Spotlight Series: Year-End Health Savings Account Eligibility And Tax Season

Yes, it's the end of the year and tax season seems far away, but as many may have switched to an HSA-qualified HDHP during open enrollment, it's important to know how year end eligibility in 2015 could affect your taxes in April of 2016 and beyond.

In order to remain compliant with maximum contribution limits, first know that HSA contributions years are based on a tax year, meaning you have until April to contribute to your prior year’s HSA if you haven’t maxed out yet. This has implications for both employers and employees as they potentially contribute to an HSA.

Implications when switching from a non-HDHP to an HSA-qualified HDHP
If you had coverage of any type for most of the year but switched during a year-end open enrollment to an HSA-eligible plan -- as long as you had HSA eligible coverage starting on the first day of the last month of your tax year (December 1 for most), you can contribute the max to your HSA and deduct it from your 2015 taxes. This is allowed based on the last-month rule.

BUT -- to enjoy the possibility of having the maximum allowed dollars in your HSA and the attractive income tax deduction, you have to adhere to a testing period. This is a rule that requires you to remain covered by an HSA-qualified HDHP for 12 consecutive months in order to claim the full deduction. As we’ll see in the following IRS-provided example, if you fail to remain eligible (other than because of death or becoming disabled), you will have to calculate a prorated deduction for the months you were ineligible so the government can tax you for the money that shouldn’t have been there AND you’ll have to pay a 10% penalty - the government’s way of discouraging this behavior.

Example 1 - as translated by Lumity
Chris selects an HSA-qualified Family HDHP with coverage that begins on December 1, 2015. Under the last-month rule, he decides to contribute $6,550 to his HSA.

Chris fails the requirements of his December 1, 2015 to December 31, 2016 testing period when he enrolls in a non-HDHP plan after changing companies in June 2016. Now he must include in his 2016 income the contributions made in 2015 that would not have been made except for the last-month rule. Chris uses the worksheet in the Form 8889 instructions to determine this amount.

Chris would include $6,004.17 ($6,550.00 – $545.83) in his gross income on his 2016 tax return and pay a 10% additional tax to this amount.

Chris thought he’d be able to deduct $6,550 from his taxes but instead has to include $6,604.59 ($6,004.17 + 600.42) for his failure to remain eligible to contribute to his HSA.

For employers, if you offered HSA plans that began covering employees December 1 of this year, be sure to impart the last-month rule and testing period knowledge by sharing this post with your employees.

For employees, make sure you understand these rules and check out these additional resources to keep yourself enlightened.

Testing Period Worksheet
HSA Contribution Worksheet
IRA to HSA Worksheet

Subscribe to get an update on our next post in the Lumity Spotlight Series as we show you how to avoid penalties if you’ve contributed too much in your HSA.

You can alleviate some of the worry when considering HDHPs using estimates of OOP expenses and value-driven health plan recommendations with Lumity’s data analytics technology. Give us a call at 1-844-2-LUMITY and find out more about how data makes a difference.