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HSA QUALIFICATION ALLOWED DESPITE STATE LAWS AGAINST QUALIFYING HIGH-DEDUCTIBLE INSURANCE

June 22, 2004

Taxpayers wanting to set up Health Savings Accounts have faced a roadblock in some states. The tax law requires taxpayers to have high-deductible health insurance to qualify for an HSA. Such high-deductible plans are illegal in some states (we believe this is true in New York, for instance).

The IRS yesterday announced (Notice 2004-43) that it will allow taxpayers to set up and fund HSAs until 2006 even if state laws prevent them from purchasing qualifying health insurance:

   Several states currently require that health 
   plans provide certain benefits without regard
   to a deductible or with a deductible below 
   the minimum annual deductible requirements
   of section 223(c)(2) (e.g., first-dollar coverage
   or coverage with a low deductible). These 
   health plans are not HDHPs under section 
   223(c)(2) and individuals covered under these
   health plans are not eligible to contribute to 
   HSAs. Because of the short period between
   the enactment of HSAs and the effective 
   date of section 223, these states have had 
   insufficient time to modify their laws to 
   conform to the standards of section 223. 
   Thus, it is appropriate to provide transition 
   relief that treats HDHPs as qualifying under 
   section 223(c)(2) when the sole reason the 
   plans are not HDHPs is because of 
   state-mandated benefits. During the 
   transition period, otherwise eligible individuals 
   covered under these plans will be treated 
   as eligible individuals for purposes of section 
   223(c)(1) and may contribute to an HSA.

IS THIS PART OF A TREND?

This is the second waiver of the high-deductible health plan requirements (see Notice 2004-25), and it may not be the last one. Now that the IRS has set a precedent of waiving the HDHP rules, it may find it hard to resist another waiver when the current one runs out in 2006.

Various state rules require coverage with lower deductibles for certain conditions. For example, Kansas until recently required that mental and nervous conditions be covered for 100 percent of the first $100 of expenses, 80 percent of the next $100, and 50 percent of the next $1,640. Such provisions were enacted because they had a political constituency. To avoid confronting interest groups, legislators are likely to instead pressure Treasury to extend the Notice 2004-43 waiver. The slogans are easy to imagine: "The IRS wants to take our high-risk mentally ill off their medications!"

While such requirements are well meaning, they limit consumer choice and probably raise the cost of insurance. We hope that the Treasury hasn't inadvertently undercut the expansion of high-deductible health insurance options with this waiver.

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