Do HSA distributions count as taxable income for tax purposes?
Health savings accounts (HSAs) are designed to allow individuals with high-deductible health plans (HDHPs) to save money tax-free for medical expenses.
Distributions from HSAs used for qualified medical expenses are not counted as taxable income, making them a tax-efficient way to cover healthcare costs.
To categorize a distribution as a "qualified medical expense," it must align with IRS guidelines, which generally cover costs like doctor's visits, surgeries, and prescriptions.
If an HSA distribution is used for a nonqualified expense, it will be taxed as ordinary income, in addition to potentially being subject to a 20% penalty if the account holder is under age 65.
Upon receiving an HSA distribution, individuals must report it on IRS Form 8889, which is then attached to their tax return.
It is essential that individuals check their IRS Form 1099-SA, as it reports distributions and helps in ensuring only proper expenses are used to avoid unnecessary taxes.
HSA contributions are made pre-tax, which means they reduce the contributor's taxable income in the year they are made, providing an immediate tax benefit.
The contribution limits for HSAs can change from year to year, with the 2023 limit for individuals being $3,850 while families can contribute up to $7,750.
Accumulated earnings within an HSA grow tax-free, meaning any investment gains within the account are not taxed as long as they remain within the HSA.
HSAs are portable accounts.
This means that they stay with the individual even when they change jobs or health insurance plans.
Unlike flexible spending accounts (FSAs), HSAs do not have a "use-it-or-lose-it" rule; funds can roll over from year to year, allowing for long-term savings.
Qualified medical expenses include not just immediate health needs but also expenses such as acupuncture, chiropractic care, and some alternative therapies can qualify.
Some individuals may also use HSAs as a retirement savings vehicle, as funds can be used for non-medical expenses after age 65 without penalty; however, they will be taxed as ordinary income.
If a distribution was made and not used for qualified expenses, the IRS requires proper documentation to avoid additional tax liabilities.
Some states may differ in the treatment of HSA distributions, where certain states might consider these distributions taxable income, even if they were used for medical expenses.
Medical expenses qualifying for HSA use can even include portions of premium costs in specific circumstances, such as COBRA or long-term care insurance.
When planning for retirement, individuals often underestimate the importance of HSA funds, which can cover future medical expenses without tax penalties.
An additional tax benefit of HSAs is their triple tax advantage: contributions are tax-deductible, growth is tax-free, and qualified distributions are tax-free.
Contributions can be made even if distributions have occurred during the year, allowing individuals to maximize tax advantages by contributing until the tax filing deadline.
As of 2023, taxpayers can still opt to make past year contributions to their HSAs until the tax filing deadline, providing an additional time frame to boost savings for medical expenses.