high deductible health plan as of the first day of that month and is not also covered under a non-high deductible health plan providing coverage for any benefit covered under the high deductible health plan.An individual will not fail to be an eligible individual solely because the individual is covered under an Employee Assistance Program, disease management program, or wellness program, if the program does not provide significant benefits in the nature of medical care or treatment.

An individual enrolled in Medicare Part A or Part B may not contribute to an HSA, though mere eligibility for Medicare does not preclude HSA contributions.

An individual may not contribute to an HSA for a given month if he or she has received medical benefits through the Department of Veterans Affairs within the previous three months. Mere eligibility for VA medical benefits will not disqualify an otherwise eligible individual from making HSA contributions.

A separate prescription drug plan that provides any benefits before a required high deductible is satisfied normally will prevent a beneficiary from qualifying as an eligible individual. 

3. What is a high deductible health plan for purposes of an HSA?

For 2012, an HDHP is a plan with an annual deductible of not less than $1,200 for self-only coverage, ($1,250 for 2013), or $2,400 for family coverage ($2,500 for 2013),  but annual out-of-pocket expenses that do not exceed $6,050 for self-only coverage ($6,250 for 2013),  or $12,100 for family coverage, ($12,500 for 2013).

Deductible limits for HDHPs are based on a 12-month period. If a plan deductible may be satisfied over a period longer than 12 months, the minimum annual deductible under IRC Section 223(c)(2)(A) must be increased on a pro-rata basis to take into account the longer period.

An HDHP may provide coverage for preventive care without application of the annual deductible. The IRS has provided guidance and safe harbor guidelines on what constitutes preventive care. Under the safe harbor, preventive care includes, but is not limited to, periodic check-ups, routine prenatal and well-child care, immunizations, tobacco cessation programs, obesity weight-loss programs, and various health screening services. Preventive care may include drugs or medications taken to prevent the occurrence or reoccurrence of a disease that is not currently present.An HDHP may impose a reasonable lifetime limit on benefits provided under the plan as long as the lifetime limit on benefits is not designed to circumvent the maximum annual out-of-pocket limitation. A plan with no limitation on out-of-pocket expenses, either by design or by its express terms, does not qualify as a high deductible health plan.

Out-of-pocket expenses include deductibles, co-payments, and other amounts that a participant must pay for covered benefits. Premiums are not considered out-of-pocket expenses.

4. What are the limits on amounts contributed to an HSA?

An eligible individual may deduct the aggregate amount paid in cash into an HSA during the taxable year, up to $3,050 for self-only coverage and $6,150 for family coverage in 2010 and 2011.[1] For 2012, HSA contribution limits increase to $3,100 for self-only coverage, and $6,250 for family coverage. For 2013, HSA contribution limits increase to $3,250 for self-only coverage, and $6,450 for family coverage.

The limit is calculated on a monthly basis and the allowable deduction for a taxable year cannot exceed the sum of the monthly limitations.

Individuals who attain age 55 before the close of a taxable year are eligible for an additional contribution amount over and above that calculated under IRC Section 223(b)(1) and IRC Section 223(b)(2). The additional contribution amount is $1,000 for 2009 and later years. In 2013, this would allow individuals age 55 and older a total contribution of up to $4,250; the total contribution for a family would be $7,450.For example, a person with self-only coverage under an HDHP would be limited to a monthly contribution limit of $271 for 2013 ($3,250 divided by 12). If a person was an eligible individual for only the first eight months of a year, the contribution limit for the year would be $2,168 (eight months multiplied by the monthly limit of $271). Although the annual contribution level is determined for each month, the annual contribution can be made in a single payment, if desired.

For married individuals, if either spouse has family coverage, then both spouses are treated as having family coverage and the deduction limit is divided equally between them, unless they agree on a different division. If both spouses have family coverage under different plans, both spouses are treated as having only the family coverage with the lowest deductible.

An HSA may be offered in conjunction with a cafeteria plan. Both a high deductible health plan and an HSA are qualified benefits under a cafeteria plan.[1]

Employer contributions to an HSA are treated as employer-provided coverage for medical expenses to the extent that contributions do not exceed the applicable amount of allowable HSA contributions.

5. Must an employer offering HSAs to its employees contribute the same amount for each employee?

An employer offering HSAs to its employees must make comparable contributions to the HSAs for all comparable participating employees for each coverage period during the calendar year.  

Comparable contributions are contributions that either are the same amount or the same percentage of the annual deductible limit under a high deductible health plan. Comparable participating employees are all employees who are in the same category of employee and have the same category of coverage. Category of employee refers to full-time employees, part-time employees, and former employees.

If an employer fails to meet comparability requirements, a penalty tax is imposed, equal to 35 percent of the aggregate amount contributed by an employer to HSAs of employees for their taxable years ending with or within the calendar year.For years beginning after 2006, highly compensated employees are not treated as comparable participating employees to non-highly compensated employees.

An employer may make contributions to HSAs of all eligible employees at the beginning of a calendar year; it may contribute monthly on a pay-as-you-go basis; or it may contribute at the end of a calendar year, taking into account each month that an employee was a comparable participating employee. An employer must use the same contribution method for all comparable participating employees.

An employer who offers a rollover, namely, a qualified HSA distribution, from a health reimbursement arrangement or a health flexible spending arrangement for any employee must offer a rollover to any eligible individual covered under an HDHP of the employer. Otherwise, the comparability requirements of IRC Section 4980G do not apply to qualified HSA distributions.

6. What is the penalty for making excess contributions to an HSA?

An HSA generally is exempt from income tax unless it ceases to be an HSA. But excess contributions to an HSA are subject to a 6 percent tax. The tax may not exceed 6 percent of the value of the account, determined at the close of the taxable year.

Excess contributions are defined, for this purpose, as the sum of (1) the aggregate amount contributed for the taxable year to the accounts, excluding rollover contributions, which is neither excludable from gross income under IRC Section 106(b) nor allowable as a deduction under IRC Section 223, and (2) this amount for the preceding taxable year reduced by the sum of (x) the distributions from the accounts that were included in gross income under IRC Section 223(f)(2), and (y) the excess of the maximum amount allowable as a deduction under IRC Section 223(b)(1), for the taxable year, over the amount contributed for the taxable year.

The 2013 Tax Facts on Insurance & Employee Benefits book also covers the following questions, among others:

•  How are funds accumulated in an HSA taxed prior to distribution?
   
• How are amounts distributed from an HSA taxed?
   
• When may an account owner transfer or rollover funds into an HSA?
   
• Can an individual's interest in an HSA be transferred as part of a divorce or separation?
   
• What happens to an HSA on the death of an account holder? Can a surviving spouse continue an account?
   
• Are amounts contributed to an HSA subject to Social Security taxes?
   
• Are employer contributions to an HSA on behalf of an employee subject to withholding?