Rules Clarified on HSA Contributions, Rollovers

June 10 , 2008

In early June, the IRS issued two notices that provide guidance on the rules for contributions to and rollovers into Health Savings Accounts.

Notice 2008-52 addresses the implications of the "full contribution rule." Notice 2008-51 addresses “qualified HSA funding distributions,” better known as rollovers from an Individual Retirement Account (IRA) to an HSA. Both of these Notices give further clarification to a series of HSA enhancements that were in the Tax Relief and Health Care Act (TRHCA), which went into effect on January 1, 2007.

There are not many surprises in the two Notices. For the most part, they articulate current understanding of HSA law, based on TRHCA and other official and unofficial guidance. The Notices provide several common examples to assist employers with these two challenging concepts.

In Notice 2008-52, the IRS focused on how the contributions changed under the HOPE Act:

• HSA-eligible employees can make the full year’s contribution, up to the indexed amount, as long as they become eligible by December 1. The indexed amounts for 2008 are $2,900 for self-only coverage and $5,800 for family coverage.
• The full contribution rule also applies to catch-up contributions for those who are age 55 or older during the year.
• The full contribution rule is subject to a 13-month testing period, which lasts from December 1 of the first year through December 31 of the following year. During the testing period, one must continue to have high-deductible health plan (HDHP) coverage and not have any non-HDHP coverage. Thus, any individual who opens an HSA in 2008 will have a testing period that starts on December 1, 2008, and ends on December 31, 2009.
• Failure to maintain HSA eligibility during the testing period makes a portion of the contribution taxable and subject to a 10 percent penalty. The portion is calculated by subtracting the sum of the monthly contribution limits that the individual would otherwise have been entitled to from the amount actually contributed. An exception exists if the failure is due to death or disability.
• If an individual makes an excess contribution to an HSA, that contribution is subject to a six percent excise tax, unless a withdrawal of the excess contribution is made before the next April 15 tax day.
• A potential double tax whammy exists for an individual who makes a full contribution, fails to maintain HSA eligibility during the testing period and receives a distribution for non-medical expenses. Both the contribution and distribution are subject to both taxation and a 10 percent penalty.

In Notice 2008-51, the IRS focused on IRA rollovers to HSAs:

• A rollover is permitted from a traditional IRA or Roth IRA, but not a Simplified Employee Pension (SEP) or SIMPLE IRA.
• The IRA rollover amount is counted against an individual’s annual HSA contribution limit, including any catch-up contributions.
• Generally, you may only make a onetime IRA rollover to an HSA. In such a case, the IRA distribution is tax-free. If you want to roll over amounts from two IRAs, you must first move money from one IRA to the next and then do a single IRA rollover. Two rollovers are allowed in a single year if the first rollover occurred during self-only HDHP coverage and the second rollover occurred during family HDHP coverage.
• A second rollover in a subsequent year is permissible. The IRA distribution would be taxable. The corresponding HSA contribution would be tax deductible.
• The rollover must be a direct trustee-to-trustee transfer.
• The rollover is subject to a testing period that mirrors the testing period described in the other Notice (i.e., December 1 of the first year through December 31 of the following year). Failure to maintain HSA eligibility makes the rollover amount taxable and subject to a 10 percent penalty. An exception exists if the failure is due to death or disability.

To review the two Notices, simply go to www.irs.gov/pub/irs-drop/n-08-51.pdf and www.irs.gov/pub/irs-drop/n-08-52.pdf.