Category Archives: HSA mechanics

How to Determine if You Used the HSA Last Month Rule

Overview

This is a fairly common question I get from readers regarding the HSA’s Last Month Rule and how to file Line 18 on Form 8889. The question usually takes the form of:

“Did I use the Last Month Rule last year?”
“Do I owe anything for the Last Month Rule?”
“What should I put on Line 18 of Form 8889 where it says Last Month Rule?”

Luckily, it should be easy to figure out whether the Last Month Rule even applies to your tax return. The goal of this article is to explain how the Last Month Rule works, and then ask 3 questions to see how it applies to you.

What is the Last Month Rule?

Let’s start by defining some terms. The Last Month Rule is a “feature” of HSA’s that generally only applies to a year that you begin HSA eligible coverage. It states that if you are an eligible individual as of December 1st of a year, you are treated as an eligible individual for that entire year. This is a benefit as it allows you the option to contribute that year’s full contribution limit instead of a pro-rata amount. You get more tax free medical spending.

As an example, assume I began coverage on June 1st, 2016. Normally, I would only be able to contribute 7/12 (Jun, Jul, Aug, Sep, Oct, Nov, Dec) or just over half of the contribution limit for that year. But since I had coverage on December 1st, I am treated as an eligible individual for the whole year and may contribute up to the full contribution limit.

What is the Testing Period?

However, there is a catch. If you take advantage of the Last Month Rule and choose to contribute more than you normally could have (e.g. 12/12 vs 7/12 above), you are bound by the Testing Period to maintain that coverage for the following year. If you do not, any contribution above the 7/12 you were allowed is considered excessive and taxed and penalized on Line 18 of Form 8889 when you file your taxes. This is generally not good and should be avoided.

Please see this article for a more complete description of the Last Month Rule and Testing Period.

Determining if the Last Month Rule applies to you

First off, let’s relieve a lot of people from worry: if you had the same HSA coverage for each month in a tax year, you can put “0” on Line 18 of Form 8889. Since the Last Month Rule applies only to those who began or changed coverage, you can ignore it and likely go onto something else more enjoyable.

If you had consistent HSA eligible insurance for each month of the year, the Last Month Rule does not apply and you can put “0” on Line 18 of Form 8889.

On the other hand, if you began or changed HSA coverage this year, let’s pose three “yes” or “no” questions to help determine if the Last Month Rule applies to you. You must answer “yes” to the following 3 questions to be eligible to use the Last Month Rule. Answering “no” to any of the following means you can only contribute the pro-rata contribution amount for the months you were HSA eligible.

1) Were you an eligible individual (have HSA eligible coverage) on December 1st of the tax year?

Answering “no” precludes you from using the Last Month Rule as it is a base requirement. This rules out people who, for example, had coverage from January – November of a year, or had coverage from February until August of a tax year. You at least have to have coverage in December to be eligible for the Last Month Rule.

If you answered “yes”, then you may be eligible to use the Last Month Rule, read on.

2) You were HSA eligible (had HSA coverage) for only part of the year?

Answering “no” means you had coverage for the full year, so by definition you can already contribute the HSA maximum contribution limit. You had coverage for 12 months, so can contribute 12/12 or 100% of the contribution limit for the year. You don’t need the Last Month Rule’s help. If this applies to you, put “0” on line 18 of Form 8889.

If you answered “yes”, you likely began coverage mid-year. Perhaps you got a new job and had HSA qualified starting on April 1st, so 9/12 months of the year. Or you had coverage for January through April, then stopped, then had coverage for November and December. If this sounds like your situation, this means that you have the option of using the Last Month Rule for that year. To actually use it, move on to question #3.

3) Did you contribute more than you would otherwise be allowed?

Answering “no” means you contributed less than or equal to your contribution limit based on your months as an eligible individual. So if you had HSA coverage for 5 months, you are allowed to contribute up to 5/12 (41.6%) of the contribution limit without using the Last Month Rule. Doing so plays it safe and avoids any of the requirements or risk of penalty associated with the Testing Period.

Answering “yes” sounds like, “I had HSA coverage for 7/12 months but I contributed the maximum contribution limit using the Last Month Rule”, or “I had coverage for 3/12 months (Oct / Nov / Dec or 25%) but contributed 1/2 (50%) of the maximum contribution limit.” In both of these scenarios, you contributed more to your HSA than you would generally be allowed. This is allowable, as you leveraged the Last Month Rule to make an increased contribution, but remember it has strings attached.

Conclusion

If you answered “No” to any of the 3 questions above, you cannot use the Last Month Rule. You will need to contribute your pro-rata contribution limit based on the number of months you were HSA eligible. You can also put “0” on Line 18 of Form 8889.

If you answered “Yes” to all 3 questions above, you used the Last Month Rule and contributed more than you generally could have. This is allowable but remember you need to maintain HSA coverage for the next year due to the Testing Period. For the current year, you can put 0 on Line 18. If you maintain that HSA coverage through the following year, you will also put “0” on Line 18 of that year’s Form 8889, pass the Testing Period, and hopefully never worry about the Last Month Rule again. Only if you don’t maintain coverage (i.e. fail the Testing Period) will you need to calculate a penalty for Line 18, which will increase your taxable income and add a penalty to your 1040 return.

Note: if this is super confusing, please consider using my service EasyForm8889.com to complete Form 8889. It asks these questions in a straightforward way and will generate your HSA tax forms in 10 minutes. It is fast and painless, no matter how complicated your HSA situation.

Can I Open an FSA While I Also Have an HSA?

Overview

Health Savings Accounts (HSA’s) and Flexible Spending Accounts (FSA’s) are both tools that help you lower your cost of medical care. There are pro’s and con’s to each, and while they work in the same manner of making health insurance purchases tax deductible, they function using different mechanisms. The HSA is more individual driven, while the FSA is an employer sponsored benefit; you can’t open an FSA without your employer’s help. Given the choice, this article compares both plans and can help you choose between an HSA and FSA.

However, the question often comes up as to whether you can have an HSA and an FSA at the same time? The short answer is “generally no” but there are some exceptions that we will dive into in this article.

HSA: No Other Health Coverage*

In order to qualify for an HSA, there are 4 hurdles you must pass, per IRS Form 969. Number 2 below is the most important here:

You are covered under a High Deductible Health Plan
You have no other health coverage except what is permitted under the “Other Health Coverage”
You are not enrolled in Medicare
You cannot be claimed as a dependent on someone else’s tax return

The IRS clearly calls out #2 in relation to Flexible Spending Accounts when it says:

Other employee health plans. An employee covered by an HDHP and a health FSA or an HRA that pays or reimburses qualified medical expenses generally can’t make contributions to an HSA.

So they are saying “No”, that a Flexible Spending Account is considered other health coverage and would violate rule #2 above, but the key word they use is “generally”. If you read on in Form 969 you will find some exceptions and types of FSA plans that you can open while you have an HSA.

FSA’s allowed with HSA’s

So the run of the mill FSA your employer probably offers you is not compatible with and HSA. Surprisingly, if you read on far enough in Form 969 you will find a short list of FSA plans that can be opened at the same time as HSA’s.

However, an employee can make contributions to an HSA while covered under an HDHP and one or more of
the following arrangements:

Limited-purpose health FSA

Post Deductible Health FSA

So it is true, the magic secret backdoor of having an HSA and FSA at the same time has been revealed by the IRS! It is just that the FSA has to be a certain type of plan. This is a great benefit because the combination of an HSA and limited FSA allows you even more tax free medical spending. For example, if you have an HSA and limited purpose FSA, you could max out your HSA contribution and still put other money aside in the limited purpose FSA. Of course, you will want to use that limited purpose FSA funds up during the year because unlike and HSA, FSA funds are use it or lose it. However, this protects your HSA contributions and allows the to compound and grow. Even better if you are getting employer contributions for either plan.

Limited-Purpose FSA

A limited-purpose FSA is a special type of Flexible Spending Account that only allows you to spend it on certain types of qualified medical expenses. It behaves much like a regular FSA but specifically limits your spending to qualified dental and vision expenses for you, your spouse and your dependents. Thus, it seems to exclude actual medical care. However, the benefit is you can contribute both to a limited purpose FSA and HSA at the same time. It makes sense if you plan on having vision or dental work performed in the year, as this limited purpose FSA (LPFSA) could be a great option to save money. You would make the contribution to the LPFSA and when those vision / dental expenses came up, use the LPFSA funds before you touch your HSA. Of course, you can’t reimburse the same expense from the LPFSA and HSA (called “Double-dipping”) but the increase in tax free medical spending is great.

Post Deductible FSA

You can also open a Post Deductible FSA at the same time as you have an HSA. This is an uncommon FSA but it basically allows you to use FSA dollars once that year’s HSA minimum deductible is hit. So if your plan’s deductible is higher than the HSA minimum, this type of FSA would kick in after you pay the amount equal to the HSA minimum deductible for a given year. This would help alleviate some pressure if you are already spending up to the HSA minimum deductible on your plan, as your plan’s deductible may be much higher. Ideally, this FSA would be employer contributions because the risk of loss (i.e. not using your post-deductible FSA) would be high as not everyone hits that amount of deductible spending every year.

Allowable Health Reimbursement Accounts (HRA’s)

In addition to including a few forms of FSA, the government allows a few types of Health Reimbursement Accounts to be used at the same time as an HSA. These are spelled out in Form 969 and include the following:

Limited purpose HRA
Suspended HRA
Post Deductible HRA
Retirement HRA

In summary, there are additional FSA and HRA options to help reduce your medical care, even if you have and are contributing to a Health Savings Account. Do proper research to make sure you stay on the good side of the IRS when it comes to these plans.

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

HSA Expenses Incurred Before Opening Account

Opening an HSA

The timing of opening your Health Savings Account –going to a bank and actually creating an account in your name– ends up being quite important for your finances. The reason is the date you open your Health Savings Account is the date that qualified medical expenses begin for you. Any medical care incurred before you open your HSA does not count as a qualified medical expense. Said another way, you cannot use pre-tax dollars to purchase medical care that occurred before you actually created your Health Savings Account. Per IRS Form 969:

For HSA purposes, expenses incurred before you establish your HSA aren’t qualified medical expenses. State law determines when an HSA is established.

It is actually easier than most people think to open up a Health Savings Account. The main difficulty comes in choosing a provider. Things I look for are low fees, online banking ability, phone app, and investment options. Once you find the financial institution you wish to bank with, you need to apply for the account. While this sounds painful, it is actually quite simple. To open the HSA, they will need standard information such as name and address, and also some information about your health insurance. They will use this to validate that you do in fact have an HDHP, and also use your self-only or family coverage for a rough determination of your contribution limit for the year. They use that information to help prevent contribution mistakes and it aides in generating Form 5498-SA and Form 1099-SA. Once you submit that, you are all set, and you can begin making contributions to your HSA.

The cost of not opening an HSA

You must overcome the tendency to delay opening your HSA, as it could come back to bite you. If you have HSA eligible insurance but have not yet opened a Health Savings Account you may be on borrowed time, as any medical expense incurred cannot be paid with pretax dollars. The risk to you can be equal to the (amount of expense) x (your tax rate). Even a $100 expense for someone in a 25% tax bracket will end up costing them $33 extra. Said another way, it takes $133 dollars taxed at 25% to pay for a $100 medical expense. For an HSA holder, they only need to earn $100 to pay for the expense. Multiply this expense by 10 and this $1,000 expense will cost you $333 in extra tax dollars paid, all of which is completely avoidable. This money adds up and there is no reason to pay it with the generous HSA contribution limits.

Effect on Contribution Limit

While opening the actual Health Savings Account begins the process of allowing qualified medical expenses, it does not have an effect on your contribution limit for the year. Your contribution limit is based on when you are an eligible individual. So you can have HSA eligible insurance and be allowed to contribute to your not-yet-open HSA. Of course, you will need to open that Health Savings Account before you make that year’s contribution.

Take the following scenarios as an example:

HSA coverage begins	HSA opened	QME begin	Contribution Limit	Last Month Rule?
January 1st	June 1st	June 1st	Full	N/A
January 1st	January 1st	January 1st	Full	N/A
June 1st	June 1st	June 1st	1/2 up to full	Optional
June 1st	October 1st	October 1st	1/2 up to full	Optional

As you can see above, delaying in opening your HSA can prevent you from paying for medical care from your HSA. If you plan on contributing to an HSA you might as well open the account as soon as possible, to take advantage of paying for medical care tax free with the HSA.

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Note: if you need to keep track of HSA purchases for yourself, your spouse, or your children, please consider my service TrackHSA.com for your Health Savings Account record keeping. You can store purchases, upload receipts, and record reimbursements securely online.

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Category Archives: HSA mechanics

How to Determine if You Used the HSA Last Month Rule

Overview

What is the Last Month Rule?

What is the Testing Period?

Determining if the Last Month Rule applies to you

1) Were you an eligible individual (have HSA eligible coverage) on December 1st of the tax year?

2) You were HSA eligible (had HSA coverage) for only part of the year?

3) Did you contribute more than you would otherwise be allowed?

Conclusion

Can I Open an FSA While I Also Have an HSA?

Overview

HSA: No Other Health Coverage*

FSA’s allowed with HSA’s

Limited-Purpose FSA

Post Deductible FSA

Allowable Health Reimbursement Accounts (HRA’s)

HSA Expenses Incurred Before Opening Account

Opening an HSA

The cost of not opening an HSA

Effect on Contribution Limit