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Using an HSA for Non-Medical Expenses

Question:  What are the tax consequences of using an HSA to pay for non-medical expenses?

Short Answer: Non-medical HSA distributions are subject to ordinary income tax at all ages, and they are also subject to a 20% additional tax for individuals who are under age 65.

General Rule: HSA Funds Can Be Used for Any Purpose

Unlike a health FSA or HRA, the HSA can be used for both medical and non-medical expenses.  The HSA is an account owned by the employee with no administrative gatekeeper to limit HSA distributions.

Medical Distributions: Tax-Free

HSAs can reimburse only IRC §213(d) qualified medical expenses on a tax-free basis.  The best general IRS overview of what constitutes a §213(d) medical expense is IRS Publication 502.

Although in almost all circumstances the Publication 502 list of §213(d) medical expenses mirrors those expenses eligible for tax-free HSA distributions, there are a few differences.  The slight modifications to the list of reimbursable expenses for account-based plans are set forth in IRS Publication 969.

The most significant discrepancy is the general exclusion of premium expenses from the list of HSA-qualified medical expenses.  Except in four limited situations, use of an HSA to pay for premium expenses would be a non-medical distribution.

For full details, see our previous post: HSA Distributions for Premium Expenses.

Also note that individuals may take a qualified tax-free medical distribution from an HSA only for medical expenses incurred after the individual established the HSA.

For full details, see our previous post: HSA Establishment Date.

Non-Medical Distributions: Subject Income Taxes and a 20% Additional Tax

The general rule is that there are two adverse tax consequence of taking a non-medical HSA distribution:

  • The distribution will be includible in gross income; and
  • The distribution will be subject to a 20% additional tax.

The HSA owner must report non-medical distributions on the Form 8889, which is included with the individual tax return (Form 1040).

Example 1:

  • Jose is age 40 (and not disabled).
  • He uses his HSA to purchase a $2,500 Ultra HD 4K TV.

Result 1:

  • Jose reports the non-medical distribution on his Form 8889.
  • Jose must include the $2,500 distribution in his gross income.
  • Jose must also pay a 20% additional tax on the $2,500 distribution ($500 additional tax).

Non-Medical Distributions Upon Reaching Age 65:No 20% Additional Tax (But Income Tax Remains)

The 20% additional tax does not apply to a non-medical distribution for an individual who:

  • Dies;
  • Becomes Disabled; or
  • Turns age 65.

An individual is considered disabled if he or she is unable to engage in any substantial gainful activity due to a physical or mental impairment which can be expected to result in death or continue indefinitely.

For more information upon about HSA tax treatment upon death, see our previous post: What Happens to an HSA Upon Death.

Although the 20% additional tax does not apply to a non-medical distribution for any individual who meets one of the exceptions, the distribution must still be included in the individual’s gross income.  In other words, only standard ordinary income taxes apply (in the same manner as a 401(k) or IRA distribution).

Example 2:

  • Jose is age 65+.
  • He uses his HSA to purchase a $2,500 Ultra HD 4K TV.

Result 2:

  • Jose reports the non-medical distribution on his Form 8889.
  • Jose must include the $2,500 distribution in his gross income.
  • Jose is subject to the 20% additional tax on the distribution because he is over age 65.

Note that if Jose is enrolled in any part of Medicare, he cannot be HSA-eligible.  That means he can no longer make or receive HSA contributions.  However, Medicare enrollment does not affect the tax treatment of his existing HSA balance or distributions.

For full details, see our previous post: How Medicare Affects HSA Eligibility.

For more details on everything ACA, see our ABD 2020 Go All the Way With HSA Guide.

Regulations

IRC §223(f):

(f) Tax treatment of distributions.

(1) Amounts used for qualified medical expenses.

Any amount paid or distributed out of a health savings account which is used exclusively to pay qualified medical expenses of any account beneficiary shall not be includible in gross income.

(2) Inclusion of amounts not used for qualified medical expenses.

Any amount paid or distributed out of a health savings account which is not used exclusively to pay the qualified medical expenses of the account beneficiary shall be included in the gross income of such beneficiary.

(4) Additional tax on distributions not used for qualified medical expenses.

(A)  In general. The tax imposed by this chapter on the account beneficiary for any taxable year in which there is a payment or distribution from a health savings account of such beneficiary which is includible in gross income under paragraph (2) shall be increased by 20 percent of the amount which is so includible.

(B)  Exception for disability or death. Subparagraph (A) shall not apply if the payment or distribution is made after the account beneficiary becomes disabled within the meaning of section 72(m)(7) or dies.

(C)  Exception for distributions after medicare eligibility. Subparagraph (A) shall not apply to any payment or distribution after the date on which the account beneficiary attains the age specified in section 1811 of the Social Security Act.

IRS Notice 2004-2, Q/A-25-27:

https://www.irs.gov/irb/2004-02_IRB#NOT-2004-2

Q-25. How are distributions from an HSA taxed?

A-25. Distributions from an HSA used exclusively to pay for qualified medical expenses of the account beneficiary, his or her spouse, or dependents are excludable from gross income. In general, amounts in an HSA can be used for qualified medical expenses and will be excludable from gross income even if the individual is not currently eligible for contributions to the HSA.

However, any amount of the distribution not used exclusively to pay for qualified medical expenses of the account beneficiary, spouse or dependents is includable in gross income of the account beneficiary and is subject to an additional 10% tax on the amount includable, except in the case of distributions made after the account beneficiary’s death, disability, or attaining age 65.

Q-26. What are the “qualified medical expenses” that are eligible for tax-free distributions?

A-26. The term “qualified medical expenses” are expenses paid by the account beneficiary, his or her spouse or dependents for medical care as defined in section 213(d) (including nonprescription drugs as described in Rev. Rul. 2003-102, 2003-38 I.R.B. 559), but only to the extent the expenses are not covered by insurance or otherwise. The qualified medical expenses must be incurred only after the HSA has been established. For purposes of determining the itemized deduction for medical expenses, medical expenses paid or reimbursed by distributions from an HSA are not treated as expenses paid for medical care under section 213.

Q-27. Are health insurance premiums qualified medical expenses?

A-27. Generally, health insurance premiums are not qualified medical expenses except for the following: qualified long-term care insurance, COBRA health care continuation coverage, and health care coverage while an individual is receiving unemployment compensation. In addition, for individuals over age 65, premiums for Medicare Part A or B, Medicare HMO, and the employee share of premiums for employer-sponsored health insurance, including premiums for employer-sponsored retiree health insurance can be paid from an HSA. Premiums for Medigap policies are not qualified medical expenses.

IRS Publication 969:

https://www.irs.gov/pub/irs-pdf/p969.pdf

Qualified medical expenses.

Qualified medical expenses are those expenses that generally would qualify for the medical and dental expenses deduction. These are explained in Pub. 502, Medical and Dental Expenses.

Additional tax.

There is an additional 20% tax on the part of your distributions not used for qualified medical expenses. Figure the tax on Form 8889 and file it with your Form 1040, 1040-SR, or 1040-NR.

Exceptions.

There is no additional tax on distributions made after the date you are disabled, reach age 65, or die.

IRS Form 8889 Instructions:

https://www.irs.gov/pub/irs-pdf/i8889.pdf

Qualified Medical Expenses

Generally, qualified medical expenses for HSA purposes are unreimbursed medical expenses that could otherwise be deducted on Schedule A (Form 1040 or 1040-SR). See the Instructions for Schedule A and Pub. 502, Medical and Dental Expenses. Expenses incurred before you establish your HSA are not qualified medical expenses. If, under the last-month rule, you are considered to be an eligible individual for the entire year for determining the contribution amount, only those expenses incurred after you actually establish your HSA are qualified medical expenses.

Distributions From an HSA

Distributions from an HSA used exclusively to pay qualified medical expenses of the account beneficiary, spouse, or dependents are excludable from gross income. (See the Line 15 instructions for information on medical expenses of dependents not claimed on your return.) You can receive distributions from an HSA even if you are not currently eligible to have contributions made to the HSA. However, any part of a distribution not used to pay qualified medical expenses is includible in gross income and is subject to an additional 20% tax unless an exception applies.

Lines 17a and 17b

Additional 20% Tax

HSA distributions included in income (line 16) are subject to an additional 20% tax unless one of the following exceptions applies.

Exceptions to the Additional 20% Tax

The additional 20% tax does not apply to distributions made after the account beneficiary:

  • Dies,
  • Becomes disabled (see Disabled, earlier), or
  • Turns age 65.

If any of the exceptions apply to any of the distributions included on line 16, check the box on line 17a. Enter on line 17b only 20% (0.20) of any amount included on line 16 that does not meet any of the exceptions.

Disabled

An individual generally is considered disabled if he or she is unable to engage in any substantial gainful activity due to a physical or mental impairment which can be expected to result in death or to continue indefinitely.


Brian Gilmore

About the author

Brian Gilmore

Brian Gilmore is the Lead Benefits Counsel at Newfront. He assists clients on a wide variety of employee benefits compliance issues. The primary areas of his practice include ERISA, ACA, COBRA, HIPAA, Section 125 Cafeteria Plans, and 401(k) plans. Brian also presents regularly at trade events and in webinars on current hot topics in employee benefits law. Connect with Brian on LinkedIn.


The information provided is of a general nature and an educational resource. It is not intended to provide advice or address the situation of any particular individual or entity. Any recipient shall be responsible for the use to which it puts this document. Newfront shall have no liability for the information provided. While care has been taken to produce this document, Newfront does not warrant, represent or guarantee the completeness, accuracy, adequacy, or fitness with respect to the information contained in this document. The information provided does not reflect new circumstances, or additional regulatory and legal changes. The issues addressed may have legal, financial, and health implications, and we recommend you speak to your legal, financial, and health advisors before acting on any of the information provided.

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