A health savings account is a tax-deductible savings plan for individuals covered by a qualified High-Deductible Health Plan (HDHP). This program allows for tax deductible contributions to a special account that allows you to pay for expenses your insurance plan does not cover with pretax and tax-free dollars.
A high deductible plan for 2019 requires a minimum deductible of $1,350 for individuals and/or $2,700 for a family. These plans must have a maximum out-of-pocket expense of at least $6,750 for an individual and $13,500 for a family.
If you are covered by a spouse’s workplace policy, Tricare, the Veterans Administration, or Medicare you are not eligible. If you are a dependent on someone else’s tax return or covered by a Flexible spending account or Health reimbursement account, you are not eligible.
How an HSA Works
The beauty of an HSA is you make contributions that are deducted from your taxable income, yet when you spend the money for qualified expenses, the distribution is tax-free as well. Any growth within the HSA account is also tax-free. So, the contributions are deductible like a traditional IRA, but earnings and distributions are tax-free, like a Roth IRA – you get the best of both worlds!
Contributions to an HSA are deductible from your taxable income in the years you contribute, and like an IRA, you can make contributions up until April the 15th or your normal tax filing deadline of the following year. For 2019 the maximum HSA contribution is $3,500 for and individual and $7,000 for a family, with an additional $1,000 per year “catch-up” contribution for those over age 55. It is important to know that for married couples the $1,000 catch-up provision applies to each spouse. If you and your spouse are each over 55 your HSA contribution limit for 2019 would be $9,000.
If you contribute to an HSA plan through your employer, your annual contributions are reduced dollar for dollar by any contributions your employer makes on your behalf. For example, if you and your spouse are under age 55 and your employer makes a $1,200 annual contribution on your behalf, you would only be allowed to contribute and deduct from your taxable income $5,800 for 2019 ($7,000 contribution limit minus $1,200 employer contribution).
If you drop out of a high deductible plan before the end of any calendar year, say you become eligible for Medicare, or you change employers and the new coverage does not qualify as a high deductible plan, your contributions for that year are simply pro-rated. Meaning if you participate for three months then changed to a plan that is not eligible for HSA contributions, you would be eligible for a 3/12ths deduction in that calendar year.
On the other hand, if you become eligible for HSA contributions during a calendar year, you can make contributions as if you were covered by a high-deductible plan for the full year. So, if you moved from an employer plan that was not HSA compliant to another employer plan that was HSA eligible in October you would be allowed to contribute as if you were eligible for the entire year. This is known as the last month rule.
The contribution rules for HSA accounts also allow others to contribute to the account on your behalf. For example, if you have a working child who is covered by an HSA compliant insurance policy, you can contribute directly to the account for them. The contribution is considered a gift so you will not receive an income tax deduction, but it may be an important step to helping your child become financially stable.
Qualified HSA Funding Distribution
An important funding technique is the ability to make a trustee to trustee transfer from an IRA into your HSA account. Each taxpayer may only do one qualified transfer in their lifetime and the amount of your HSA contribution will be reduced dollar for dollar in the year you make a conversion. But this is an outstanding opportunity to convert dollars that are potentially taxable in the future to dollars that can be tax free. If you are young and make a conversion, the potential for tax free growth can’t be beat. Even if you are just shy of Medicare eligibility, the income tax savings of this strategy make it worthy of consideration.
An important note for couples is that only one person can own an HSA account. To maximize the Qualified HSA funding distribution benefit, one spouse will open a family HSA for a calendar year and use their qualified finding distribution. In the following year the other spouse will open a separate HSA account and use their own once in a lifetime qualified funding distribution to fund that account. This would allow a couple to convert up to $18,000 from IRA where distributions are likely to be taxable into HSA accounts that compound tax free and provide tax free future benefits.
You are allowed to rollover funds, via a trustee-to-trustee transfer, from one HSA account to another without triggering a taxable event. This means if you leave an employer’s plan and wish to establish an HSA account through a different provider, you can consolidate your account with the new provider and simplify your financial life. Or if you wish you can change HSA account custodians anytime you wish.
If you name your spouse as the beneficiary of your HSA account, the account will be treated as the spouse’s HSA upon your death. For other beneficiaries the fair market value becomes a taxable distribution to the beneficiary.
Funds from your HSA account can be used for qualified medical expenses for you and your family. The IRS is a bit liberal in their definition of family. Anyone who qualifies as a dependent on your income tax return can have medical expenses paid from your HSA account. You, your spouse, your children under age 19 or under age 24 if a full-time student, grandchildren, parents, and foster children are all included.
Medically necessary expenses not covered by insurance can be paid from your HSA account without taxation. Even things like drug and alcohol rehab, home modifications for disabilities, acupuncture, dental and vision care, and over the counter drugs prescribed by your doctor, are all allowed expenses.
Although your current insurance premiums cannot be paid from you HSA account, you can use those funds to pay for Long-term care insurance and Medicare Part B and Part D premiums.
For a complete listing of eligible expenses see IRS publication 502.
Look Back Provision
If you have an HSA account open during any tax year and do not have enough money contributed to cover all the allowed reimbursements, you can use future years contributions to pay yourself back. For example; In 2018 you had an HSA balance of $4,000 but in December you had a large unexpected $5,000 medical expense. You would be able to make 2019 contributions and then reimburse yourself for the extra $1,000 expense you incurred in 2018.
Like IRA accounts, there are certain transactions that are prohibited inside your HSA account. You cannot have any self-dealing transactions such as sale leasing or exchange of property between yourself and your HSA account, you cannot charge your HSA account for services you provide, and you cannot use your HSA account as collateral for any loans. A violation of these rules will trigger a deemed distribution from your HSA account and subject all the funds to taxation in the year the violation occurs. For more information on prohibited transactions see section 4975 of the tax code.
For the full IRS guidance on Health Savings Accounts see Publication 969.
The recent income tax revamp has made income tax planning early in the year a must for many self-employed professionals. The ability to take a 20% deduction of business income, available for single filers with income below $157,500 and married filers with income below $315,000, is too good to pass up. Filers with taxable income at these levels will be in the 24% marginal tax bracket, so being able to qualify for the business income deduction is worth thousands, particularly when proper tax planning can prevent many from reaching the next 32% bracket. There are a number of ways to game your reported income, allowing many filers with reportable income well above these limits to qualify for the 20% exclusion.
First, the exclusion counts toward reducing your income below the phaseout thresholds. A married couple with employment income of $175,000 and a like amount received as business income would see their total income of $350,000 reduced by 20% of the business income or $35,000 allowing them to remain within the proscribed income limits.
Contributions made to an Health Savings Accounts will also reduce your taxable income. For 2018 single filers can deduct up to $3,450 and couples up to $6,900.
A real biggie for high earners looking to qualify for the 20% exclusion is retirement plan contributions. Money contributed to your qualified retirement plans can make a huge difference. For 2018 those under age 50 can contribute $18,500 to a 401k and those 50 and above can contribute up to $24,500. Presumably as a business owner you can also be sure to offer a generous match. Matching contributions are a deductible business expense that benefits you the owner directly yet reduces your reported profits and thus your total income for purposes of qualifying for the 20% deduction. And for very high earners, adding a defined benefit plan to your existing defined contribution plan might be a smart move, depending on the demographics and size of your workforce.
Don’t overlook simple things like using tax free municipal bonds for your savings versus taxable bonds and CDs.
Going beyond the basics, some business owners could benefit from reimagining their business ownership. Suppose you are a professional who owns your place of business. Setting up a separate company to own the real estate could be a smart move. You lease the building back from the owner at a fair market rate creating business income that is not subject to the target income limits.
Busy professionals have little time to devote to income tax planning and their CPAs are busy during tax season, but the difference between qualifying for the deduction and not qualifying could hinge on how soon you begin a given strategy.
With the end of the year approaching now is the time to look for opportunities to save on income taxes. Here are some items you should look for.