Tag Archives: Last Month Rule

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.

What is an Eligible Individual for an HSA?

Qualifying for an HSA

The IRS defines eligibility for contributing to a Health Savings Account. They group these requirements into the term “eligible individual”, and if one is an eligible individual, than they can open and contribute to a Health Savings Account. However, some of the requirements of an eligible individual change from year to year, specifically the definition of a High Deductible Health Plan (HDHP). It is important to know if you are an eligible individual because it determines your contribution limit for that month, and hence, the year. You need to proactively monitor changes in these definitions, especially if your health care coverage changes. Making contributions when you are not an eligible individual can lead to penalties via excess contributions.

HSA eligibility determined monthly

Your status as an eligible individual is determined by the IRS at the beginning of each month. They do not do this for you, but instead rely on you to know the rules and proceed as appropriate. Doing this incorrectly can cost you money, either through excess contributions or not contributing enough.

Practically, this means that throughout the year, on the first day of the month you need to test against the 4 requirements of an eligible individual. This is easier than it sounds: if you were an eligible individual the month prior, and nothing changed regarding your insurance, you are likely an eligible individual the next month. The one exception here is at the beginning of the year as HDHP definitions can change, causing your plan to no longer fit the definitions for an HSA.

The requirements for being an eligible individual are a package deal. If you do not meet any one of them, you are not an eligible individual, so you can’t contribute to an HSA that month. On the other hand, if you are an eligible individual at the beginning of the month, that eligibility lasts for the entire month. This means is you can contribute to your HSA for that month i.e. 1/12 of your contribution limit.

Your status as an eligible individual may change throughout the year. Since you are “tested” each month on the 1st, the result may come back differently. You may be an eligible individual for January – June, ineligible for July – November, and eligible in December again. This would effect the calculation for your contribution limit for the year. You can also look back over the year and determine if you were an eligible individual for each month, generally by looking at the insurance you had on the 1st.

What follows is a discussion of the 4 requirements that define an eligible individual for an HSA. All of this can be found in IRS Publication 969.

1) Covered by HDHP

This is the big one that makes or breaks it for most people. Your health insurance must meet certain criteria to be considered a High Deductible Health Plan. If it does, you have met 1 of the requirements for being an eligible individual. If it does not, you are not allowed to contribute to an HSA during that time.

You must be covered under a high deductible health plan (HDHP), described later, on the first day of the month.

For both self-only and family coverage, the IRS sets minimum deductibles and maximum out-of-pocket amounts. Your plan must have a higher deductible and lower maximum out of pocket amount to be considered an HDHP. You can find contribution limits and HDHP definitions on the sidebar of this post.

These are generally straightforward but you need to be careful when you change coverage or the year turns over. These amounts change from year to year, and unfortunately, what is an HDHP one year may not be one the next.

2) No Other Health Coverage

You cannot have other health insurance and be considered an eligible individual. For example, you cannot be on both an HDHP and a spouse’s plan at the same time. Of course you can do this if you want, but you will not be able to contribute to an HSA.

You have no other health coverage except what is permitted under “Other Health Coverage”, later.

The exceptions that the IRS lists under “Other Health Coverage” include limited purpose FSA or HSA (not regular FSA’s that you are thinking of), Suspended HRA’s, post deductible FSA and HRA, and retirement HRA’s.

3) You are not enrolled in Medicare.

This one seems pretty straightforward: if you are enrolled in Medicare, you are not eligible for contributing to an HSA for that month. Most people stay on Medicare once they join it, so at that point they are done contributing to their HSA. Of course, you still get to enjoy your existing HSA contributions, and once you are 65, you can enjoy them for non-medical expenses. A nice boost to retirement, if you will.

However, the risk you run with Medicare is that it retroactively applies coverage in a weird way. If you apply for Medicare after you turn 65, its coverage retroactively applies up to the 6 months prior. The result is you are disqualified as an eligible individual for those months, and you risk excess contributions for that time.

4) You are not a dependent

This one is pretty straightforward, you cannot be a dependent on someone else’s tax return and contribute to your own HSA.

You cannot be claimed as a dependent on someone else’s tax return.

However, if you are not a dependent but still on a parent’s plan, you can still contribute to an HSA. This is common for adult children on a parent’s HSA plan – and they can contribute the family limit in their own account!

Eligible Individual using the Last Month Rule

The one override for being an eligible individual is the Last Month Rule, which can grant eligible individual status to months prior to you being insured. It is often uses when you begin HSA eligible insurance, but if you have HDHP eligible coverage on December 1st, it allows you to be an eligible individual for up to the full year.

Under the last-month rule, you are considered to be an eligible individual for the entire year if you are an eligible individual on the first day of the last month of your tax year (December 1 for most taxpayers).

This has the effect of allowing you to contribute the full contribution limit, even if you didn’t have HSA insurance for the full year. However, there is a catch, and it is you must maintain that coverage for the following 12 months by means of the Testing Period. If you don’t, you can owe taxes and penalties on the amount you “over” contributed. You do not need to use the Last Month Rule, and instead can play it safe by contributing the percentage of the contribution limit for months you were covered.

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Note: if you need help determining your HSA contribution limit based on being an eligible individual or not, please consider using my service EasyForm8889.com to complete Form 8889. It asks simple questions to determine this for you, no matter how complicated your HSA situation.

HSA Contribution with Upcoming Medicare Coverage

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

I will be purchasing high deductible medical insurance on Sept. 1 of this year. I will qualify for Medicare on Sept. 1 of next year. Being that is only 11 months, would it be best to prorate the $3400 for 11 months for 2017 taxes in order to avoid a penalty, or would it be better to prorate each year (2017 and 2018) separately?

HSA’s and Medicare are very entangled as some of the Medicare rules can lead to over-contribution. I would urge you to further research this and apply it to your situation.

Please see my article: Medicare Part A Retroactive Coverage and HSA’s.

Basically, there is a clause in Medicare Part A that applies if you sign up for Medicare after your 65th birthday. In those cases, your Medicare coverage will retroactively apply up to 6 months prior to that date it truly began. Weird and crazy law. The problem is having Medicare coverage makes you HSA ineligible, so if you contributed to your Health Savings Account for those months it can lead to excess contributions.

Best case is this does not apply to your situation and your upcoming Medicare coverage truly beings on September 1st of 2018. Worst case it is will retroactively begin on March 1st, 2018.

As such, this limits your contribution amounts for 2017. I do not recommend using the Last Month Rule to contribute more in 2017, since you may end up failing the Testing Period in 2018 if Medicare kicks in. For 2017, you can safely contribute 4/12 (Sep Oct Nov Dec) of your contribution limit without issue. For 2018, you can contribute the pro rata amount of the months you have HSA insurance and do not have Medicare.

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Note: if you need help determining your HSA contributions in light of Medicare coverage, please consider using my service EasyForm8889.com to complete Form 8889. It is fast and painless, no matter how complicated your HSA situation.