health savings account - symposium

Professional Advisors Fall Symposium October 1, 2015

Health Savings Accounts Presented by Tom Krieg, CPA 1

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Professional Advisors Fall SymposiumHealth Savings Accounts (HSAs)

How to Maximize Client Benefits While Successfully Navigating Complexity

Date or subtitlePresenter – Thomas M. Krieg, CPA, Partner

October 22, 2015

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Your Presenter

Tom Krieg, CPAPartner, Employee Benefit Services

Phone: (715) 843-7443Email: [email protected]: www.linkedin.com/in/thomaskrieg

20+ years of experience with Wipfli LLP

Areas of focus:

• Health savings accounts and consulting

• Cafeteria plan design, consulting, and nondiscrimination testing

• Affordable Care Act reform consulting and compliance

• Retirement plan design, consulting, administration, recordkeeping, and compliance

• Individual retirement accounts consulting and compliance

• IRS audits of benefit plans



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Disclaimer

Please note that these materials are incomplete without the accompanying oral comments by the presenter. These materials are informational and educational in nature and may represent the speaker‘s own views. These materials are for the attendees use only and not for distribution outside of the agency or publishing on a public website.

Absence of Federal Tax Penalty Protection: The Internal Revenue Service recently issued regulations that require written advice regarding tax matters to meet very detailed and comprehensive requirements before it can be relied upon by a taxpayer to avoid penalties that may apply if the tax benefits or results discussed in the document are disallowed. Compliance with these rigorous standards and requirements exceeds the scope of this engagement. Consequently, the analysis and advice contained in this document regarding federal tax matters is not intended to be used, and may not be relied upon by you or your organization, for the purposes of avoiding any federal tax penalty. Information on these slides is current through September 30, 2015.

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Agenda

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Agenda

Background

Fundamentals of HSAs

Opportunities and Benefits

Administrative Complexity – What can go wrong?

Q & A

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Background - Legislative History

Health Savings Accounts (HSAs) first became available January 1, 2004.

Created by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003.

Statutory rules governing HSAs found primarily in Internal Revenue Code (IRC) Section 223.

Legislative Guidance.• IRS Notice 2004-2 – 38 Questions & Answers (Q&A).• IRS Notice 2004-50 – 88 Additional Q&A.• IRS Notice 2008-59 – 42 Additional Q&A .• Other guidance - IRS Notices 2004-23, 2004-43, 2005-8, 2005-86, 2007-22, 2008-51, 2008-52, 2010-59, 2012-14, 2013-57, 2014-1; Revenue Rulings 2004-38, 2004-45, 2005-25.

Not subject to ERISA.

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Background – HSA Outlook

HSA Statistics – Devenir Study• 31% of all employers now offer Health Savings Accounts (HSAs), up from 4% in 2005.

• $21 billion deposited to HSAs in 2014.• 14.5 million accounts with over $28.4 billion in assets as of 12/31/2014, an increase of 29% for accounts and 25% for assets from 12/31/2013.

• Future projections for 12/2017 – Exponential growth–30 million accounts (117% growth rate over 3 years).–$40 billion in assets (90% growth).

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Background – HSA Outlook

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Background – Health Care Landscape

Health Care Landscape• Health care costs rising faster than overall inflation rate.• Affordable Care Act driving growth of HSAs.

–The “Marketplace” (HealthCare.gov) most common plan is “silver” HSA-eligible plan.

–Cadillac Tax – 40% excise tax on high cost plans ($10,200 single; $27,500 family) effective 1/1/2018.

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Background – Health Care Landscape

Health Care Landscape• Qualifying high-deductible health plan (HDHP) paired up with HSAs is a popular solution due to consumer-driven benefits.

• Small business has been the early adopters. Now seeing more widespread activity among “larger” employers.

• Consumer-driven concept – Encourages individuals to become actively involved in making health care decisions -choosing coverage, service providers, health care services, managing own fitness and wellness

• Consumers tend to spend their own money more wisely than they spend other people’s money.

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Background - Outlook

So, what can we expect? • Affordability of health care will continue to rank very high as a concern by both business owners and employees.

• Health care inflation expected to continue to rise faster than the overall inflation rate.

• Business owners will continue to look to advisors for solutions to combat rising health care costs.

• HSAs will become more popular than ever, which means your clients and you may be a future HSA account owner, if you currently are not.

• Affordable Care Act is expected to bolster, not hamper growth of HSAs.

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Fundamentals of HSAs

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What is an HSA?

HSAs are tax-favored trust or custodial accounts designed to pay for medical expenses by eligible individuals, spouse, and tax dependents.

The owner maintains controls over the administration of the account and funds roll over year to year – never forfeited.

Similar to an Individual Retirement Account (IRA).Contribution limits are released annually by the Internal

Revenue Service by the end of May for the upcoming year.HSAs are a favorable vehicle for individuals to save for future

qualified medical and retiree health expenses on a tax-free basis.

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High Deductible Health Plan (HDHP)

For 2015, a health insurance plan that has:

1) Annual deductible of at least:$1,300 (individual coverage)$2,600 (family coverage) and

2) Annual out-of-pocket expense (including deductible, co-payments, and co-insurance) of no more than:

$ 6,450 (individual coverage)$12,900 (family coverage)



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Eligibility

An “Eligible Individual” can establish an HSA.An “Eligible Individual” means, with respect to any month, an

individual who:1) Is covered by a HDHP on the first day of such month,2) Is NOT covered by another plan which is NOT a HDHP

(see next slide about “permitted coverages”),

3) Is NOT enrolled* for benefits under Medicare, and 4) May not be claimed as a dependent on another individual’s

tax return.* Note: Mere eligibility for Medicare at age 65 does not in itself trigger ineligibility for contributing to an HSA. It is possible to contribute to HSA over age 65 if participant did not file for Social Security benefits. Medicare Part A cannot be waived if receiving Social Security benefit.

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Permitted Coverages

Other coverages allowed that do not trigger ineligibility:• Dental • Vision• Limited purpose health flexible spending account, limited purpose health-reimbursement arrangement (HRA), or post-deductible HRA (exercise care here as rules are complex)

• Employee assistance plan (referral-based only) • Accident• Disability• Long-term care• Insurance that pays a fixed amount per day of hospitalization



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Eligibility

Carefully note these observations:• Very important - HDHP must apply cost of prescription drugs to annual deductible, unless meets the definition of a “preventive care” prescription drug (i.e. cholesterol-lowering, tobacco cessation, obesity weight-loss).

• An uninsured individual may not contribute to HSA.• Cannot have dual coverage (i.e., spouse’s plan) unless both plans are HDHPs.

• Eligibility does not depend upon income (no limits) or the amount of earned income (i.e., unemployed are eligible to contribute).

• If ineligible to contribute to HSA, may still withdraw funds tax-free for qualified medical expenses.

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Establishing an HSA

Any eligible individual may establish HSA with a qualified trustee or custodian (i.e., insurance company or bank).

No permission or authorization necessary from the IRS or employer.

Trustee or custodian does not need to be the same institution as the insurer for the HDHP.

Trustee must report contributions and year-end account value on Form 5498-SA and distributions on Form 1099-SA.



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Establishing an HSA

The account is set up in the name of one individual. HSA cannot be set up in the name of two individuals (joint

account), but medical expenses of spouse and dependents can still be reimbursed from the account.

Greater than 2% S-corporation shareholders and partners in a partnership may participate in HSA, even though they cannot participate in a cafeteria plan (Section 125).

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Contribution Limits

For 2015:• Eligible individuals with SELF ONLY coverage under a HDHP may contribute up to $3,350.

• Eligible individuals with FAMILY coverage under a HDHP may contribute up to $6,650.

• Catch-up contributions can also be made to HSA if the individual is age 55 and older (for 2015, the catch-up contribution is $1,000.) If each spouse is age 55 or older, each spouse must have an individual HSA account if each want to make “catch-up” contributions. Note: Do not confuse the catch-up contribution age with the retirement plan age which is 50.



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Contributions

The maximum annual contribution amount is subject to statutory limits, which are released in May of each year.

If spouses have separate HDHP coverage and one has family coverage, both are treated as having family coverage.

If spouses have separate HDHP self-only coverage, they are treated separate for contribution deduction purposes.

An individual who ceases to be an eligible individual during a year may still contribute to his or her HSA for the months of the year in which he or she was an eligible individual.

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Contributions

Spouses with family coverage may split the contribution limits any way they wish. Typically the spouse with coverage establishes the HSA (but not required to be that way).

Tax filing status does not affect his/her contribution.

Maximum HSA contribution no longer impacted by annual deductible under the individual’s HDHP.

All HSA contributions for the eligible individual’s tax return must be made by the date for filing his/her federal income tax return (extension of time is irrelevant).



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Contributions

Contributions may be made either by the employer or the employee.

Contributions may be funded via payroll deduction (on a pre-tax basis through a cafeteria plan) or via the employee’s checking account.

HSA payroll deductions made through a cafeteria plan can change on a month-by-month basis at employee’s election (not subject to the irrevocable rule like other deductions under the plan).

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Contributions

Employer contributions that are not made “through a cafeteria plan” are subject to the comparability regulations, which mandate contributions must generally be the same for all individuals with identical coverage (i.e., $500 / $1,000 for those with single and family coverage, respectively. Penalty for failure to comply – 35% excise tax.

Employer contributions made “through a cafeteria plan” are not subject to the comparability regulations. “Through a cafeteria plan” means that the plan allows for pre-tax employee deferrals.



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Monthly Contribution Rule

An individual’s annual HSA contribution limit is based on the months of coverage during the individual’s tax year.

If HDHP coverage maintained for full year, the full catch-up contribution may be made regardless of when the 55th birthday falls during the year.

If HDHP coverage not maintained for full year, must pro-rate the “catch-up” contribution for the number of full months of eligibility.

However, covered on December 1, individual is treated as eligible for the entire year and get the full contribution.

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Monthly Contribution Rule - Example

Example – Making contributions for individual who ceases to be HSA-eligible mid-year.

Michael, age 42, has self-only HDHP coverage and is HSA-eligible for the first six months of 2015 and then drops coverage and enrolls on spouse’s non-HDHP. The statutory maximum HSA contribution is $3,350. Michael may contribute $1,675 to his HSA (6/12 x $3,350) by the due date of his tax return without extensions (which is April 18, 2016, because the Emancipation Day holiday in D.C. is observed on April 15, 2016).



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Full Contribution Rule

Special rule for mid-year enrollees – Rule allows a full year HSA contribution based on the coverage in place on December 1, even though coverage was only for a portion of the year.

To utilize, HDHP coverage must be maintained for the entirecalendar year following calendar year after first becoming eligible.

If coverage not maintained, individual suffers adverse tax consequences – subject to a 10% penalty for the excess amount deposited over the monthly contribution method rule.

Rule can only increase, not decrease, the amount that can be contributed under the monthly contribution rule.

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Full Contribution Rule - Example

Example: Full contribution rule:Jill, age 38, enrolls in family HDHP coverage on January 1, 2015, and is HSA-eligible on that date. Her coverage changes to self-only HDHP coverage on September 1, 2015, and she retains that coverage through December 31, 2015. She is eligible for all 12 months. She contributes $5,550 (8/12 x 6,650) + (4/12 x $3,350) She ceases to be an eligible individual on January 1, 2016.

Jill is an HSA eligible individual with self-only coverage on December 1, 2015. Her full contribution amount is $3,350. Since this is less, she can use the monthly contribution rule and is not required to maintain coverage until December 31, 2016.



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Spouse Contribution - Example

How does the Special Rule for Married Individuals Work? In 2015, Jim (age 58) and Linda (age 53) are married and both have family coverage. They will be able to contribute up to the maximum family limit ($6,650 for 2015). They have not made any special agreement about the division of the combined HSA limit. Thus, Jim may contribute $4,325 (1/2 of combined limit of $6,650 + $1,000 age 55 catch-up) and Linda may contribute $3,325 to her HSA.

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Tax Treatment

Account holders must file Form 8889 as an attachment to Form 1040 and report the amount of contributions to the HSA and distributions from the HSA.

Distributions are reported by custodian on Form 1099-SA.Contributions and fair market value of account is reported on

Form 5498-SA by custodian.Employers are required to report both employee and

employer HSA contributions on Form W-2 for non-shareholder employees.



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Tax Treatment

Employer contributions made to employee’s HSA account is a tax-deductible expense and excluded from employee’s income.

Greater than 2% S-corporation shareholders include employer HSA contributions in Box 1 federal taxable wages and report as deduction on Form 1040 as an “above the line deduction.” Net effect is not to pay tax on it.

Consult IRS Notice 2005-8 which discusses special rules for employer contributions to self-employed including partners in a partnership and S-corporation shareholders.

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Tax Treatment

Distributions made for non-medical reasons prior to death, disability, or attainment of age 65 are subject to ordinary income taxes on individual’s tax return, plus a 20% penalty.

At age 65, distributions can be made for non-medical reasons without penalty, but subject to income tax.



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What Are Tax Consequences After Death?

If the HSA passes to a surviving spouse, the account becomes the HSA of the surviving spouse and remains tax-exempt if exclusively used to pay qualified medical expenses.

If account passes to a person other than a surviving spouse, the HSA ceases to be a HSA as of the date of death. The fair market value of the account, reduced by payment of any decedent qualified medical expenses within 1 year after death, is included in the beneficiary’s income in year of account owner’s death.

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What are Qualified Medical Expenses?

Expenses paid for the account beneficiary, spouse, or tax dependents for medical care as defined in IRS Code Section 213(d) (including nonprescription drugs as long as they are prescribed by a physician), but only to the extent the expenses are not covered by insurance or otherwise.

Medical, dental, and vision expenses are allowable.Expenses must be incurred on or after the date the HSA was

established.Expenses paid by HSA cannot be taken as itemized

deductions or reimbursed by another source (no “double-dipping”).

Account fees paid from HSA are non-taxable distributions.



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What are Qualified Medical Expenses?

Generally, health insurance premiums are not qualified medical expenses.

HSA may pay for long-term care insurance, COBRA health care continuation coverage, and health care coverage while individual is unemployed.

For individuals over 65, premiums for Medicare Part A, B, or D, Medicare HMO, and the employee share of premiums for employer-sponsored retiree health insurance can be paid from an HSA.

Premiums for Medicare supplements are NOT qualified medical expenses.

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Who Determines if Distributions are Qualified?

The eligible individual HSA account owner makes the determination whether the expense is a “qualified medical expense” not the trustee, custodian, or employer.

Important to maintain sufficient records for distributions taken. Recommend receipts be retained with tax records for year distribution is reimbursed.

This is best audit defense to substantiate claim in the event of an IRS audit which may challenge the HSA owner’s determination.

It is very common to use a debit card for HSA distributions. Point-of-sale systems have become very sophisticated to identify nonqualified items.



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Opportunities and Benefits

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Reduce Health Care Costs

The premise behind HSAs and HDHP is to empower the consumer who can positively impact health care costs incurred.

Many employers are seeing significant cost savings from this model as health care claims tend to decrease as consumer becomes more informed.

Employers share premium savings (or reduction in claims for self-insured medical plans) with employees by “seeding” their HSA accounts, especially in initial adoption year.

Healthy employees benefit most since premium cost is reduced which frees up funds to be redirected to the HSA (which accumulate when medical expenses are reduced).



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The HSA Tax Break – Extraordinary!

Sometimes referred to as a “super-charged vehicle.” No account has this three-tiered tax savings:

• Tax-free contributions – not subject to federal or state income tax. Plus, if contributions made through a cafeteria plan they are not subject to employment taxes under FICA, FUTA, or SUTA. Contributions are never subject to forfeiture!

• Tax-free earnings – no income tax on interest OR on dividends, or realized gains/losses if funds are invested.

• Tax-free distributions – distributions are tax-free if used for qualified health care expenses for individual, spouse, and or tax-dependents.

HSAs are the tax equivalent of a “deductible Roth IRA” and there is no such thing.

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“Medical Retirement Plan Opportunity”

Guidance makes it clear - No time limit to reimburse expenses from HSA.

Distributions from HSA can be used to reimburse prior years’ expenses as long as the expenses were incurred on or after the date the HSA was initially established (Notice 2004-50 Q&A #39).

HUGE planning opportunity to accumulate funds in HSA by not reimbursing expenses (if can afford to do that).

HSA funds may be invested in mutual funds and more custodians are beginning to offer these options. Word of caution – Watch fees as they vary significantly!



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Recordkeeping Requirements

Recordkeeping becomes very important.Sufficient records must be kept to show that distributions:

• Used exclusively to reimburse for qualified medical expenses• Have not been previously reimbursed, and • Have not been taken as an itemized deduction in any prior year.

Sole responsibility lies with the HSA account holder.

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Interaction of HSA with FSA and HRA

Is it possible to contribute both to a FSA, HRA, and HSA?• Yes, an individual may participate in all three vehicles or any combination, if designed to be compatible with the HSA.

• Limit FSA to dental and vision expenses only and the HRA to post-deductible expenses.

• Tax planning suggestion:–To maximize available tax deductions (assuming already

contributing maximum to HSA), utilize the FSA for reimbursement of dental and vision expenses (up to a maximum of $2,550).

–FSAs have new $500 carryover option to reduce forfeitures.

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Administrative Complexity – What can go wrong?

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Ineligibility Triggered by Medicare – Excess Contribution

Example HSA ineligibility triggered:George, single and age 66, applies for Social Security benefits on July 1, 2015, and is automatically enrolled in Medicare Part A. He continues to maintain health coverage through employer and continues working through December 31, 2015. He contributes the full HSA contribution of $4,350 in 2015.

Problems:1) George may not make a full contribution of $4,350 in 2015. 2) He has excess contributions in his HSA and learns of this

from accountant in March 2016.



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Ineligibility Triggered by Medicare – Excess Contribution

How do we correct?• The correct contribution is 6/12 x ($3,350 + $1,000 catch-up) = $2,175. Excess contributions of $2,175 (plus pro-rata earnings) should be withdrawn on or before the due date of the tax return (including extensions). This avoids the 6% excise tax on excess contributions.

• Notes:• The 6% excise tax is cumulative and continues in future years if excess not withdrawn.

• No guidance issued about whether earnings are subject to excise tax. Instructions imply excise tax does not apply on earnings.

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Reimburse Non-Qualified Expenses

Example – Nonqualified expenses reimbursed:John has an adult son, Jeff, under age 26 on his health plan through his employer, but Jeff does not qualify as John’s tax dependent since he provides his own support. John uses his HSA to reimburse for Jeff’s medical expenses, including over-the-counter drugs.

Problems:1) Expenses for children up to age 26 who no longer qualify as

income tax dependents may not be reimbursed tax-free under HSA (this rule differs for FSAs and HRAs which do allow reimbursement), even though can remain on father’s health plan.

2) OTC drugs may not be reimbursed without Physician prescription and only reimbursable if tax dependent.



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Reimburse Non-Qualified Expenses

Correction:

HSA distributions that are made by mistake can be returned to the HSA if distribution was made “because of a mistake of fact due to reasonable cause.”

So long as the mistaken distribution is returned to the HSA no later than April 15 following the first year in which the HSA account holder knew that the distributions was a mistake, the distribution is not taxable or subject to penalty.

If not returned, the distribution is subject to income tax and a 20% penalty for nonqualified distributions.

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Failure to Set Up Cafeteria Plan (Section 125)

Example – Pre-tax payroll deduction; no cafeteria plan:ABC implements HDHP and pays 80% of the cost of self-only health insurance, with remaining 20% paid by the employee. ABC allows employees to deduct health insurance premiums and HSA elective deferrals on pre-tax basis.

Problem:Premiums and HSA contributions may not be deducted pre-tax via payroll deduction without a cafeteria plan.

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Failure to Set Up Cafeteria Plan (Section 125)

Correction:

Setup cafeteria plan as soon as possible. Employer will have exposure for required withholding and payroll taxes for time period plan was not in place.

Cafeteria plans offers tremendous value. Plan setup is inexpensive (generally less than $1,000) and provides immediate payback to employer due to FICA savings at 7.65% for all dollars through plan. Most plans have short payback as a result of FICA savings. Wipfli has set up hundreds of these plans for our clients if you need assistance.

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Catch-Up Contribution Example

Example – Two catch-ups deposited to same account:Mark and Mary, both age 60, have family coverage under a plan that Mark purchased through Healthcare.gov as a self-employed individual. Mark believes he has a joint HSA account (because medical expenses can be reimbursed for each of them). He deposits $8,650 to the account ($6,650 family coverage plus $1,000 catch-up for each of them since both are at least age 55)Problem:HSA is an individual account (no such thing as a joint HSA) and only one catch-up contribution may be deposited to an individual account. There is an excess contribution of $1,000 in the account.



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Catch-Up Contribution Example

Solution:Withdraw the excess contribution prior to due date of tax return and deposit the $1,000 to a separate account in Mary’s name.

Mark and Mary are still allowed to deduct $8,650 on the tax return (as long as Mary’s contribution is deposited on or before the unextended due date and is designated as a prior year contribution). This also avoids the 6% excise tax.

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