The "extender" bill that capped 12 years of GOP tax policy early this morning includes some important improvements in the taxation of health savings accounts.
HSAs are IRA-like savings accounts for taxpayers covered by high-deductible health insurance plans. If you meet the tax law requirements, you can make deductible contributions to the plans. Withdrawals are tax-free to the extent of your unreimbursed health costs; unused amounts accumulate tax-free for tax-free withdrawals against future expenses; they can also be withdrawn as taxable penalty-free payments at retirement.
ONE-TIME FLEX-PLAN ROLLOVER PROVISION
One strange provision allows taxpayers to roll health flexible spending account ("cafeteria plan") balances into HSAs. The rollover is available only one time, and its limited to the balance in your flex plan account as of September 21, 2006. It can be done through December 31, 2011. You have to meet several requirements:
- You have to qualify to have an HSA.
- The funds have to be rolled directly into the HSA; you can't take the funds in cash from the flex-plan and roll them into the HSA.
- The employer has to allow all employees who are covered by qualifying high-deductible plans to make the rollover.
CAP ON PLAN DEDUCTIBLE LIMITATION LIFTED
The tax law had limited HSA contributions to the lesser of an indexed annual limit or the maximum deductible under the qualifying high-deductible plan. The law repeals the second limitation starting in 2007. If you have the lowest qualifying family insurance plan deductible in 2007 - $2,200 - your maximum 2007 HSA contribution will be $5,650, instead of $2,200.
NO CONTRIBUTION REDUCTION FOR PLANS STARTED MID-YEAR
Up until now, employers who first became eligible for HSAs in mid year - say, because their employers switched to high-decuctible coverage in mid year - could only make a pro-rated HSA contribution. For example, if your employer's family coverage became HSA eligible with a $5,000 deduction on July 1, 2006, you could only contribute $2,500 to your HSA in 2006.
The new law allows you to make a full HSA contribution if you are HSA-eligible on the last day of the year. The catch: you have to stay HSA qualified for 12 months, or part of your HSA contribution gets recaptured in income with a 10% excise tax to boot.
DISCRIMINATION IN EMPLOYER CONTRIBUTIONS ALLOWED ON BEHALF OF NON-HIGHLY COMPENSATED
The HSA rules allow employers to contribute to employee HSAs. Until now the contributions had to be "compararable" for all employees. The new rules allow employers to discriminate against "highly-compensated" employees when making contributions to employee HSAs.
ONE-TIME IRA CONTRIBUTION RULE
The new rules allow taxpayers to make a one-time contribution to their HSA from an IRA, starting next year. The contribution is limited to the annual HSA contribution limit ($5,650 for 2007 for family coverage). This will be most attractive to employees who are new to HSAs; they will be able to fully fund the HSA tax-free on the first date of eligibility. As HSAs function as self-insurance reserves, this should make the transition to high-deductible plans less frightening to those used to first-dollar coverage or low co-pays.
The bill also makes some technical changes that make it easier for employees with flex plans to transition to HSAs.
Bottom line: it will be a little easier to move into HSAs, and a little less complicated to use them. That's a good thing, though small consolation for a bill full of provisions that will expire either next year or in 2011.
UPDATE II -- Full Tax Update new law coverage:
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
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