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Health Savings Accounts (HSA) – IRC Sec. 223

In section 1201 of the Medicare Prescription Drug, Improvement and Modernization Act of 2003, congress enacted a new tax-preferred program called a Health Savings Account (HSA). The reform package sunsets Medical Spending Accounts (MSA) on 12/31/03 replacing them with the much more flexible HSA. Both MSAs and HSAs use a high-deductible plan coupled with tax-deferred savings account. The HSA differs from the MSA in several ways.

  • Minimum deductible for 2006 to $1,050 an individual and $2,100 for the family.
  • Preventive care may be included without disqualifying the plan.
  • Contributions of up to 100% of the plan deductible are allowed.
  • Maximum contribution in 2006 for an single to $2,700 and for a family $5,450.
  • A catch-up contribution provision of $700 is allowed for individuals age 55 and over beginning in 2006. This may be increased by $100 per year up to $1,000 per year in 2009 and thereafter.
  • Funding Flexibility: Employer contributions are excludable from income; individual contributions are deductible “above the line”, i.e., itemization is not required in order to deduct the contribution; salary reduction payroll contributions must be made through a section 125 cafeteria plan.
  • Employer contributions are subject to a nondiscrimination rule. If an employer makes contributions for any employee, according to the MSA rule, comparable, annual contributions for all employees covered under the High Deductible Health Plan (HDHP) are required.
  • Rollovers from MSAs are allowed.
  • Funds can only be used for tax-deductible expenses as defined by IRC Sec. 213(d) as well as nonprescription drugs as described in Rev. Rul. 2003-102, 2003-38 I.R.B. 559. A 10% penalty plus ordinary income tax applies for distributions for other than tax-deductible expenses. Distributions to individuals age 65 or older are subject to ordinary income tax only.
  • A trustee must serve as repository for funds contributed to the HSA. This may be a bank or an insurance company.
  • Funds may accumulate and be invested in a tax-exempt trust account.
  • Like the MSA, an HSA is established for the benefit of the individual, is owned by the individual and is portable when changing jobs. A partner or 2% S Corp shareholder may participate in an HSA.
  • Contributions can be made in one or more payments, but the HSA participant may claim only up to the amount funded.

You may view the full text of HSA Notice 2004-2 on the Treasury Department's web site.

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