Health savings accounts (HSAs) are a means of saving for medical expenses on a tax-favored basis. This article is intended to provide basic information about HSAs.

What is an HSA?

In general, HSAs are modeled after Archer medical savings accounts. Thus, an HSA is a trust or custodial account created exclusively for the benefit of the account holder and is subject to rules similar to those that apply to IRAs. Contributions to and distributions from HSAs receive favorable federal income tax treatment, and the funds in an HSA are not subject to federal income tax.

Who is eligible to benefit under HSAs?

HSAs are available to individuals under age 65 who are covered by a “high deductible” health plan and no other health plan other than one providing certain permitted coverage. Contributions can be made to an HSA either by the individual or by someone else on his or her behalf, including an employer. HSA contributions may be made available as an option under a cafeteria plan.

What is a “high deductible” health plan?

For 2007, a “high deductible” plan is a health plan with an annual deductible for individual coverage of at least $1,100 or $2,200 for family coverage, and the maximum out-of-pocket amount must not exceed $5,500 for individual coverage and $11,000 for family coverage.

How are contributions to an HSA taxed?

Contributions to an HSA are deductible, within limits, as an above the line adjustment in computing adjusted gross income (AGI) for federal income tax purposes. Employer contributions are excludible from employees’ gross income within the same limits. Earnings on amounts in an HSA are not currently taxable, nor are distributions from an HSA that are used to pay qualified medical expenses.

What are the limits on deductibility of HSA contributions?

For 2007, the maximum annual contribution to an HSA is $2,850 for an eligible individual with self-only coverage, or $5,650 for family coverage. These amounts also are increased annually for cost of living adjustments. For individuals who have reached age 55 by the end of the taxable year, the annual contribution limit is increased by $800 in 2007, $900 in 2008, and $1,000 in 2009 and thereafter. Starting in 2007, the maximum deductible contribution is not limited to the eligible individual’s annual deductible under the high deductible health plan. There is full year contribution for part of year participation provided that the plan is maintained for at least 12 months.

How are distributions from an HSA taxed?

Distributions from an HSA to pay the medical expenses of the individual and his or her spouse or dependents are excludible from income. Distributions that are not used to pay medical expenses are subject to income tax. Such distributions also are subject to an additional 10 percent penalty tax unless the distribution is made after age 65 or on account of death or disability.
You can get additional tax information from the IRS internet site at www.irs.gov

Parveen Maheshwari is a Certified Public Accountant. His office is located in Burlingame, CA and can be reached at 650-340-1400 or parveen@cpamax.com

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