Guest Article

(From the July 21, 2008 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS Issues New Guidance on HSAs -- Part I

The IRS recently issued Notice 2008-59 and proposed regulations to address a variety of open questions about health savings accounts, or "HSAs." Depending on the outcome of the November election this could be the last comprehensive HSA-related guidance for some time. No doubt mindful of that possibility, it appears IRS is trying to tie up as many loose ends as possible during the Bush Administration's final year.

The proposed regulations feature long-awaited guidance on a special exception to the comparable contribution rule permitting employers to contribute more to the HSAs of non-highly compensated employees than to those of highly compensated employees (HCE's). Notice 2008-59 is a collection of 42 miscellaneous questions and answers organized under the following seven topics:

This article -- the first in a series on Notice 2008-59 and the proposed regulations -- will focus on guidance from the Notice 2008-59 "Contributions" section that is of particular interest to employers.

Background on HSAs

Contributions to HSAs by or on behalf of "eligible individuals" are entitled to favorable tax treatment, subject to certain limits. Specifically, eligible individuals can take an above-the-line deduction for HAS contributions, and employer contributions to HSAs are not included in the eligible individual's taxable income. See IRC §§ 106(d) and 223(a). Also, HSA distributions generally are not taxed if they are used to pay "qualified medical expenses." Distributions used for other purposes are subject to income tax and, if the account holder is not yet Medicare eligible, a 10 percent penalty tax.

An "eligible individual" is someone who is covered by a "high-deductible health plan" (HDHP) and no other health insurance that is not an HDHP. An HDHP generally is a health plan with a deductible of at least $1,100 for single coverage and $2,200 for family coverage, and which limits out-of-pocket expenses to $5,600 and $11,200, respectively. (These parameters are subject to annual inflation adjustment.) Except for preventive care services, HDHPs may not provide benefits below the minimum deductible amounts.

Employers do not have to contribute to employees' HSAs, but if they do they must make "comparable contributions" to the HSAs of all "comparable participating employees." Employer contributions are comparable if they are the same dollar amount or the same percentage of the annual deductible under the employees' HDHPs. The term "comparable participating employees" generally refers to employees who are eligible individuals covered by the employer's HDHP and who have the same category of coverage (i.e., self-only or family coverage). However, if an employer contributes to the HSAs of any employees covered by other HDHPs (i.e., HDHPs not offered through the employer), then "comparable participating employees" includes all employees who are eligible individuals.

The comparable contribution requirements apply separately to part-time and full-time employees. A part-time employee is any employee who is customarily employed for less than 30 hours a week. Also, as noted, employers can make larger contributions to the HSAs of rank-and-file employees than to the HSAs of HCEs. Furthermore, Treasury regulations exempt certain collectively bargained employees from the comparable contribution rules.

The comparable contribution requirement is tested on a calendar year basis. A 35 percent excise tax is imposed on any employer who fails to make comparable contributions to employees' HSAs during a calendar year. The 35 percent excise tax applies to the employer's aggregate contributions to its employees' HSAs during the calendar year.

The maximum annual contribution to an eligible individual's HSA, from all sources, is $2,900 for single coverage and $5,800 for family coverage. These annual contribution limits are adjusted each year for inflation.

Tax Treatment of Employer Contributions to HSAs of Employees' Spouses

As noted, employer contributions to employees' HSAs generally are not included in the employees' gross incomes or treated as wages for employment tax purposes. But what if an employer contributes to the HSAs of employees' spouses? Notice 2008-59 (Q/A-26) confirms that these contributions must be included in the employees' gross income and wages, unless the spouse also is the employer's employee. This is true even if the employer's contributions are made to the spouse's HSA pursuant to the employee's IRC § 125 salary reduction election.

Recovering Employer Contributions to Employees' HSAs

When an employer contributes to its employees' HSAs, the employer generally may not recoup those contributions. For example, employers who contribute to employees' HSAs at the beginning of the year may not recover any of those contributions from the HSAs of employees who change jobs in the middle of the year. However, Notice 2008-59 provides two limited exceptions to this general rule.

The first exception applies if the employer contributes to the HSA of an employee who was never an eligible individual. In this case, the employee's "HSA" was not an HSA because the employee never was eligible to fund it. The employer can ask the financial institution to refund its contributions, but it must do so before the end of the taxable year. Otherwise, the employer's contributions to the employee's account must be treated as gross income and wages to the employee on his or her Form W-2 for the year in which the employer made the contributions. The Notice (Q/A-23) illustrates this rule with the following examples:

The second exception is available for situations where the employer contributes more than the IRC § 223(b) maximum annual contribution limit to the employee's HSA due to an error. Again, the employer can ask the financial institution to return the excess amounts, or simply include those amounts as gross income and wages on the employee's Form W-2 for the year in which the contributions were made. (Q/A-24).

Allocating Employer Contributions to Prior Year

The general rule is that eligible individuals may contribute to an HSA for a year until the deadline for filing their tax return for that year, without extensions (i.e., April 15 for most taxpayers). Notice 2008-59 clarifies that any employer contributions to an employee's HSA during the period from January 1 through April 15 can be allocated to the previous year. The employer must notify the HSA trustee or custodian and the employee that contributions are being allocated to the previous year. However, any contributions so allocated still must be reported on the employee's Form W-2 for the year the contributions are actually made. The Notice (Q/A-21) illustrates this rule with the following example.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2008, Deloitte.