Health Savings Accounts (HSAs) have become a popular tool for managing healthcare costs while providing tax advantages. As healthcare expenses rise, understanding the tax implications of HSAs is essential for maximizing their benefits.
This article examines the taxation aspects of HSAs, focusing on contributions, distributions, and other key considerations.
Tax Treatment of Contributions
Contributions to HSAs offer valuable tax benefits. Under U.S. tax law, they are tax-deductible, even for those who do not itemize deductions, reducing adjusted gross income (AGI) and potentially lowering tax liability. For 2024, the IRS sets maximum contribution limits at $4,150 for individuals and $8,300 for families, with a $1,000 catch-up contribution for those aged 55 and older.1Internal Revenue Service. Rev. Proc. 2023-23 (2024 HSA Limits)
Employer contributions to HSAs are excluded from employees’ gross income, but total contributions from both employer and employee must stay within IRS limits. Self-employed individuals also benefit from the same tax-deductible treatment. Contributions can be made until the tax filing deadline for that year’s return; for 2024 contributions, that deadline is April 15, 2025.2Internal Revenue Service. Instructions for Form 8889 (2024) Payroll deductions for contributions are commonly made pre-tax under an employer cafeteria plan, further reducing taxable income.
Tax Treatment of Distributions
HSA distributions are tax-free when used for qualified medical expenses as defined by the tax code. Amounts not used for qualified medical expenses are subject to ordinary income tax and a 20% additional tax, but this additional tax does not apply to distributions made after you turn age 65, become disabled, or die.3Internal Revenue Service. Publication 969: Health Savings Accounts
Strategic planning, such as timing withdrawals in lower-income years, can reduce the tax burden on non-qualified distributions. Account holders can also reimburse themselves later for past qualified expenses if the expenses were incurred after the HSA was established and proper documentation is maintained.
Eligible Expenses
Understanding eligible expenses is critical to maximizing HSA benefits. Qualified medical expenses generally include doctor visits, surgeries, prescription medications, and many common health-related supplies. Over-the-counter medications and menstrual care products also qualify without a prescription when paid from an HSA.
Dental and vision care, such as cleanings, braces, eyeglasses, and contact lenses, are also eligible. Mental health services, including therapy and psychiatric care, are recognized. Maintaining thorough records and receipts is essential to substantiate distributions in case of an IRS audit.
Tax Reporting Requirements
HSA tax reporting requires specific documentation. Account holders receive Form 1099-SA from their HSA custodian, detailing distributions for the tax year.4Internal Revenue Service. About Form 1099-SA This information is reported on Form 8889, which is filed with Form 1040.5Internal Revenue Service. About Form 8889
Form 5498-SA, issued by HSA custodians, reports total contributions made for the year; retain it to ensure your records match what’s reported on Form 8889.6Internal Revenue Service. About Form 5498-SA
Excess Contributions and Penalties
Excess HSA contributions occur when total contributions exceed the annual limits, often due to miscalculations involving employer contributions. The tax code imposes a 6% excise tax on excess contributions for each year the excess remains in the account.7Legal Information Institute. 26 U.S.C. § 4973 (Excess Contributions) To avoid this penalty, the excess amount—and any earnings—must be withdrawn by the tax return due date for that year, including extensions.8Internal Revenue Service. Instructions for Form 5329 (2024)
For example, if an individual over-contributes by $500, they must withdraw the excess and any related earnings before the filing deadline for that year. Failure to correct excess contributions results in ongoing penalties that erode the HSA’s tax advantages. Prompt correction is essential to preserving the tax efficiency of HSAs.