Tax Tips for Health Savings Account Holders

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This year, the first generation of Health Savings Account holders will file a full-year tax return, and they should consider both the tax benefits and implications of this new savings vehicle.

An HSA, like an Individual Retirement Account (IRA), is a tax-advantaged savings tool, but unlike an IRA, it also is a spending tool

This year, the first generation of Health Savings Account holders will file a full-year tax return, and they should consider both the tax benefits and implications of this new savings vehicle.

According to PFPC, a leading provider of customer account servicing and recordkeeping for HSAs , the number of questions from account holders is expected to increase as the April tax deadline approaches. “Managing the tax aspect of owning a Health Savings Account is easy once you understand what’s expected by the IRS and use a tool, like a debit card, to keep a record of all transactions,” says James S. Gandolfo, senior director and vice president at PFPC .

“An HSA, like an Individual Retirement Account (IRA), is a tax-advantaged savings tool, but unlike an IRA, it also is a spending tool,” says Jennifer Immel, J.D., LL.M., a wealth planner with PNC. “To get the most from the tax benefit, it is important to make the maximum permissible contribution and, when and if you spend, make sure it is on qualified medical expenses. Keep track of all your records.”

The IRS suggests considering the following to maximize contributions before filing an income tax return:

  • If you held a qualifying high deductible health plan in 2005, you still have time to maximize contributions to your Health Savings Account for last year. Account holders can make a contribution for the previous year--based on the month that they first owned a High Deductible Health Plan --through the federal tax deadline of the current year, which this year is April 17.
  • However, if you make a contribution between January 1 and April 17, it’s important to note the year for which the contribution is designated. If you don’t specify that the contribution was for 2005, it likely will be treated as though it were a 2006 contribution, and you may be capped this year on what you can contribute.
  • Contributions are tax-deductible on your federal tax return. Some states don’t recognize contributions to an HSA as deductible, so check your state laws or consult your tax advisor.
  • Reasons to contribute to an HSA :
  • HSA voluntary contributions are tax-deductible.
  • Interest and investment growth, including dividends earned in the account is tax-free.
  • Tax-free withdrawals may be made for qualified medical expenses.
  • Unused funds and interest are carried over, without limit, from year to year.
  • An HSA can be retained even if you change plans, jobs or retire.

In return for these tax-advantages, consumers must keep the paperwork supporting their HSA transactions. Tax-free withdrawals are for qualified medical expenses only, and the IRS defines what a qualified medical expense is and what is not. For the complete list of IRS-allowable expenses, please request a copy of IRS Publication 502, call 1-800-829-3676, or visit the IRS website at http://www.irs.gov and click on "Forms and Publications."

Reporting requirements: You will need to complete IRS form 8889 with your income tax return, regardless of whether you itemize. This form communicates to the IRS your total withdrawals and deposits to and from your account during the year.

Any documentation of contributions, withdrawals and purchases should also be kept. Keep copies of receipts, canceled checks or credit card statements for every qualified medical expense. “An HSA that offers a debit card can simplify recordkeeping,” said Gandolfo. “There will be an electronic record of all debit card transactions, which should simplify tax time for you and your accountant.”

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Susan Austin
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