Is Your HSA Taxable?
4 min read •
30 sec brief
As healthcare costs continue to rise, health savings accounts (HSAs) have earned their place in the media spotlight. If you have a high deductible health plan, you may be grappling with large out-of-pocket bills. HSAs won’t eliminate these expenses, but they could make them cheaper (and tax-free).
As healthcare costs continue to rise, health savings accounts (HSAs) have earned their place in the media spotlight. If you have a high deductible health plan, you may be grappling with large out-of-pocket bills. HSAs won’t eliminate these expenses, but they could make them cheaper (and tax-free). By following these rules, you’ll save on healthcare through your HSA’s built-in tax benefits.
Stay within the HSA contribution limit — or pay a tax
If you’ve been contributing, you may have wondered how the IRS keeps track. Well, that’s the purpose of Form 5498-SA. Don’t worry, it’s not another task for your to-do list. Your HSA provider sends it for you.
Before you start contributing, make sure you have a high-deductible health plan. Once you check that box, you can start making deposits. The limit for 2019 is $3,500 and $7,000 for couples filing jointly. If you’re 55 or older, you can add another $1,000 every year.
Here’s where it gets tricky — if you or your employer goes over these limits, you’ll be slapped with a 6 percent tax on the excess amount. And you’ll continue being charged 6 percent every year until the extra contribution is removed. It’s possible to avoid this penalty by withdrawing the extra amount before filing your tax return. Also, you’re on the hook for any money you’ve earned on the excess contribution. Both need to be reported as taxable income.
You’ve made an HSA withdrawal. Now what?
There are good reasons why HSAs are so popular. Your money goes in pre-tax, reducing your total tax income liability. If you invest the balance, your earnings grow tax-free. Assuming you stay within your annual contribution limits, you won’t owe an extra cent in taxes. But this could change the second you make a withdrawal.
No matter what type of expense, you’ll receive Form 1099-SA at the end of the year. Your provider fills this out on your behalf and it will include your total withdrawals for the year.
You report all HSA withdrawals on Form 8889. In the eyes of the IRS, withdrawals for non-qualified medical expenses are considered income. That means you’ll owe regular income tax on it. And on top of that, you’ll have to pay a 20 percent penalty.
How to know if your medical expense is qualified
To avoid the headache of paying extra taxes and a penalty, you need to know what is considered a qualified medical expense. These types of expenses won’t cost you anything extra. The alternative is where you run into trouble.
Publication 502 tries to explain the difference, but let’s face it — it’s not always clear. That’s where Form 1099-SA comes in handy. If you see the number five in Box 3, at least one of your HSA withdrawals wasn’t for a qualified medical expense. Unfortunately, it’s also a sign you’ll owe more money at tax time. You can also see a list of all IRS approved HSA expenses here.
The best way to avoid paying taxes on your HSA
Mistakes like these may seem small, but they have the ability to snowball. Before you know it, you could chip away at an entire year’s healthcare savings. Or worse, you could pay more than you would have without the HSA. Do yourself a favor before making an HSA withdrawal — confirm it’s a qualified medical expense first. No exceptions. The same rule applies when reimbursing yourself from your HSA. Double-check every single time.
If you’re not sure, press pause on the transaction. No one expects you to be a tax expert, so there’s no shame in asking for help. A qualified tax professional can confirm exactly which expenses count — and which ones will cost you.
Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.
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