IRS May Exercise Levy Power over HSAs

Wednesday, August 05, 2009

When individuals do not pay all of their taxes, the IRS has several powers to collect the back taxes, plus penalties and interest. Recently, the IRS clarified that its powers extend to Health Savings Accounts (HSAs).

Recall that HSAs differ from other benefit spending accounts (e.g., Health FSAs and Health Reimbursement Arrangements [HRAs]) in that the participant actually owns and controls the account, not the employer. In July, the IRS Office of Chief Counsel issued a Chief Counsel Advisory Memorandum, with two key holdings:

• An HSA is property that is subject to an IRS levy
• The HSA owner is liable for a 10% excise tax on nonmedical HSA distributions unless, at the time of the levy, the owner is age 65 or older or disabled.

The first rule was a simple statement of fact:  a taxpayer who does not pay a tax liability is subject to the IRS power to levy “upon all property and rights to property” of the taxpayer. The right to withdraw funds from an account is a property interest. Thus, the IRS can use its levy power to obtain funds from an HSA.

The second rule noted a similarity between the HSA excise tax and early distributions from qualified retirement plans. However, these types of retirement plans have a specific levy exception, while the applicable HSA provision in the Internal Revenue Code (§223) does not. Therefore, if the IRS withdraws funds from an HSA, based on its levy power, the HSA participant must pay an additional 10% excise tax, unless the participant is over the age of 65 or is disabled.

Interestingly, the Memorandum did not address a related issue:  whether the amount of the levy would be considered taxable income because the levy is a nonmedical distribution. Presumably, such a levy would be taxable as well. This is not exactly the kind of news a delinquent taxpayer wants to hear.

The Memorandum was issued by the Office of Chief Counsel to IRS field or service center employees. It does not stand as official precedent but is helpful in understanding where the IRS stands on a certain issue.