Recent COVID-19 Regulations: Information and Solutions To Help

It’s Not Too Late (Yet) to Save on 2020 Taxes with an HSA

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“[T]here’s a huge misconception surrounding these children and Health Savings Accounts. Parents can’t reimburse their non-dependent adult children’s qualified expenses tax-free from a parent’s account, even if the child is enrolled in the parent’s coverage. Recall, though, that eligibility to fund an account is determined person-by-person. Children who meet the requirements . . . can open their own Health Savings Account.”

William G. (Bill) Stuart

Director of Strategy and Compliance

April 29, 2021

For the second consecutive year, most Americans’ deadline to file federal income taxes extends beyond the traditional April 15 date. This year, it’s May 17 for residents of 47 states and June 15 for Texans, Oklahomans, and Louisianans (though some taxpayers faced penalties and interest if they didn’t file by April 15).

It’s not too late to generate some tax savings associated with Health Savings Accounts.

The Mechanics of Tax-Deductible Contributions

It’s important to understand how to contribute to your account for 2020. Most account owners make pre-tax payroll contributions through their company’s Cafeteria Plan. This is the ideal means of contributing because you avoid not only federal and state income taxes (except in California and New Jersey, the two states that include contributions in state-taxable income), but also federal payroll (FICA) taxes as well. If your income is below $142,800 in 2020, you gain an instant 7.65% return on your deposits by avoiding federal payroll taxes.

The alternative – and the only option now to fund your account for 2020 – is via personal tax-deductible contribution. You deposit personal funds into your Health Savings Account, then deduct this amount on your personal income tax return. The process is simple if you hire a tax preparer or purchase tax-preparation software. Your preparer or the software will put the right figures in the right places. If you’re old school, here’s the process:

Form 8889: You must file this form when you make contributions to or make withdrawals from your account, inherit an account, or fail to remain eligible through a testing period following certain activity. You list personal contributions on Line 2 and complete the rest of the form, then complete the remaining lines.

Schedule 1: You copy the figure on Line 13 of Form 8889 to Line 12 of Part II Schedule 1. Part II lists the value of various adjustments to income.

Form 1040, 1040-SR, or 1040-NR: Copy Line 22 from Schedule 1 into Line 10a of whichever of these forms you use.

There, it’s that simple. You don’t need to commit this information to memory. If you use tax-preparation software and you indicate that you own a Health Savings Account, the program asks you the right questions and puts the correct figures in the right places. If you or your tax preparer use pencil and paper, you merely need to remember to fill out Form 8889 and transfer the right figures to the right forms per the instructions on the relevant lines to realize your federal tax deduction for contributions outside a Cafeteria Plan. Then, follow a similar process on our state tax return (if applicable).

Think about Fully Funding Your Account

If you were eligible for all 12 months in 2020 didn’t contribute to the limit ($3,550 for self-only and $7,100 for family coverage), you can do so before you file your tax return. When you send funds to your Health Savings Account provider, be sure to note that the contribution is for 2020. The provider’s default probably is to apply 2021 deposits to the year that they’re received. Then, note the contribution on your federal and state tax returns to receive the deduction from taxable income.

If you’re expecting a refund and want to put it toward your 2020 contribution, consider borrowing money to deposit into your account, then repaying the loan promptly when you receive your refund.

Think about a Spousal Catch-up Contribution

Is your spouse age 55 or older and eligible to fund a Health Savings Account? Remember, eligibility is determined person-by-person, and it’s not limited to plan subscribers. Anyone who’s covered on an HSA-qualified plan has no disqualifying coverage, and doesn’t meet the definition of someone else’s tax dependent can open and fund an account.

If she satisfies these requirements, she can open her own Health Savings Account and deposit a catch-up contribution of up to $1,000 annually. Under current tax rules, spouses must open their own accounts, as catch-up contributions must be deposited into an account owned by the person who’s eligible to make the contribution.

Your spouse can also contribute any portion of the $7,100 family contribution limit that you two choose to assign to her. It’s generally more advantageous for the employee to make pre-tax payroll contributions through a Cafeteria Plan (thus avoiding payroll taxes), but in some cases, it may be prudent or necessary (as in the case that the employee is no longer HSA-eligible) to deposit more of or the entire family contribution into that account.

Think about Your Non-Dependent Children

Under federal law, parents can keep their children on their medical plan until the child’s 26th birthday, even if the child is no longer a tax dependent. That’s great news for students and workers just starting their working lives with companies that don’t offer employer-sponsored coverage or pay enough to make that coverage truly affordable.

But there’s a huge misconception surrounding these children and Health Savings Accounts. Parents can’t reimburse their non-dependent adult children’s qualified expenses tax-free from a parent’s account, even if the child is enrolled in the parent’s coverage. Recall, though, that eligibility to fund an account is determined person-by-person. Children who meet the requirements listed above (HSA-qualified plan, no disqualifying coverage, not a tax dependent) can open their own Health Savings Account. And anyone can fund it – including you, the parent. But the account owner – in this case, your child – receives the tax benefit.

But fund it to what level? Federal tax law doesn’t address this topic specifically. But read on to learn why it may be to the family contribution limit.

Think about Your Domestic Partner or Ex-Spouse

Adult non-dependent children aren’t the only family members whose qualified expenses can’t be reimbursed tax-free from your Health Savings Account. The same holds true for domestic partners, who aren’t recognized as family members under federal tax law. Ditto for ex-spouses. You can’t reimburse an ex-spouse’s qualified expenses tax-free from your account, even if you’re under court order to pay her out-of-pocket expenses.

Recall that eligibility is determined person-by-person, so your domestic partner or ex-spouse may be qualified to open and fund an account. If so, anyone can fund it (again, the account owner receives the tax deduction). They can then reimburse their own (and their dependents, if applicable) qualified expenses tax-free.

How much can they contribute? Again, federal tax law is silent. But at an industry meeting in 2010, an Internal Revenue Service employee, representing himself and not the agency, was asked this question. The trade group asked specifically about domestic partners. Their logic:

  1. Married couples are limited to splitting the family contribution limit between them as they wish. Their total deposits (exclusive of catch-up contributions) don’t exceed the annual ceiling. But domestic partners (as well as ex-spouses and adult children) aren’t married to anyone else covered on the family contract.
  2. The contract tier (self-only or family) determines the annual contribution limit. Both the employee (or owner of the nongroup policy) and the domestic partner are covered on a family plan.
  3. Therefore, each can contribute to the family maximum contribution.

The IRS employee, processing the logic based on his understanding of tax law, agreed with the conclusion, according to the notes of the meeting (which are available to the public). Although the group didn’t ask and the IRS employee didn’t expand the scenario beyond domestic partners, the same logic applies to ex-spouses and adult non-dependent children. In all cases, these family members aren’t married to someone else on the contract and are covered on a family plan.

A conservative attorney may tell you to split contributions as you wish without exceeding the contract limit (a total of $7,100 in 2020 among all people covered on the contract). But most compliance people and account providers lean on this documentation to suggest that each person in these scenarios can contribute to the family limit.

Think about Your Future

Estimates vary about how much money you’ll need in retirement to pay for medical, dental, and vision care, including Medicare premiums and cost-sharing. The most popular figure, Fidelity’s $295,000 for a couple retiring at age 65 in 2020, is on the low end. Other estimates place the figure as high as the low $4-00,000s. A Health Savings Account is the only long-term account to which you can contribute without paying payroll taxes and avoiding federal and state income taxation on both contributions and distributions (except for those state income taxes imposed on contributions by California and New Jersey). It’s too late for most account owners to consider reducing their retirement contributions (but not below the figure needed to capture the full employer match) and diverting the difference to a Health Savings Account, with the understanding that those funds won’t be spent before retirement.

But residents of Texas, Oklahoma, and Louisiana, with three or four pay periods remaining before their federal taxes are due June 15, do have an opportunity. Because they can adjust their contributions prospectively to a qualified retirement plan, they may want to reduce those payroll deductions, increase their take-home pay, and contribute that additional realized income to a Health Savings Account as a 2020 contribution.

What We’re Reading

Many Americans aren’t familiar with the term family glitch. It’s a feature of the Affordable Act that determines whether an employee’s company’s insurance is affordable (and therefore the employee doesn’t qualify for premium subsidies through a federal- or state-facilitate marketplace). Coverage is affordable if the individual plan payroll deduction is no more than 9.83% of the employee’s income, even if she needs family coverage. This article highlights how this formula harms families.

John Goodman, an industry thought leader whose articles appear frequently in this section, critiques a proposal to open Medicare to Americans age 50 to 64. He raises important questions about how the program will be financed.

What happens to your Health Savings Account when you pass away? In this article, I stress that you have the power to make that decision. But if you don’t, your state of residence will. And its decisions may be very different from your wishes. You can learn more in this Benefit Strategies document located in our Health Savings Account library. (Other topics include Health Savings Accounts and Medicare, Health FSAs, HRAs, contribution limits for partial-year eligibility, certain family situations, certain business structures, and other relevant topics.)

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