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TREASURY DEFENDS ABILITY TO ENFORCE HEALTH SAVINGS ACCOUNT RULES

May 31, 2004

The Treasury responded last week to a statement implying that the IRS would be unable to police withdrawals from HSAs. Kevin Knopf, Benefits Tax Counsel for the Treasury Department, told a luncheon audience the requirement that HSA withdrawals be spent on medical expenses to qualify for tax-free treatement would be difficult to enforce.

In response, Treasury Assistant Secretary for Tax Policy Greg Jenner issued a statement saying that the HSA rules would be no more an enforcement problem than other tax breaks. Tax Analysts reports:

   Jenner insisted that the IRS is more than capable 
   of regulating the accounts. "HSA custodians will
   be required to submit forms to the IRS showing 
   the amount of distributions from the HSA 
   account during the year, and HSA account 
   holders will be required to report the use to 
   which those distributed amounts were put," 
   Jenner said. "As with other deductions taken 
   on their tax returns, individuals will do their best
   to fill out their forms and comply with the tax 
   laws, maintaining adequate records to enable 
   them to substantiate the claimed tax benefits." 

No links are available to the Jenner statement or the Tax Analysts article.

UPDATE: MORE THOUGHTS ON HSA ENFORCEMENT
The reporting requirements will probably be similar to those shown on Form 8853. This form computes the tax-free distributions from MSAs, which are treated much like HSA distributions. As you can see from line 9 of the form, they don't ask for a lot of detail.

Will enforcement be a big problem? It may not, as a practical matter. The requirement for the use of high-deductible plans will cause most MSA holders to have a lot of qualifying medical expenses. Most HSA users will probably try to accumulate funds in the HSA to take advantage of their tax-free income buildup. While they accumulate HSA funds, they are likely to also accumulate qualifying expenses, which apparently will be available to allow tax free distributions in years after they are incurred.

The real enforcement challenge will be those who use HSAs to have their cake and eat it too. Such taxpayers will use their MSA as a pain-free deduction by putting the cash in and taking it out without regard to their actual medical costs. In the long run this is poor planning because it wastes the tax-free accumulation feature of HSAs. Of course, if every taxpayer took a long-run view of things, there would be a lot less work for the Tax Court.

Plain old fraudulent HSAs might also be a problem. Some taxpayers may claim HSA deductions without a qualifying high-deductible health plan. A W-2 disclosure of whether or not the employee has a qualifying plan would go far to limit this ploy, but it wouldn't eliminate it.

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