HSA Tax Implications
You can probably guess the major implication of contributing to an HSA: It lowers your income taxes. But there are a few other tax implications to be aware of so you don’t end up owing more than you expect.
Make sure you are HSA eligible
You should always be aware of whether or not you’re eligible to make pre-tax contributions to your HSA. You are only eligible to contribute to your HSA if you have an HDHP and do not have additional coverage as part of a spouse’s traditional health plan. You can have additional insurance to cover dental, vision, disability, long-term care, accidents and hospitalization, but if you maintain supplemental traditional insurance coverage, you will have to pay income taxes on your HSA contributions.
If your eligibility status changes throughout the year, you must take that into consideration when calculating how much you can contribute to your HSA. If you contribute too much to your HSA, you will be subject to additional taxes and penalties.
Make appropriate distributions
If you use your HSA money to pay for anything other than a qualified medical expense, and you’re under the age of 65, you’ll have to add the amount you used to your taxable income on your tax return. Then you’ll have to pay an additional 20 percent tax penalty on that amount.
If you’re unsure of what’s considered a qualified medical expense, the IRS offers this general guidance: HSA money should be used to pay for the cost of diagnosing, treating, preventing, curing or mitigating a disease or illness.
Watch out for itemized deductions
Since HSA contributions are pre-tax, you can’t include medical expenses that you paid for using HSA money in your itemized tax deductions. Make sure you record all medical expenses you paid for with your HSA so you don’t accidentally make this mistake.
Know state tax rules
A few states have different rules when it comes to taxing HSAs at the state level. Specifically, Calfiorna and New Jersey don’t treat HSAs as tax-deductible at the state level. So in those states your HSA contributions will be subject to state income tax and your HSA will be treated like a regular taxable brokerage account. Be sure to check the rules in your state to make sure you follow all tax and reporting regulations.
In Tennessee and New Hampshire, HSA interest and earnings does count toward your overall dividend and interest income for the year. If you meet a certain threshold, this income is taxable and reportable, so make sure to check the law in your state to appropriately pay and report.
Stay current with your taxes
The IRS can levy your HSA in order to pay your outstanding tax bill. If they do, and you’re under the age of 65, you’ll have to pay a 20% tax penalty on the involuntary distribution. This is another of the many reasons why it is important to stay up-to-date on your tax payments.