Recent IRS Notice provides answers to a variety of technical HSA issues.

In 2003, the Medicare Prescription Drug, Improvement, and Modernization Act added Section 223 to the Internal Revenue Code (Code), permitting eligible individuals to establish Health Savings Accounts (HSAs). HSAs are medical savings accounts to which individuals enrolled in high deductible health plans (HDHPs) and their employers may make tax-free contributions. The account funds may be withdrawn tax-free at any time to pay for qualified medical expenses, which are amounts paid for medical care as defined in Code Section 213(d) for an individual and his or her spouse and dependents.

On June 25, 2008, the Internal Revenue Service (IRS) issued Notice 2008-59 (the Notice), which contains long-awaited guidance in the form of 42 questions and answers on a range of technical HSA issues. The Notice includes detailed examples and addresses HSA eligibility rules, requirements for qualification as an HDHP, contributions to and distributions from HSAs, prohibited transactions and rules on establishing an HSA.

Eligible Individuals

The Notice first tackles situations affecting one’s status as an individual eligible to make HSA contributions. In order to be HSA-eligible, an individual must be covered by an HDHP with a minimum deductible that satisfies Code Section 223 (for 2008, the minimum deductibles are $1,100 for self-only coverage and $2,200 for family coverage). An employer generally cannot pay or reimburse any amount of an employee’s medical expenses before this deductible is satisfied without disqualifying the employee (and the HDHP’s actual deductible may be higher than the statutory minimum).

To be an eligible individual, an individual cannot be covered by any other health plan that provides coverage other than permitted insurance, disregarded coverage or preventive care as defined in Code Section 223. The Notice provides several examples of the effects of other types of health coverage on eligibility. First, the Notice provides that reimbursement of HDHP premiums from a health reimbursement arrangement (HRA) does not constitute disqualifying coverage, even if paid prior to meeting the minimum HDHP deductible. In addition, other, non-HDHP coverage that covers dependents in family HDHP coverage does not constitute disqualifying coverage. However, if an individual with family HDHP coverage is covered by an HRA or flexible spending account (FSA) that reimburses Code Section 213(d) medical expenses of any covered individual before the minimum HDHP deductible has been satisfied, he or she is not an HSA-eligible individual.

With regard to other health coverage, the Notice also states that an individual may be covered by a second, non-HDHP health plan and remain HSA-eligible as long as the second plan has a deductible that equals or exceeds the statutory minimum HDHP deductible. The Notice also clarifies that mere access to benefits does not disqualify an individual. For instance, an individual who is eligible for, but not enrolled in, any Medicare benefit, maintains HSA-eligible status, as does an individual who is eligible for medical benefits through the U.S. Department of Veterans Affairs but only receives medical care that is disregarded coverage or preventive care.

Another issue pertaining to HSA eligibility involves onsite health care. Access to free or below-market health care at an employer’s on-site clinic does not void eligible status as long as the clinic does not provide significant benefits in the nature of medical care. In defining “significant benefits,” the Notice illustrates that a manufacturing plant providing free physicals and immunizations, nonprescription pain relievers and treatment for on-site injuries is not providing significant benefits. On the other hand, a hospital which permits employees to receive free care at its facilities for all medical needs would be providing significant benefits.

The Notice also describes the effects of certain family HDHP coverage on HSA-eligibility. If an individual has family HDHP coverage with an “umbrella deductible” under which benefits are paid once the entire family incurs a minimum amount of covered expenses, but which also has an “embedded individual deductible” which provides benefits to each individual who incurs expenses in excess of the statutory minimum family deductible, that individual may still be an eligible individual. In fact, a post-deductible HRA or FSA may pay or reimburse the qualified medical expenses of an individual with family HDHP coverage at any time after the statutory minimum deductible for family coverage has been satisfied.

High Deductible Health Plans

The Notice clarifies certain issues relating to calculation of deductibles under HDHPs. When changing mid-year from a family HDHP to a self-only HDHP, amounts applicable towards the deductible for the HDHP should be credited towards meeting the self-only limit utilizing any method that is reasonable, consistent and compliant with COBRA continuation coverage requirements. The Notice suggests that appropriate allocation methods include allocating to the self-only deductible only the expenses incurred by the individual; allocating expenses incurred during family coverage on a per-capita basis; or, if the family deductible was satisfied before the change, treating the individual as having satisfied the self-only deductible for that year. The Notice also explains that for purposes of determining whether the HDHP or statutory deductible is satisfied, only qualifying medical expenses under Code Section 213(d) which are also covered by the HDHP may be taken into account.

The Notice also addresses the question of whether an HDHP can subject certain specified benefits to a separate or higher deductible and still remain an HDHP. Plans must provide significant benefits in order to qualify as HDHPs. A plan may be designed with reasonable benefit restrictions, as long as the Plan still provides significant other benefits. Amounts paid to satisfy the separate deductible are not treated as out-of-pocket expenses under Code Section 223. For example, a plan may still be treated as an HDHP if it has a separate, higher deductible for substance abuse treatment benefits than it does for other covered benefits, as long as it provides significant other benefits. In this case, expenses incurred in paying for substance abuse treatments would not be treated as out-of-pocket expenses. However, a plan that only provided benefits for hospitalization expenses would not qualify as an HDHP because significant other benefits are not available in addition to the covered charges.


Eligible individuals and employers may contribute to the HSA up to an annual statutory maximum with respect to the months of the year that the individual was an eligible individual until the due date for filing the individual’s tax return (without extension) for the year. In other words, contributions to HSAs made between January 1 and April 15 of the following year (for most taxpayers) may be allocated to the prior year. Individuals may also make a rollover contribution from an existing HSA to a new HSA.

The Notice explains that coverage for dependent children and spouses by a non-HDHP, Medicare or Medicaid does not affect the contribution limit. Moreover, the maximum limit for a married couple is the statutory maximum for family coverage, even where one spouse has family coverage and the other has self-only coverage or where both spouses have family coverage. In such cases, the contribution limit is divided between the spouses. If eligible to make catch-up contributions, each spouse must make contributions to his or her own HSA.

The Notice also describes employer remedies for contributions made in error. Employers who contribute to the account of an employee who was never an eligible individual may request that the financial institution return the contributions to the employer. Those who contribute in excess of the statutory maximum are permitted to request that the financial institution return any excess amounts. Employers need to recover these amounts by the end of the taxable year; otherwise, such contributions are included as gross income and reported on the employee’s W-2 Form. Employers may not, however, recoup amounts contributed to an HSA for a year in which an employee ceased to be an eligible individual.

Finally, the Notice confirms that contributions by employers to the HSA of a non-employee (for instance, to the spouse of an employee), including salary reduction amounts made through a Code Section 125 cafeteria plan, must be included in the gross income and wages of the employee.


An HSA can be administered through a debit card that restricts payments and reimbursements to health care, but only if the funds in the HSA are otherwise readily available via other methods and the employer provides notice of such methods. Permissible methods include online transfers, withdrawals from automatic teller machines or check writing. Also, an HSA account beneficiary may authorize a third party to withdraw funds from his or her account. However, the beneficiary is liable for a 10 percent additional tax if the funds are used other than to pay qualified medical expenses. In addition, the Notice lists certain costs that constitute qualified medical expenses, including the following:

  • Medicare Part D Premiums for the account beneficiary or his or her spouse once the beneficiary reaches age 65
  • COBRA costs
  • Premiums for a spouse or dependent receiving unemployment compensation
  • Medical expenses incurred by an account beneficiary’s child who is claimed as a dependent by the beneficiary’s former spouse

Prohibited Transactions

The Notice also addresses prohibited transactions under Code Section 4975 as they affect HSAs. If an account beneficiary engages in a prohibited transaction with respect to his or her HSA, the HSA is disqualified as of the first day of the taxable year in which the prohibited transaction occurs. Moreover, the assets are deemed distributed and a 10 percent additional tax applies to distributions that were not used for qualified medical expenses during the year. If the employer was the party engaging in the prohibited transaction, then the employer—not the account beneficiary—is liable for the tax. Prohibited Transactions under the Notice include the following:

  • Any extension of credit between the account beneficiary and his or her HSA
  • Pledging one’s HSA as security for a loan
  • Any extension of credit between the HSA trustee and the HSA

However, if an HSA trustee extends credit to an account beneficiary that is not secured by the account beneficiary’s HSA and that cannot be repaid with HSA funds, the extension of credit is not a prohibited transaction.

Establishing an HSA

The Notice clarifies that only expenses incurred on or after the date of establishment of the HSA may be reimbursed tax-free. Because an HSA holds funds for the account beneficiary as an exempt trust, the law of state in which the trust is sitused determines the date of establishment. The IRS notes that in most states, a trust must actually be funded to be established. State law also determines whether the account beneficiary’s signature is a necessary component to the establishment of the trust.

HSAs funded by rollovers or transfers from an Archer MSA or another HSA retain the original account’s date of establishment, even if the transfer is to another HSA with a new trustee. Moreover, if an account beneficiary has an HSA, and later establishes another, any later HSA carries the original date of establishment as long as the account beneficiary had an HSA with a balance greater than zero at any time during the 18-month period before the new HSA is established.


Finally, the Notice addresses an administrative issue for HSA accounts. An HSA trustee generally receives fees for administration and maintenance of the HSA. These fees should not be reported as distributions from the HSA but instead are reported on Form 5498-SA in the fair market value of the HSA at the end of the taxable year.