Ten Powers of HSAs

Apr 8, 2024 | AEB Insights, Employee Benefits, Strategy Design

Why Identify Ten Powers of HSAs?

  • For Employers;  Are you looking for an excellent business expense deduction?
  • For Employees: Are you interested in Pre-Tax Savings for Qualified Medical Expenses?

A Health Savings Account (HSA) may be a viable answer to your dreams.  HSAs enable employees to set aside pre-tax funds to later pay for qualified medical expenses.  The catch?  The business must provide employees with an HSA-eligible health plan — usually an HDHP (High Deductible Health Plan). By using the untaxed dollars in an HSA to pay for deductibles, copayments, coinsurance, and other expenses, your employees may be able to lower their out-of-pocket health care costs.

Per the IRS, a Health Savings Account (HSA) is a tax-advantaged trust or custodial account established with a qualified HSA trustee to pay or reimburse certain medical expenses. In other words, the HSA is designed to pay for day-to-day medical costs via HSA funds that an individual or family member may incur while remaining tax-free.

What about a Flexible Spending Account?  Isn’t that the same?

No.  There are vast differences between these two very different types of programs that can be used to pay for medical expenses.

How does an HSA differ from an FSA?

Saving to pay medical bills - HSA vs FSA HSAs and FSAs both help employees save for qualified medical expenses.

  • HSAs may offer higher contribution limits and allow employees to carry funds forward.
  • FSAs generally have lower contribution limits, and funds cannot carry over.

The main downside to an FSA for employees is the “use-it-or-lose-it rule.” If the employee fails to incur enough qualified expenses to drain his or her FSA each year, any leftover balance generally reverts to the employer.  To participate in an HSA, one must meet stringent eligibility criteria, and it’s impossible to have both.

HSA eligibility criteria

To contribute to an HSA, employees must:

  • Be enrolled in an HSA-eligible health plan, e.g., HDHP.
  • Not be enrolled in a health plan that is not an HSA-eligible plan, such as a full-purpose health care flexible spending account (FSA)
  • Not be enrolled in Medicare [3]
  • Not claimed as a dependent on someone else’s tax return [4]

The Ten Powers of HSAs follow below:

1) HSAs may offer higher contribution limits

HSAs may offer higher contribution limits, but the IRS sets the limits each year. HSA contribution limits in 2024 are $4,150 ($3,850 in 2023) for self-only coverage and $8,300 ($7,750 in 2023) for family coverage. It is not uncommon for the employer to contribute a portion of the annual contribution deducted from the limit to ascertain the available balance for the employee portion. For example, if the employer contributes $1,000, the maximum 2024 employee contribution would be $3,150 for self-only coverage or $7,300 for family coverage plans.

2) Employees may be eligible to make catch-up contributions.

Employees may be eligible to make catch-up contributions. If employees are age 55 or older, they can make additional catch-up contributions to their HSA. The catch-up contribution limit for 2024 is $1,000. This allows individuals nearing retirement to save more for future healthcare expenses. [5] For example, a 56-year-old employee enrolled in self-only coverage is first eligible to contribute $4,150 in 2024 but can contribute $5,150, including the catch-up option.

3) Post-tax contributions to an HSA made by the employee or someone other than the employer are tax deductible even if the employee doesn't itemize their deductions on Schedule A (Form 1040).

Post-tax contributions to an HSA made by the employee or someone other than the employer are tax deductible even if the employee doesn't itemize their deductions on Schedule A (Form 1040). Deposits paid directly to a health savings account (HSA) can result in an HSA tax deduction. However, contributions paid through [6] an employer are already excluded from the employee's income on their W-2. So, the HSA deduction rules don’t allow an additional deduction for those contributions. If the employee uses the health savings account (HSA) to pay their medical expenses, they do not get to itemize medical deductions for the same expenses.[6] However, if they have enough medical expenses not paid with the HSA, they may be able to claim them as an itemized deduction. Deductible expenses must be more than 7.5% of their adjusted gross income (AGI) to itemize. An HSA contribution deduction lowers their AGI, which could make it easier for you to pass the 7.5% hurdle.[7]

4) Employer contributions to an HSA (including cafeteria plan contributions) can be excluded from the employee’s gross income.

Employer contributions to an HSA (including cafeteria plan contributions) can be excluded from the employee’s gross income.[8] Generally, contributions made by an employer to the health savings account (HSA) of an eligible employee are excludable from an employee's income and are not subject to federal income tax, Social Security or Medicare taxes.[9]

5) Different Business Models and HSAs Funding Restrictions.

Different Business Models and HSAs Funding Restrictions. There are many types of small business models, from C-Corps, S-Corps and LLCs, and the IRS regulates HSAs for all. Each has a different set of HSA funding restrictions. Regardless of business type, all contributions must first comply with current IRS regulations on employer HSA contributions.

  • C-Corp business owners: As the business is considered a completely separate legal entity, the IRS views owners the same as employees. If you’re a C-corp business owner, you’re eligible for your company’s HSA, including making pre-tax contributions to an HSA account.
  • S-Corps with more than 2% business ownership, are impacted by HSA funding restrictions. Employer contributions to an S Corp HSA cannot provide owners with a tax-free contribution. Any contributions from the S Corp business to the owners’ HSAs are considered taxable income—those business owners can’t make pre-tax contributions to their HSA. But while the S Corp HSA contributions are taxable to the owners, they’re also tax deductible to the business as a compensation expense. And even after-tax HSA contributions still provide a valuable tax advantage on qualified medical expenses. For employees, those with less than a 2% ownership of an S Corp, the restrictions do not apply—meaning an S Corp business can make tax-free contributions to their employees’ HSAs as long as they’re consistent with the current IRS regulations on the employer.
  • LLCs with employees may be able to implement an HSA for the LLC to allow employees to make pre-tax contributions with enrollment in an HSA-eligible health plan. This type of LLC HSA is commonly known as a Cafeteria or 125 Plan. The LLC business owner cannot participate directly, but offering their employees this type of HSA "Cafeteria Plan" brings many benefits. A cafeteria plan is an employee benefits plan administered under Section 125 of the federal tax code [10] (hence why the plan is sometimes also referred to as a 125 plan). This type of plan allows the LLC employees to pay certain expenses with pre-tax income, and to choose the benefits they want (just like in an actual cafeteria!). Along with the LLC owner, its employees must participate in a qualified HDHP to be eligible for a tax-exempt HSA. Those employees who meet eligibility requirements for an HSA can then set aside a portion of their pre-tax income to pay for qualified medical expenses. [11] The LLC owner can also contribute to their employees’ HSAs up to the maximum annual limit set by the IRS and treat the contribution as a business expense.[11]

6) Employer contributions are deductible as a business expense to the company.

Employer contributions are deductible as a business expense to the company. The IRS sets the allowable limits for employer contributions each year. In 2024, the maximum contribution per employee is $1,000. [8]

7) An HSA is considered “portable,” meaning it follows the employee even if they change jobs or leave the workforce entirely.

An HSA is considered “portable,” meaning it follows the employee even if they change jobs or leave the workforce entirely. The HSA is a portable account—meaning that employees can keep it open even if they change jobs. Further, the pre-tax deductions may help employees qualify for other income-based tax credits, and their HSA contributions can even be invested and turned into income-producing assets.

8) Employers are not required to offer HSAs, but there are many reasons to do so.

Employers are not required to offer HSAs, but there are many reasons to do so. The size of the business (number of employees) determines overall employer healthcare requirements based on the Affordable Care Act (ACA). Small businesses with fewer than 50 full-time employees are not subject to any mandates. This means that small employers are not obligated to provide their employees with healthcare insurance. The IRS deems that a large employer is mandated to provide a specified percentage of their full-time equivalent employees and their families with minimum essential healthcare insurance. A “large employer” is defined by the IRS as any organization that employs, on average, a combination of 50 or more full-time and full-time equivalent (FTE) employees during six months or more of the previous year. Any large employer who fails to comply with the IRS mandate must pay a no-coverage penalty—$2,500 times the total number of full-time employees minus the first 30 of those employees. This no-coverage penalty is considered an excise tax and isn’t tax deductible.

Large and small employers—mandate or no mandate—should look beyond requirements and instead focus on the many benefits of offering an HSA-compatible health plan with an HSA. This is a situation where it shouldn't be considered just because it isn't required. Offering an employer-sponsored HSA to employees is a win-win for the business and its employees.

The employer benefits from:

  • lower payroll taxes (if the HSA is set up to allow pre-tax contributions),
  • positive upticks in employee satisfaction,
  • leverage points for employee recruitment and retention, and
  • lower health benefits costs.

The employees, in turn, also benefit from:

  • lower taxable income,
  • more flexibility and control of their healthcare spending, and
  • enhanced long-term savings options.

9) Employees may make tax-free withdrawals for qualified medical expenses.

Employees may make tax-free withdrawals for qualified medical expenses. HSA funds provide participants with a flexible tool to cover various medical expenses. [1] They can reimburse these expenses only to the extent that they are not covered by insurance or other coverage to include Medicare.

  • Qualified out-of-pocket medical expenses you incur before meeting the HDHP deductible
  • Medical, dental, or vision coinsurance and copayments
  • Prescription drugs and over-the-counter medications. Many purchase receipts indicate whether an item may be HSA- or FSA-eligible.
  • Some medical treatments not covered by insurance, e.g., visits to a chiropractor
  • Medical equipment, e.g., eyeglasses, crutches, or walkers.

10) HSAs can pay for non-medical expenses but with tax implications.

HSAs can pay for non-medical expenses, but with tax implications. It is advised to monitor the HSA and only use it for eligible medical expenses. However, while the funds can be used for non-medical expenses, [1] such distributions are subject to income tax. If the account holder is under age 65, the distribution is also subject to an additional 20% excise tax. Employers and AEB can work with employees to counsel them on alternatives to such distributions in the event of a hardship.