25 Apr HSAs and Taxes
Health savings accounts or HSAs are a tax-favored account, similar to a savings or investment account, owned by the individual. One of the most attractive features of an HSA is the special tax rules that apply.
Federal Taxes
HSAs enjoy what is known as a triple tax advantage under federal law. First, provided the employee meets the four eligibility conditions, contributions made to the employee’s account are exempt from federal income tax. (See Eligibility and High Deductible Health Plans (HDHPs) for details.) Contributions made through a § 125 cafeteria plan, as is usually the case at work, are also exempt from payroll taxes (e.g., Federal Insurance Contributions Act (FICA)). Secondly, federal taxes do not apply to earnings on the HSA, such as interest, dividends, and investment gains. Lastly, when HSA funds are withdrawn to pay qualified medical expenses, the amounts are not taxed.
Note that HSA funds can be withdrawn for purposes other than qualified medical expenses, but in these cases, taxes (and penalties if under age 65) will apply.
An employer’s contribution and an employee’s pre-tax contribution, through a § 125 cafeteria plan, must be reported on the annual Form W-2 in box 12 using code W.
State Taxes
In most states, HSAs are treated the same way for state income tax purposes as they are under federal tax law. HSA contributions, earnings (e.g., interest, dividends, investment gains), and withdrawals for qualified medical expenses are tax-free. There are exceptions, however. California and New Jersey do not exclude HSA contributions from taxable income. Also, state taxes may apply to HSA earnings in California, New Hampshire, New Jersey, and Tennessee.
Employees who have HSAs, or who are considering establishing an HSA are encouraged to work with their personal tax advisors to ensure they understand all provisions.
Original content by the Mineral Platform. This information is provided with the understanding that Payroll Partners is not rendering legal, human resources, or other professional advice or service. Professional advice on specific issues should be sought from a lawyer, HR consultant or other professional.