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Guest Article
(From the January 5, 2004 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)
The Treasury Department and IRS on December 22 issued initial guidance on the new Health Savings Accounts, or "HSAs." The complete text of Notice 2004-2 is available on the IRS's Web site, at http://www.irs.gov/pub/irs-drop/n-04-2.pdf.
The notice provides basic information about HSAs and the Treasury Department's position on several key issues, such as whether employer contributions to HSAs are subject to FICA taxes. But it defers to future guidance more complicated issues, including coordinating "highdeductible health plans" (HDHPs) with HRAs, Health FSAs, and other insurance. A second round of guidance that addresses these and other issues may be available early next summer.
A summary of Notice 2004-2 follows. The summary is subdivided into the same 5 sections used in the notice.
I. What Are HSAs and Who Can Have Them?
This section addresses basic questions about "eligible individuals," HDHPs, and the other types of health coverage an eligible individual can maintain. It basically summarizes the requirements codified at the new IRC section 223, but also clarifies some issues the statute leaves ambiguous. For example, the notice (Q/A 7) clarifies an employer's self-insured medical reimbursement plan can be an HDHP if it satisfies the applicable requirements (e.g., the minimum annual deductible and maximum out-of-pocket expense requirements).
With respect to family coverage, Notice 2004-2 (Q/A 3) explains a plan is not an HDHP if it can begin making payments before the family incurs annual covered medical expenses in excess of the minimum annual deductible, or $2,000 in 2004. Thus, an HDHP cannot have embedded deductibles for each covered family member unless the embedded deductibles exceed the minimum annual deductible. The notice illustrates this rule with the following examples.
Example (1): A Plan provides coverage for A and his family. The Plan provides for the payment of covered medical expenses of any member of A's family if the member has incurred covered medical expenses during the year in excess of $1,000 even if the family has not incurred covered medical expenses in excess of $2,000. If A incurred covered medical expenses of $1,500 in a year, the Plan would pay $500. Thus, benefits are potentially available under the Plan even if the family's covered medical expenses do not exceed $2,000. Because the Plan provides family coverage with an annual deductible of less than $2,000, the Plan is not an HDHP. |
II. How Can an HSA Be Established?
Among other things, this section confirms that, beginning January 1, 2004, any eligible individual can establish an HSA with a qualified HSA trustee or custodian. (The HSA does not have to be opened at the same institution that provides the HDHP. Q/A 10.) An eligible individual's employer may be involved in establishing an HSA, but there is no requirement for employer involvement. Also, an eligible individual does not need the IRS's authorization or permission to establish an HSA. Q/A 8.
In addition to insurance companies and banks, which are specifically authorized by the statute, the notice states any other person the IRS has approved to be a trustee or custodian of IRAs or Archer MSAs is automatically approved to be an HSA trustee or custodian. Others can use the procedures outlined in Treas. Reg. Sec. 1.408-2(e) (relating to IRA nonbank trustees) to request approval to be HSA trustees or custodians. Q/A 9.
III. Contributions to HSAs
The Medicare Prescription Drug, Improvement and Modernization (MPDIM) Act (P.L. 108-173) does not amend IRC section 3121(a) (relating to the definition of "wages" for FICA tax purposes) to create a specific exclusion for employer contributions to HSAs. However, Notice 2004-2 clarifies employer contributions to HSAs (including employee contributions to HSAs through IRC section 125 cafeteria plans) are not subject to FICA. Q/A 19. (The MPDIM does amend IRC sections 3306(b) and 3401(a) to create specific exclusions from FUTA and the income tax withholding requirement s, respectively, for such contributions.) This section also provides guidance on computing the aggregate maximum annual contribution limit in certain circumstances. In general, the maximum annual contribution limit is the sum of the individual's monthly limits, based on status, eligibility and health plan coverage as of the first day of the month. (There is no earned income requirement for contributions to HSAs.) The monthly contribution limit is 1/12 of the lesser of the HDHP's annual deductible or $2,600 ($5,150 in the case of family coverage). The aggregate maximum annual contribution limit is reduced by contributions to an Archer MSA. Q/A 12.
Like the maximum annual contribution limit, the catch-up contribution limit for eligible individuals between ages 55 and 65 is computed monthly. The notice (Q/A 14) illustrates this with the following example.
Example: An individual attains age 65 and becomes eligible for Medicare benefits in July, 2004 and had been participating in self-only coverage under an HDHP with an annual deductible of $1,000. The individual is no longer eligible to make HSA contributions (including catch-up contributions) after June, 2004. The monthly contribution limit is $125 ($1,000/12 + $500/12 for the catch-up contribution). The individual may make contributions for January through June totaling $750 (6 x $125), but may not make any contributions for July through December, 2004. |
Example (1): H and W are married. H is 58 and W is 53. H and W both have family coverage under separate HDHPs. H has a $3,000 deductible under his HDHP and W has a $2,000 deductible under her HDHP. H and W are treated as covered under the plan with the $2,000 deductible. H can contribute $1,500 to an HSA (1/2 the deductible of $2,000 + $500 catch-up contribution) and W can contribute $1,000 to an HSA (unless they agree to a different division). |
IV. Distributions from HSAs
The big news from this section is that neither employers who contribute to HSAs nor HSA trustees or custodians are responsible for verifying how account beneficiaries use the proceeds from HSA distributions. Q/A 29 and 30. This is significant because HSA distributions used to pay "qualified medical expenses" are not taxable income to the account beneficiary, even if the account beneficiary is no longer an eligible individual. Q/A 28. But HSA distributions used for any other purpose are taxable income to the account beneficiary, and may be subject to a 10 percent excise tax. According to the notice (Q/A 29), account beneficiaries are responsible for maintaining sufficient records of their medical expenses to show HSA distributions are not taxable.
(In a separate section, the notice (Q/A 37) states eligible individuals may use debit, credit, or stored-value cards to receive HSA distributions for qualified medical expenses. The notice does not specifically address whether, or to what extent, Revenue Ruling 2003-43, which outlines the rules for using debit, credit, or stored-value cards with HRAs and Health FSAs, applies to HSAs. But in keeping with the rule that employers and HSA trustees and custodians are not responsible for adjudicating HSA claims, that revenue ruling's substantiation procedures for HRAs and Health FSAs presumably do not apply to HSAs.)
The section (Q/A 30 and 31) reiterates qualified medical expenses are expenses the account beneficiary, his spouse, or dependents, pay for medical care as defined in IRC section 213(d), subject to special rules for health insurance premiums. The notice clarifies that nonprescription drugs can be qualified medical expenses. (The IRS issued Revenue Ruling 2003-102 earlier this year to clarify Health FSAs and HRAs can pay for nonprescription drugs.) Any expenses covered by insurance or incurred before the HSA exists are not qualified medical expenses.
V. Other Matters
Among other things, this section (Q/A 32) addresses some basic issues regarding applying the special nondiscrimination rule to employer contributions to HSAs. In general, if employers make HSA contributions they must make available comparable contributions on behalf of all "comparable participating employees" during the same period. According to the notice, "Contributions are considered comparable if they are either the same amount or same percentage of the deductible under the HDHP."
The notice clarifies that the comparability rule does not apply to contributions made through an IRC section 125 cafeteria plan. Additionally, the rule is applied separately to part-time employees, defined as employees customarily employed for fewer than 30 hours per week. If an employer's contributions for a period fail the comparability rule, the employer is subject to a 35 percent excise tax on the employer's aggregate HSA contributions for that period.
Also, the notice clarifies HSAs are not subject to COBRA continuation coverage under IRC section 4980B (Q/A 35), or the IRC section 419 limits on employer contributions to funded welfare benefit plans (Q/A 36). (The Department of Labor has not yet indicated whether HSAs are subject to the COBRA continuation coverage requirements at ERISA sections 601 through 608, but it likely will follow the Treasury Department's lead on this issue.)
Finally, the notice (Q/A 34) reiterates that employer contributions to HSAs must be reported on employees' Forms W-2. Furthermore, IRS will release forms and instructions on how to report HSA contributions, deductions, and distributions. (These forms and instructions will be similar to those required for Archer MSAs.)
IRS Seeking Comments
The IRS and Treasury Department are seeking comments on the guidance provided in Notice 2004-2, as well as on other issues for which guidance is needed. Regulators are particularly interested in comments on the following:
Please contact your Deloitte advisor if you have any questions or need additional information.
Thompson Publishing Group will be offering an HSA follow up presentation with Steven Kraus, Martha Priddy Patterson, and others from Deloitte in mid-February. That session will include discussion of Notice 2004-2. We will keep you posted on details for the Thompson conference.
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 questions or need additional information about this article, please contact Martha Priddy Patterson (202.879.5634) or Robert B. Davis (202.879.3094). Copyright 2003, Deloitte. |
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