Travis H. Long, CPA, Inc. Blog

Originally published in the Cedar Street Times

February 19, 2016

Two weeks ago we started a discussion on Health Savings Accounts.  We discussed why they are so valuable, how you qualify for an HSA, what type of an account it is, how you contribute to it, whether or not you can fund it with an IRA transfer, and what you can spend the money on and for whom.  If you would like to read the article, you can find it on my website at www.tlongcpa.com/blog .

Do Expenses Have to Be Paid Directly From the HSA?

Another important tip is that technically you do not have to pay the medical expenses directly from the HSA account.  You can reimburse yourself if needed.  In fact, you can reimburse yourself at any point in the future from your HSA account for qualified expenses that were incurred at any point after you first established the HSA.  It could be ten years later or more, and you can still reimburse yourself as long as you keep really good records, and can prove you did not deduct those expenses somewhere else, such as on Schedule A, or pay for them out of the HSA account in the past.  Then you can reimburse yourself for them in the current year and treat the reimbursement as a qualified distribution, and not be subject to any tax or penalties.

This could come in very handy if some year you have a big expense, but do not have enough money in the account to cover it all.  You could pay yourself back over a period of years.  Remember, by paying the expenses out of this account, you have been able to use pretax dollars to pay for or reimburse yourself for medical expenses you incurred.  That said, I would recommend always paying directly from the HSA account unless it is impossible to do so.

Should Spouses Have Separate HSA Accounts?

Here is an important pointer, if you have family coverage, you should consider setting up an HSA account for each spouse.  You can only make the additional contribution for your 55 plus spouse if he has his own HSA account.  There are a few other advantages to having separate accounts as well.  As mentioned before, people over 65 can pay their health insurance and Medicare premiums out of their HSA, unlike people under 65.  They can also pay these expenses for their spouse, or dependents, if each is over 65.  However, if you were under 65 and were the only HSA account holder, and your spouse or dependent was over 65, you would not be able to pay the premiums.  You would need your 65+ spouse to have an HSA account and have money in it in order to pay the premiums.  You also cannot transfer money from one spouse’s HSA account to another.  So you need to contribute over the years to each spouse’s account in order to prepare for this.

Another advantage of each spouse having an HSA account is for the payment of long-term care insurance.  It is clear that if each spouse has an HSA, they can each pay their respective long-term care insurance subject to the normal caps.  Without separate accounts, the instructions to the Form 8889 seem to imply you cannot take the deduction for a spouse.

What Happens When I Pass Away?

When you pass away, your spouse can take over the account and use it like his or her own.  However, if it is left to a beneficiary other than a spouse, or is undesignated and goes to your estate, then it is considered an immediate distribution, and the entire balance is included in taxable income.  It is not, however, subject to the 20 percent penalty tax.  Whoever is the named beneficiary and receives the HSA money, pays the tax.  If an estate receives it, it is taxable income on the decedent’s final 1040.  If some other person receives it, then it is taxable to that person’s 1040.  If any final medical expenses are paid from the account within one year of death, those would be qualified distributions and reduce the taxable portion.

Any Pitfalls?

Be alert to prohibited transactions covered by IRC Section 4975 – these are basically self-dealing transactions where you or someone or an entity related to you receives a special benefit in some way from the account.  For instance, if you could borrow money from the account, that could be self-dealing.  Fortunately, the custodian buffer will prevent you from doing a lot of things that might happen otherwise, but there are still some things you could do that would be considered self-dealing that the custodian would not know about.  For instance, if you named your HSA as collateral for a personal loan.  That would be a prohibited transaction, and the entire balance would be deemed distributed immediately, and it would trigger taxable income and a 20 percent penalty on the entire balance.

Form 8889

The Form 8889 itself is a fairly simple two page form.  Part I deals with determining your current year deduction for contributing money to the HSA, and making sure you did not overcontribute.  You add up the contributions from yourself, your employer, plus contributions to any MSAs which count toward the HSA cap, plus if you happen to do a once in a lifetime rollover from your IRA, that would get added in as well.

Part II deals with the distributions from the HSA.  Here you essentially list the total distributions, and then subtract any rollovers to other HSA custodians, and subtract any qualified medical expenses.  Anything left over would generally be a nonqualified distribution subject to the 20 percent penalty unless one of the exceptions applies – turning 65, becoming disabled, or passing away.

Part III calculates the penalty for overcontributing due to changes in your health insurance coverage status.

If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .

Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041. This article is for educational purposes.  Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.