This week, the U.S. Congress passed the Tax Relief and Health Care Act of 2006 (the Act) which is expected to be signed into law shortly by President Bush. A portion of the Act makes exciting new changes to the laws governing Health Savings Accounts (HSAs). In general, HSAs are tax-favored accounts that permit individuals to pay or be reimbursed for current and future qualified medical expenses (To learn more about this subject visit: http://www.mwe.com/info/news/ots0504d.htm). The Act will make it easier for HSA account holders to accumulate greater amounts in their HSAs and to consolidate amounts from various tax-favored accounts into HSAs.
The most significant changes include:
Rollover Health FSAs and HRAs to HSAs
The Act permits individuals with health Flexible Spending Arrangements (FSAs) or Health Reimbursement Arrangements (HRAs) to rollover their funds into an HSA for a limited time. The maximum amount that may be rolled over is the lesser of (i) the balance in the health FSA/HRA as of September 21, 2006, or (ii) the balance in the health FSA/HRA as of the date of the rollover. These balances are determined on a cash basis, meaning that expenses not yet submitted for reimbursement are not taken into account. One rollover is permitted per health FSA or HRA, and the employer must transfer the funds directly to an individual's HSA before January 1, 2012. If an individual who makes a rollover contribution ceases to be an HSA-eligible individual during the 12-month period starting with the month of the rollover contribution and ending 12 months later, the amount rolled over is includible in the individual's gross income and subject to a 10 percent additional tax (however, no amount is included in the income if the individual dies or becomes disabled). This provision is effective on the date of enactment.
Health FSA 'grace period' coverage not treated as disqualifying coverage
The Act provides that health FSA coverage is not treated as disqualifying coverage for purposes of making HSA contributions during a health FSA grace period if (i) the balance in the health FSA at the end of the plan year is zero, or (ii) the individual transfers the balance in the health FSA at the end of the plan year to an HSA under the rollover rule described above. This provision is effective for taxable years beginning after December 31, 2006. Note, however, that because the rollover provision is effective immediately, the two provisions can be used to eliminate disqualifying health FSA coverage for grace periods running from January 1, 2007 through March 15, 2007.
HSA contribution limit increased
The Act changes the maximum contribution to an HSA for 2007 to $2,850 for self-only coverage and $5,650 for family coverage. The Act repeals the current rule under which the maximum HSA contribution is the lesser of (i) the stated deductible under the high deductible health plan (HDHP), or (ii) specified dollar limits for self-only and family coverage.
Full-year HSA contributions permitted for partial-year HDHP enrollees
Under the Act, an individual who is covered under an HDHP during the last month of a taxable year is treated as having been an eligible individual for all prior months in that year. Accordingly, this rule permits an individual to make HSA contributions as if he/she was enrolled in the HDHP during the entire year, provided the individual meets the other eligibility requirements. If an individual takes advantage of this provision and ceases to be an HSA-eligible individual during a 12-month period (starting with the last month of the taxable year and ending 12 months later), then any HSA contributions not made for this provision are includible in the individual's gross income and subject to a 10 percent additional tax (however, no amount is included in income if the individual dies or becomes disabled).
Comparable contribution requirements relaxed
The Act modifies the comparable contribution requirements to permit an employer to make greater HSA contributions for non-highly compensated employees than for highly compensated employees.
Rollovers from IRAs to HSAs
The Act permits an individual to make a one-time rollover from an IRA to an HSA. The rollover must be a direct trustee-to-trustee transfer. The maximum amount that may be transferred is the maximum amount that can be contributed to the HSA for the year in which the transfer is made. If an individual who makes an IRA to HSA rollover contribution ceases to be an HSA-eligible individual during the 12-month period starting with the month of the rollover contribution and ending 12 months later, then the amount rolled over is includible in the individual's gross income and subject to a 10 percent additional tax (however, no amount is included in income if the individual dies or becomes disabled).
Most of the HSA provisions are effective for tax years beginning after December 31, 2006, which means many employers can take advantage of the new rules for next year’s benefit offerings. Employers who offer HSAs to their employees should consider the effect of the new rules on their HSA programs and whether or not to implement such changes for the coming year.