Category Archives: HSA Benefits

Spending HSA Funds on Step Children

Overview

You have HSA eligible coverage and opened a Health Savings Account, diligently making contributions throughout the year. You now have a nice nest egg to protect yourself from routine care, medical surprises, and emergencies. However, on whom you can spend your HSA funds can be confusing. We have previously discussed who can use your HSA funds but the issue of step children, or children of separated parents, is a special case. Sometimes, taxes and step children can be a tricky situation. In this article, we will discuss that step children can be the beneficiaries of your HSA funds.

The IRS Chimes In

The IRS generally lists 4 categories of people on whom you can spend your HSA contributions:

You
Your spouse
Your dependents
Anyone you could claim as a dependent

You will notice that step children are not mentioned in the common recipients here. But if you dig a little deeper into the IRS materials you will find a surprising answer. In a rare moment of foresight, the IRS directly addresses the case of step children issue in a follow up discussion of this rule. This appears in Form 969:

HSA-spend-on-spouse-children-step-children

The IRS states that if the parents have been divorced or separated or living apart for the last 6 months of the calendar year, the child is considered a dependent for both parents. That child then falls into point 3 in the above list of HSA eligible expenses, so you can spend your HSA on them.

A child of parents that are divorced, separated, or living apart for the past 6 months of the calendar year is treated as the dependent of both parents.

However, it isn’t clear if this “6 months” applies only to the 3rd case (living apart) or all three cases (divorced and separated). All hail the Oxford comma! Why the IRS includes this confusing 6 months of calendar year test is beyond me, perhaps it is used as some basis to confirm the parents are actually living apart for good. So what if the parents separated in January-June versus later in the year, say September? Does the 6 months of a calendar year (July-December) have to be satisfied before the child is treated as a dependent? That just seems weird to me.

HSA’s and Step Children

My interpretation (which has not been confirmed) is that the 6 months applies only to parents living apart. Thus, if you are divorced or separated, your HSA funds can be applied to your step children, regardless of who has custody of the children. Also note that this applies to your spouse’s children i.e. your stepchildren.

Let’s assume a situation where a mother and father with 1 child separate and remarry; here are some examples of who can spend HSA funds:

Mother spends HSA on child
Stepfather spends HSA on child (technically their stepchild)
Father spends HSA on child
Stepmother spends HSA on child (technically their stepchild)

In addition, if the mother and father remarry and their respective spouse has children, they now have stepchildren of their own and can spend their HSA on them:

Mother spends HSA on their stepchild
Father spends HSA on their stepchild

In sum, the HSA is flexible enough to allow for spending funds on stepchildren, if you can make your way past the IRS wording.

Note: If you need help preparing your HSA tax form 8889, please consider my service EasyForm8889.com. It asks you simple questions and fills out Form 8889 correctly for you in about 10 minutes.

Paying for Unemployed Spouse’s Premium Using HSA

This question was submitted by HSA Edge reader Dave. Feel free to send in your question today to evan@hsaedge.com.

My spouse became unemployed and we want to use our HSA to pay our premium under IRS rules. However, we have a family plan with both of us on it. Can I use the funds to pay the entire premium or do I need to prorate it to her portion for payment tax free from the HSA?

Using HSA for Insurance Premiums

Sorry to hear that your spouse is in this situation. Using HSA funds to pay for insurance premiums is a great benefit of HSA’s and one way they provide an unemployment safety net.

First off, make sure that your spouse is receiving unemployment compensation from the state or federal government. This means signing up for unemployment benefits and being receiving actual money from a government entity. Do this as soon as possible. Why? Besides receiving funds that will help you during this time, this step is required to treat premiums as qualified medical expenses. Moreover, it is the sole justification in the event anyone at the IRS asks why your premiums were treated as such.

Your HSA can pay for health care coverage while receiving unemployment compensation under federal or state law.

You will need this evidence for each month you treat the premium as a qualified medical expense, and hence, pay for it with your HSA.

Considerations for Family Coverage

Now that you have met the prerequisites, you can pay for your health insurance using your HSA. This has two main benefits:

Cash flow – you use previously saved funds for current expenses
Tax deduction – you use tax free funds for the insurance premiums

As for the amount of the premium, can see the IRS guidance from Form 969 below. It is admittedly vague on this topic but I don’t see any reason you need to prorate the insurance premium only for your spouse.

HSA-unemployment-insurance-premiums-for-spouse

In fact, the spouse case is called out in the highlighted area. if the intent was to split the premium they would have said so explicitly there. Instead, there is no mention of prorating any premium amount, and instead the rules state that “if conditions are met, you may pay for the premium”. Without any mention of prorating, I don’t see it as required. Going a step further, requiring the premium be prorated would be messy and dilute the benefit significantly. For example, consider the case of family coverage with 2 dependents: would only 25% of the premium be HSA eligible?

Based on the above, my take is that if anyone on the family coverage is receiving unemployment benefits, the entire premium can be paid with the HSA.

Note: I created TrackHSA.com to track medical expenses you pay using Health Savings Account, even insurance premiums. It provides record keeping to store purchases, upload receipts, and record reimbursements securely online.

Reduce Social Security and Medicare Taxes with an HSA

We all know that one of the reasons people open Health Savings Accounts is the triple tax advantage, which, simply stated, means:

HSA contributions are tax free
HSA earnings grow tax free
HSA distributions for qualified medical expenses are tax free

However, there is a hidden fourth tax advantage to HSA’s that is not widely known, and can save you money. The fact is that HSA contributions can be payroll tax deductible as well. In the term “payroll tax” I lump the various taxes often described as FICA taxes which include Social Security, Medicare, and Unemployment Insurance. This is on top of the exclusion to income tax as shown in #1 above.

How to avoid Social Security and Medicare taxes an with HSA

There are various ways to contribute to an HSA which include:

Post-tax contributions
Pre-tax contributions
Employer Contributions
Qualified Funding Distribution (from IRA)

The main method people use to contribute to their HSA is #1 above, via post-tax HSA contributions. This involves depositing money into your HSA from your bank account using dollars you previously paid taxes on. Unfortunately, since those dollars likely came from an employer you would have already paid income, social security, and Medicare taxes. The income tax will be “returned” to you when you file Form 8889, but the Social Security and Medicare taxes are gone and cannot be credited back. In this way, you cannot avoid Social Security or Medicare taxes with a post-tax contribution.

The good news is you can avoid paying Social Security and Medicare taxes using pre-tax contributions. Pre-tax contributions are contributions withheld from your paycheck by your employer and deposited into your HSA for you. This often takes the form of a Cafeteria Plan, which is an automated contribution plan on behalf of the employee. This is an important distinction, because per IRS Form 15, only pre-tax contributions using a cafeteria plan can avoid Social Security and Medicare taxes:

However, HSA contributions made under a salary reduction arrangement in a section 125 cafeteria plan aren’t wages and aren’t subject to employment taxes or (Social Security, Medicare) withholding.

They distinguish that from a “payroll deduction plan” which, while undefined, is likely looser and does not meet the same requirements as a section 125 deduction. The result is you have to be using a section 125 cafeteria plan to make a pre-tax contribution that avoids these additional taxes. Your employer will have more information about this but is likely using this vehicle since it is most advantageous for both the employee and the employer. Contributions made in this way will be deducted from your paycheck before income, Social Security, and Medicare taxes are paid. In this way you save that money and it goes into your HSA instead of being paid to the government. As we will see, this can be a significant amount of money.

How much FICA taxes can you save with an HSA?

Here is a theoretical example of how much you can save on FICA taxes in addition to regular income tax using cafeteria plan HSA contributions. For 2017, you are taxed 6.2% of your income for Social Security up to a salary limit of $127,200. In addition, Medicare is taxed at 1.45% of wages with no ceiling.

Let’s say that for 2018, you have Family HSA insurance which has an (ever-changing) contribution limit of $6,900. Let’s say that you make contribution the family maximum using post-tax dollars. As mentioned, there is no way to avoid Social Security and Medicare Taxes on these amounts. Thus, you will pay:

	Post-Tax	Cafeteria Plan
Contribution	$6,900	$6,900
Social Security (6.2%)	$427.80	$0
Medicare (1.45%)	$100.50	$0
Total:	$528.30	$0

Contrast that with the cafeteria plan, contributions to which avoid these two taxes.

In addition to this, your HSA contribution might save you on various state taxes as well. Many states remove HSA contributions from state tax calculation. One notable exception is are tax hungry states like California who does not allow HSA contributions to be deducted from state income tax. Either way, state taxes for things like Disability and Unemployment insurance can range from 1-2%, so that is another $75 to $150 right there.

How employers save on taxes with an HSA Cafeteria Plan

It is also in an employer’s interest to establish a cafeteria plan for employee’s HSA contributions. This is because employers must also make a contribution to Social Security and Medicare coffers on behalf of the employee. While the employee contributes 6.2% and 1.45% percent of salary (up to limits for SS) to the government, the employer must make the same contribution for employee’s salary. That means that for each dollar you are paid, 12.4% is going to Social Security (6.2% + 6.2%) and 2.9% is going to Medicare (1.45% + 1.45%). This results in a tax of 15.3% going to the government for each dollar you ear.

The cafeteria plan deduction offered to employees also extends to the employer. So employer Social Security and Medicare contributions are not required for employee contributions made through a cafeteria plan to an HSA. So the same example applies, for each employee contributing $6,900 to an HSA via cafeteria plan, the employer can save $528.30 in taxes. Per IRS Form 15:

Your contributions to an employee’s health savings account (HSA) aren’t subject to social security, Medicare, or FUTA taxes, or federal income tax withholding if it is reasonable to believe at the time of payment of the contributions they’ll be excludeable from the income of the employee.

Note: if you need help with your HSA taxes this year, please consider using my service EasyForm8889.com to help complete Form 8889. It is fast and painless, no matter how complicated your HSA situation.