Guest Article

(From the August 11, 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 III

The IRS recently issued Notice 2008-59 and proposed regulations to address a variety of open questions about health savings accounts, or "HSAs." This is the third in a series of articles on aspects of the guidance which are of particular interest to employers. The focus of this article is on permitting HSA account owners to access their funds with debit cards that permit payments only for health care.

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 HSA 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.

HSA trustees or custodians may not limit an account holder's ability to use HSA assets to pay expenses other than qualified medical expenses. An individual may use his or her HSA for any purpose as long as he or she is willing to accept the tax consequences discussed above.

Debit Cards and HSAs

Employers increasingly use debit cards with their health flexible spending arrangements (FSAs) and health reimbursement arrangements (HRAs) so participants can gain easy, immediate access to their account balances when needed to pay medical expenses. However, in order to avoid administratively cumbersome substantiation procedures, these debit cards generally must be set up so that they can be used only to pay medical expenses and nothing else.

Employers who incorporate HSAs into their health plans might want to allow employees to use debit cards to access their HSAs for the same reasons. And even though HSAs are not subject to the same substantiation rules as health FSAs and HRAs, there are valid reasons why employers also might want to restrict the use of these debit cards to paying qualified medical expenses. One is consistency, especially if those same employees have access to HSA-compatible health FSAs or HRAs. Another is discouraging employees from using their HSAs for non-medical expenses so the funds will be available when medical expenses arise.

The problem though, as indicated above, is that neither HSA trustees nor employers can place limits on how individual account holders use their HSAs. Thus, the question that has come up is whether an HSA debit card can restrict payments and reimbursements to qualified medical expenses. The answer, according to Notice 2008-59, Q/A-27, is "yes," but only if the funds in the HSA are "otherwise readily available." What this means, according to the notice, is that "in addition to the restricted debit card, the HSA account beneficiary must also be able to access the funds other than by purchasing health care with the debit card, such as through online transfers, withdrawals from automatic teller machines or check writing." Additionally, the notice admonishes, "Employers must notify employees that other access to the funds is available."

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.