Tag Archives: Qualified Medical Expenses

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.

Delaying Reimbursement for HSA Purchases

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

Does a $45 unreimbursed qualified medical expense (QME) equal only a $45 tax free withdraw later, or does it equal a ($45 + interest/gains) tax free withdraw later? Do you see the distinction?

Paying for Medical Expenses

Each year, you are allowed to make contributions to your HSA based on your coverage and age. Funds in your HSA can be distributed tax free for qualified medical expenses. Regardless of how the funds get in the account, they can come out tax free if used correctly.

That said, you face a choice each time you make a purchase for a qualified medical expense. You can either:

Pay for the expense using funds from your HSA
Pay for the expense using non-HSA funds (say, cash or your credit card)

If you use option 1, the transaction occurs quickly: you buy your medical item and your HSA is reduced.

If you elect option 2, the transaction can occur quite slowly: you buy your medical item with non-HSA funds, and you are now allowed to reimburse that purchase from your HSA at any time in the future. Reimburse means you can transfer funds from your HSA to another (bank) account you own to “pay back” the expense. Doing so in effect pays for the expense with tax-free funds from your HSA. See more information in the article “Using your HSA as an ATM“.

Delaying Reimbursement of Medical Expenses

The interesting thing is the timing of this distribution. If you do it immediately, the transaction ends up looking a lot like #1 above: the money flows from your HSA to your account, and the transaction is fully paid and reimbursed and completed. However, delaying this reimbursement provides some interesting options:

The amount of the purchase remains in your HSA
It can earn interest
It can be invested in stocks, ETFs, or bonds
It may grow to more than the initial amount of the purchase

The crux of your question is with the last bullet above – the purchase may grow to more than the initial amount. Perhaps substantially so. How do I handle this increased amount in my HSA?

Investment Gains in your HSA

In your example, you made a $45 purchase paid with cash instead of using HSA funds. You can reimburse (transfer) that $45 from the HSA to your bank account tax-free at any time, but not more than $45 since the receipt does not justify a higher amount. Going further, say you invested that $45 and it earned $100 before you reimburse (transfer) out the $45. You now have $100 sitting in your HSA. You cannot reimburse it against the $45 receipt, but you can use it to pay for future medical expenses.

Earnings in your HSA are handled just like any other HSA contribution.

When a new medical purchase occurs, this “new” $100 in your account provides two options:

Distribute it to pay for the purchase
Again pay using other funds and continue to invest the $100

Using #2 above, you can see how the whole cycle can repeat and grow your HSA.

This is a powerful concept because doing so allows you to grow medical (and later, retirement) funds tax free and distribute them at no (or low) cost. In theory, you can invest your HSA and grow it beyond the contribution limit for a given year.

Note: I created TrackHSA.com to track medical expenses you plan to later reimburse from your Health Savings Account. It provides record keeping to store purchases, upload receipts, and record reimbursements securely online, no matter how far in the future you choose to reimburse them.

Paying for Medical Expenses with Prior Year HSA Contributions

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

My tax adviser informed me I can set up an HSA for 2017 if I do so quickly before the tax filing deadline in April. However, I don’t have a health savings account yet so need to open one. They also told me I can reimburse myself for the eligible out of pocket healthcare expenses that I had in 2017, from my 2017 contributions. However, the HSA custodian tells me I am not allowed to do so. What are the facts?

Your tax adviser offered good advice about opening the HSA and using prior year contributions to fund 2017. Even though we are in the new year, as long as you make the contributions by the tax deadline, you can apply them to the prior year. That said, the credit union is correct that HSA funds can only be used for expenses occurring after the HSA is established. This means that you cannot use the prior year contributions in you newly created HSA to reimburse prior year medical costs. This is called out in IRS Form 969:

HSA-expenses-before-opening-HSA

While you can make contributions for 2017, no medical expenses in 2017 will be considered qualified medical expenses. Even though you lose the ability to pay for those medical expenses with HSA funds, you at least make the contribution, gain the tax deduction, and can pay for future medical expenses with your HSA funds. This is on top of whatever you do in the current year, so assuming you have the funds to contribute, this is the best remaining option.

You cannot reimburse medical expenses that occur before the HSA is established

Note that if you had opened the HSA during the year, you could have used the prior year contributions to pay for qualified medical expenses. Since your HSA was opened after the medical expenses occurred, you cannot use the HSA (ever) to pay for them.

The takeaway is that it is important to open your Health Savings Account if you plan on contributing to it. Delaying this runs the risk that medical expenses will not be qualified medical expenses.

Note: to track valid prior year expenses that you plan to reimburse, consider my service TrackHSA.com for your Health Savings Account record keeping. You can store purchases, upload receipts, and record reimbursements securely online, no matter how far in the future you choose to reimburse them.