Travis H. Long, CPA, Inc. Blog

Originally published in the Cedar Street Times

May 17, 2013

Perhaps you remember a time when you thought you would get a nice fat tax deduction because you spent thousands of dollars on health care costs that insurance did not cover, only to realize you got nothing out of the deal?  The cause that lead to this depressing realization was either because you did not meet the threshold for medical expenses, based on a percentage of your adjusted gross income, or even if you did, you still did not have enough itemized deductions to get you over the standard deduction.

As of January 1, 2013, that threshold was raised even higher – now 10 percent of your adjusted gross income (7.5% for another three years for people over 65).  For most people this would generally mean if you make $100,000, you get no benefit for the first $10,000 of medical expenses.

A health savings account is a fantastic option which basically allows even people taking a standard deduction to effectively get a tax deduction for much, if not all, of their out-of-pocket medical expenses.  There is also no “use-it-or-lose-it” clause such as can be found in the less flexible “Flexible Spending Arrangement” (FSA).  Qualified medical expenses for HSA purposes used to be a broader definition than medical expenses in IRC section 213(d) used for itemized deductions, but a few years ago it was essentially unified.

Eligibility to open a health savings account is dependent on whether your health plan qualifies as a high deductible health plan (HDHP).  For 2013, an individual plan must have a minimum deductible of $1,250, and $2,500 for a family plan, among other requirements.  The premiums for high deductible plans are much lower (but shop around!) since you are paying a good chunk of the first-dollar costs – just like car insurance deductibles.

You then open a checking account with a company that provides custodial health savings accounts and contribute money to this account.  Any contributions to the account lower your taxable income in the year of contribution, just like contributing to an IRA.  Then you in turn use that account to directly pay all your qualified medical expenses (as well as spouse or dependent expenses) with a checkbook or debit card.  With the savings created by lower health insurance premiums you should already have some money to contribute to your account.  For 2013 you can contribute up to $3,250 for a single plan or $6,450 for a family plan (add a thousand to those figures if you are over 55).

Whatever you do not use stays in your account for the future, and you can keep contributing each year.  If you never use it, you can take it out and use it for whatever purpose you want with no penalty after age 65.  It would be taxable income, however, if not used for medical purposes.  If you use it before age 65 for nonqualified expenses, there is a 20 percent penalty, plus it is taxable income.

Some people even view an HSA as another way to stuff a few more dollars into a “retirement plan,” but without the requirement to have earned income, plus the benefit of not having to take minimum distributions by age 70 1/2.  If you are enrolled in Medicare, however, you can no longer contribute.  Some custodians also allow you to link the account to an investment firm and then invest the money in stocks, bonds, mutual funds, etc.

If you pass away and your spouse is named as the beneficiary, your spouse steps into your shoes and becomes the new HSA owner.  If it passes to your estate, it becomes taxable income included on your final 1040 tax return.  If it passes to any other beneficiary, the HSA becomes taxable income to the recipient except for medical expenses paid within one year after death.  One other tidbit of information – the State of California does not conform to Federal legislation regarding HSAs, so you receive no deduction for contributing to an HSA account and any income generated by the funds is taxable for California purposes.

Many companies have been switching to these plans over the past five or six years due to the savings in premiums, and many of the companies pass some of the savings back to the employees by contributing to the HSA account.

At this point, it looks like HSAs will still exist under ObamaCare, and could conceivably become even more popular if ObamaCare does not pan out and insurance rates keep rising.  HSA plans have been found to lower the consumption of healthcare services since they do place an economic incentive for consumers to find lower cost options since the consumers pay for 100 percent of the care up to the deductible.  Plans that shelter the consumer from any cost at all do not provide this incentive.

However long they stay around, HSAs certainly are a great option for many people today.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.