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The IRS and Treasury have provided guidance on health savings accounts (HSAs) established under Sec. 223, as added by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, for tax years beginning after 2003. HSAs are designed to help individuals save for qualified medical and retiree health expenses. Tax-favored contributions may be made by, or on behalf of, eligible individuals; amounts in an HSA can be accumulated over time or distributed tax free to pay or reimburse qualified expenses.

An HSA is a tax-exempt trust or custodial account established exclusively to pay qualified medical expenses of the account beneficiary who, for the months for which contributions are made to an HSA, is covered under a high-deductible health plan that satisfies certain requirements as to deductibles and out-of-pocket expenses. HSA funds can be used to cover health insurance deductibles and any co-payments for medical services, prescriptions or products; they can also be used to purchase both over-the-counter drugs and long-term care insurance and to pay health insurance premiums during any period of unemployment. However, distributions not used for qualified expenses will be taxable; a 10% penalty will be imposed to deter the use of an HSA for nonmedical purposes. HSA contributions may be made by:

1. An individual and family members, even if the individual does not itemize deductions;

2. An individual's employer (contributions are not taxed to either the employer or the employee); and

3. Employees who participate in cafeteria plans, through a salary reduction plan.

HSA distributions are not subject to tax if used to pay qualifying medical expenses. To encourage saving for health expenses after retirement, HSA owners between age 55 and 65 can make additional catch-up contributions ($500 for 2004). By 2009, an additional $1,000 can be added to the HSA.

Notice 2004-2 contains guidance, in question-and-answer format, explaining what HSAs are, who can have them, how to create them and the basic rules for contributions and withdrawals. The notice clarifies the following:

* Employer contributions to employee HSAs are not subject to FICA taxes.

* HSAs are allowed for employees covered by employer self-insured medical reimbursement plans with qualifying high deductibles.

* Like medical savings accounts (MSAs), HSA trustees or custodians do not have to determine if withdrawals are used for medical costs.

* Special rules cover determining the deductible for high-deductible family coverage.

* Like MSAs, in addition to banks and insurance companies, persons may be approved as HSA custodians under the IRA nonbank trustee rules; existing IRA or Archer MSA trustees or custodians are automatically approved.

* HSA trustees or custodians that do not sponsor high-deductible plans may (not must) request proof or certification that an individual is eligible to contribute.

* Otherwise eligible individuals without earnings may contribute to HSAs; this includes the self-employed and unemployed.

The IRS requests comments on the rules, as follows:

1. The appropriate standard for preventive care in Sec. 223(c)(2)(C).

2. The relationship between Sec. 223 and the rules governing health flexible savings accounts (FSAs) in Sec. 125 cafeteria plans and proposed and final regulations (in particular, Prop. Regs. Sec. 1.125-2, Q&A-7).

3. Whether transition relief should be provided in cases of inappropriate coordination of a high-deductible health plan with other coverage.

4. The relationship between HSAs and health FSAs or reimbursement arrangements.

5. The application of the Sec. 125 nondiscrimination rules to HSAs offered under a cafeteria plan.

6. The corrective procedures when employer contributions exceed the statutory contribution limits.

7. The relationship between limits on out-of-pocket expenses in Sec. 223(c)(2)(A) and reasonable lifetime maximums on benefits in health insurance plans.

Comments can be submitted electronically, to Notice.2004.2.Com, or to:


P.O. Box 7604

Ben Franklin Station

Room 5226


(Notice 2004-2)

Washington, DC 20044
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Article Details
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Title Annotation:From The IRS
Author:Laffie, Lesli S.
Publication:The Tax Adviser
Date:Feb 1, 2004
Previous Article:IRS releases 2003 guidelines for "adequate disclosure".
Next Article:ITIN program revisions.

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