To be an eligible individual and qualify for an HSA, you must meet the following requirements.

Other health coverage.   You (and your spouse, if you have family coverage) generally cannot have any other health coverage that is not an HDHP. However, you can have additional insurance that provides benefits only for the following items.

• Liabilities incurred under workers' compensation laws, tort liabilities, or liabilities related to ownership or use of property.

• A specific disease or illness.

• A fixed amount per day (or other period) of hospitalization.

  You can also have coverage (whether provided through insurance or otherwise) for the following items.

• Accidents.

• Disability.

• Dental care.

• Vision care.

• Long-term care.

  

Plans in which substantially all of the coverage is through the above listed items are not HDHPs. For example, if your plan provides coverage substantially all of which is for a specific disease or illness, the plan is not an HDHP for purposes of establishing an HSA.

Any eligible individual can contribute to an HSA. For an employee's HSA, the employee, the employee's employer, or both may contribute to the employee's HSA in the same year. For an HSA established by a self-employed (or unemployed) individual, the individual can contribute. Family members or any other person may also make contributions on behalf of an eligible individual.

Contributions to an HSA must be made in cash. Contributions of stock or property are not allowed.

Additional contribution.   For 2004, if you are an eligible individual who is age 55 or older, your contribution limit is increased by $500. For example, if you have self-only coverage, you can contribute up to the amount of your annual health plan deductible plus $500, but not more than $3,100. However, see Enrolled in Medicare, later.

Example.

In 2004, you have an HDHP for your family for the entire months of July through December. The annual deductible of the HDHP is $4,000. You reach age 55 on September 5, 2004. On the worksheet for line 3, you would show $4,500 for 6 months (July through December). You divide this total ($27,000) by 12 to determine your contribution limit ($2,250) for the year.

  

For 2005, the additional contribution amount is $600.

You will generally pay medical expenses during the year without being reimbursed by your HDHP until you reach the annual deductible for the plan. When you pay medical expenses during the year that are not reimbursed by your HDHP, you can ask the trustee of your HSA to send you a distribution from your HSA.

You can receive tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA. If you receive distributions for other reasons, the amount you withdraw will be subject to income tax and may be subject to an additional 10% tax. You do not have to make distributions from your HSA each year.

For 2004, if you establish an HSA by April 15, 2005, you can receive tax-free distributions for qualified medical expenses incurred on or after the first day of the first month you became an eligible individual.

A distribution is money you get from your health savings account. The trustee will report any distribution to you and the IRS on Form 1099-SA, Distributions From an HSA, an Archer MSA, or Medicare+Choice MSA.

Special rules for insurance premiums.   Generally, you cannot treat insurance premiums as qualified medical expenses for HSAs. You can, however, treat premiums for long-term care coverage, health care coverage while you receive unemployment benefits, or health care continuation coverage required under any federal law as qualified medical expenses for HSAs. If you are age 65 or older, you can treat insurance premiums (other than premiums for a Medicare supplemental policy, such as Medigap) as qualified medical expenses for HSAs.

  

The premiums for long-term care coverage that you can treat as qualified medical expenses are subject to the limits under section 213(d)(10). These limits are based on age and are adjusted annually.

Do not send these records with your tax return. Keep them with your tax records.

An HSA is generally exempt from tax. You are permitted to take a distribution from your HSA at any time; however, only those amounts used exclusively to pay for qualified medical expenses are tax free. Amounts that remain at the end of the year are generally carried over to the next year (see Excess contributions, earlier). Earnings on amounts in an HSA are not included in your income while held in the HSA.

You should choose a beneficiary when you set up your HSA. What happens to that HSA when you die depends on whom you designate as the beneficiary.

You must file Form 8889 and file it with your Form 1040 if you (or your spouse, if married filing a joint return) had any activity in your HSA during the year. You must file the form even if only your employer or your spouse's employer made contributions to the HSA.

This section contains the rules that employers must follow if they decide to make HSAs available to their employees. Unlike the previous discussions, “you” refers to the employer and not to the employee.

An Archer MSA is a tax-exempt trust or custodial account that you set up with a U.S. financial institution (such as a bank or an insurance company) in which you can save money exclusively for future medical expenses.

Qualifying for an Archer MSA

To qualify for an Archer MSA, you must be either of the following.

• An employee (or the spouse of an employee) of a small employer (defined later) that maintains an individual or family HDHP for you (or your spouse).

• A self-employed person (or the spouse of a self-employed person) who maintains an individual or family HDHP.

You can have no other health or Medicare coverage except what is permitted under Other health coverage, later. You must be an eligible individual on the first day of a given month to get an Archer MSA deduction for that month.

If another taxpayer is entitled to claim an exemption for you, you cannot claim a deduction for an Archer MSA contribution. This is true even if the other person does not actually claim your exemption.

Small employer.   A small employer is generally an employer who had an average of 50 or fewer employees during either of the last 2 calendar years. The definition of small employer is modified for new employers and growing employers.

Growing employer.   A small employer may begin HDHPs and Archer MSAs for his or her employees and then grow beyond 50 employees. The employer will continue to meet the requirement for small employers if he or she:

• Had 50 or fewer employees when the Archer MSAs began,

• Made a contribution that was excludable or deductible as an Archer MSA for the last year he or she had 50 or fewer employees, and

• Had an average of 200 or fewer employees each year after 1996.

Changing employers.   If you change employers, your Archer MSA moves with you. However, you may not make additional contributions unless you are otherwise eligible.

High deductible health plan (HDHP).   To be eligible for an Archer MSA, you must have an HDHP. An HDHP has:

• A higher annual deductible than typical health plans, and

• A maximum limit on the annual out-of-pocket medical expenses that you must pay for covered expenses.

Limits.   The following table shows the limits for annual deductibles and the maximum out-of-pocket expenses for high deductible health plans for 2004.

  

Type of coverage	Minimum annual deductible	Maximum annual deductible	Maximum annual out-of-pocket expenses
Self-only	$1,700	$2,600	$3,450
Family	$3,450	$5,150	$6,300

Family plans that do not meet the high deductible rules.   There are some family plans that have deductibles for both the family as a whole and for individual family members. Under these plans, if you meet the individual deductible for one family member, you do not have to meet the higher annual deductible amount for the family. If either the deductible for the family as a whole or the deductible for an individual family member is below the minimum annual deductible for family coverage, the plan does not qualify as an HDHP.

Example.

You have family health insurance coverage in 2004. The annual deductible for the family plan is $4,500. This plan also has an individual deductible of $2,000 for each family member. The plan does not qualify as an HDHP because the deductible for an individual family member is below the minimum annual deductible ($3,450) for family coverage.

Other health coverage.   You (and your spouse, if you have family coverage) generally cannot have any other health coverage that is not an HDHP. However, you can have additional insurance that provides benefits only for the following items.

• Liabilities from workers' compensation laws, torts, or ownership or use of property.

• A specific disease or illness.

• A fixed amount per day (or other period) of hospitalization.

You can also have coverage (whether provided through insurance or otherwise) for the following items.

• Accidents.

• Disability.

• Dental care.

• Vision care.

• Long-term care.

Contributions to an Archer MSA must be made in cash. You cannot contribute stock or other property to an Archer MSA.

Who can contribute to my Archer MSA?   If you are an employee, your employer may make contributions to your Archer MSA. (You do not pay tax on these contributions.) If your employer does not make contributions to your Archer MSA, or you are self-employed, you can make your own contributions to your Archer MSA. Both you and your employer cannot make contributions to your Archer MSA in the same year. You do not have to make contributions to your Archer MSA every year.

  

If your spouse is covered by your HDHP and an excludable amount is contributed by your spouse's employer to an Archer MSA belonging to your spouse, you cannot make contributions to your own Archer MSA that year.

Limits

There are two limits on the amount you or your employer can contribute to your Archer MSA.

• The annual deductible limit.

• An income limit.

Annual deductible limit.   You (or your employer) can contribute up to 75% of the annual deductible of your HDHP (65% if you have a self-only plan) to your Archer MSA. You must have the HDHP all year to contribute the full amount. If you do not qualify to contribute the full amount for the year, determine your annual deductible limit by using the worksheet for line 5 in the Form 8853 instructions.

Example 1.

You have an HDHP for your family all year in 2004. The annual deductible is $4,000. You can contribute up to $3,000 ($4,000 × 75%) to your Archer MSA for the year.

Example 2.

You have an HDHP for your family for the entire months of July through December, 2004 (6 months). The annual deductible is $4,000. You can contribute up to $1,500 ($4,000 × 75% for 6 months ÷ 12) to your Archer MSA for the year.

If you and your spouse each have a family plan, you are treated as having family coverage with the lower annual deductible of the two health plans. The contribution limit is split equally between you unless you agree on a different division.

Income limit.   You cannot contribute more than you earned for the year from the employer through whom you have your HDHP.

  If you are self-employed, you cannot contribute more than your net self-employment income. This is your income from self-employment minus expenses (including the one-half of self-employment tax deduction).

Example 1.

Bob Smith earned $25,000 from ABC Company in 2004. Through ABC, he had an HDHP for his family for the entire year. The annual deductible was $4,000. He can contribute up to $3,000 to his Archer MSA (75% × $4,000). He can contribute the full amount because he earned more than $3,000 at ABC.

Example 2.

Joe Craft is self-employed. He had an HDHP for his family for the entire year in 2004. The annual deductible was $3,600. Based on the annual deductible, the maximum contribution to his Archer MSA would have been $2,700 (75% × $3,600). However, after deducting his business expenses, Joe's net self-employment income is $1,950 for the year. Therefore, he is limited to a contribution of $1,950.

Individuals enrolled in Medicare.   Beginning with the first month you are enrolled in Medicare, you cannot contribute to an Archer MSA. However, you may be eligible for a Medicare Advantage MSA, discussed later.

You will generally pay medical expenses during the year without being reimbursed by your HDHP until you reach the annual deductible for the plan. When you pay medical expenses during the year that are not reimbursed by your HDHP, you can ask the trustee of your Archer MSA to send you a distribution from your Archer MSA.

You can receive tax-free distributions from your Archer MSA to pay for qualified medical expenses (discussed later). If you receive distributions for other reasons, the amount will be subject to income tax and may be subject to an excise tax as well. You do not have to make withdrawals from your Archer MSA each year.

A distribution is money you get from your Archer MSA. The trustee will report any distribution to you and the IRS on Form 1099-SA, Distributions From an HSA, Archer MSA, or Medicare+Choice MSA.

Qualified medical expenses.   Qualified medical expenses are those expenses that would generally qualify for the medical and dental expenses deduction. These are explained in Publication 502, Medical and Dental Expenses. Examples include amounts paid for doctors' fees, prescription and non-prescription medicines, and necessary hospital services not paid for by insurance. Qualified medical expenses are those incurred by you, your spouse, and your dependents.

  

You cannot deduct qualified medical expenses as an itemized deduction on Schedule A (Form 1040) that are equal to the tax-free distribution from your Archer MSA. This is the amount on line 9 of Form 8853.

Do not send these records with your tax return. Keep them with your tax records.

Reporting Distributions on Your Return

How you report your distributions depends on whether or not you use the distribution for qualified medical expenses (defined later).

• If you use a distribution from your Archer MSA for qualified medical expenses, you do not pay tax on the distribution but you have to report the distribution on Form 8853. Follow the instructions for the form and file it with your Form 1040.

• If you do not use a distribution from your Archer MSA for qualified medical expenses, you must pay tax on the distribution. Report the amount on Form 8853 and file it with your Form 1040. If you have a taxable Archer MSA distribution, include it in the total on Form 1040, line 21, and enter “MSA” and the amount on the dotted line next to line 21. You may have to pay an additional tax on your taxable distribution.

If an amount (other than a rollover) is contributed to your Archer MSA this year (by you or your employer), you also must report and pay tax on a distribution you receive from your Archer MSA this year that is used to pay medical expenses of someone who is not covered by an HDHP, or is also covered by another health plan that is not an HDHP, at the time the expenses are incurred. See the instructions for Form 8853 for more information.

Rollovers.   Generally, any distribution from an Archer MSA that you roll over into another Archer MSA or an HSA is not taxable if you complete the rollover within 60 days. You can make only one rollover contribution to an Archer MSA during a 1-year period. See the instructions for From 8853 for more information.

Additional tax.   There is a 15% additional tax on the part of your distributions not used for qualified medical expenses. Figure the tax on Form 8853 and file it with your Form 1040. Report the additional tax on Form 1040, line 62, and enter “MSA” and the amount on the dotted line next to line 62.

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

An MSA is generally exempt from tax. You are permitted to take a distribution from your Archer MSA at any time; however, only those amounts used exclusively to pay for qualified medical expenses are tax free. Amounts that remain at the end of the year are generally carried over to the next year (see Excess contributions, earlier). Earnings on amounts in an MSA are not included in your income while held in the MSA.

You should choose a beneficiary when you set up your Archer MSA. What happens to that Archer MSA when you die depends on whom you designate as the beneficiary.

You must file Form 8853 with your Form 1040 if you (or your spouse, if married filing a joint return) had any activity in your Archer MSA during the year. You must file the form even if only your employer or your spouse's employer made contributions to the Archer MSA.

This section contains the rules that employers must follow if they decide to make Archer MSAs available to their employees. Unlike the previous discussions, “you” refers to the employer and not to the employee.

A Medicare Advantage MSA is an Archer MSA designated by Medicare to be used solely to pay the qualified medical expenses of the account holder. To be eligible for a Medicare Advantage MSA, you must be enrolled in Medicare and have a high deductible health plan (HDHP) that meets the Medicare guidelines.

A Medicare Advantage MSA is a tax-exempt trust or custodial savings account that you set up with a financial institution (such as a bank or an insurance company) in which the Medicare program can deposit money for qualified medical expenses. The money in your account is not taxed if it is used for qualified medical expenses, and it may earn interest or dividends.

An HDHP is a special health insurance policy that has a high deductible. You choose the policy you want to use as part of your Medicare Advantage MSA plan. However, the policy must be approved by the Medicare program.

Medicare Advantage MSAs are administered through the Federal Medicare program. You can get information by calling 1-800-Medicare (1-800-633-4227) or through the Internet at www.medicare.gov.

Health FSAs are employer-established benefit plans. These may be offered in conjunction with other employer-provided benefits as part of a cafeteria plan. Employers have complete flexibility to offer various combinations of benefits in designing their plan. You do not have to be covered under any other health care plan to participate.

Self-employed persons are not eligible for an FSA.

You contribute to your FSA by electing an amount to be voluntarily withheld from your pay by your employer. This is sometimes called a salary reduction agreement. The employer may also contribute to your FSA if specified in the plan.

You do not pay federal income tax or employment taxes on the salary you contribute or the amounts your employer contributes to the FSA. However, contributions made by your employer to provide coverage for long-term care insurance must be included in income.

Distributions from a health FSA must be paid only to reimburse you for qualified medical expenses you incurred during the period of coverage. You must be able to receive the maximum amount of reimbursement (the amount you have elected to contribute for the year) at any time during the coverage period, regardless of the amount you have actually contributed. The maximum amount you can receive tax free is the total amount you elected to contribute to the health FSA for the year.

You must provide the health FSA with a written statement from an independent third party stating that the medical expense has been incurred and the amount of the expense. You must also provide a written statement that the expense has not been paid or reimbursed under any other health plan coverage. The FSA cannot make advance reimbursements of future or projected expenses.

Qualified medical expenses.   Qualified medical expenses are those specified in the plan that would generally qualify for the medical and dental expenses deduction. These are explained in Publication 502, Medical and Dental Expenses. Examples include amounts paid for doctors' fees, prescription and non-prescription medicines, and necessary hospital services not paid for by insurance.

  You cannot receive distributions from your FSA for the following expenses.

• Amounts paid for health insurance premiums.

• Amounts paid for long-term care coverage or expenses.

• Amounts that are covered under another health plan.

If you are covered under both a health FSA and an HRA, see Notice 2002-45, Part V, which is on page 93 of Internal Revenue Bulletin 2002-28 at www.irs.gov/pub/irs-irbs/irb02–28.pdf.

  

You cannot deduct qualified medical expenses as an itemized deduction on Schedule A (Form 1040) that are equal to the distribution you receive from the FSA.

Flexible spending accounts are “use-it-or-lose-it ” plans. This means that amounts in the account at the end of the plan year cannot be carried over to the next year. Your employer is not permitted to refund any part of the balance to you.

For the health FSA to maintain tax-qualified status, employers must comply with certain requirements that apply to cafeteria plans. For example, there are restrictions for plans that cover highly compensated employees and key employees. The plans must also comply with rules applicable to other accident and health plans. Chapters 1 and 2 of Publication 15-B, Employer's Tax Guide to Fringe Benefits, explain these requirements.

HRAs are employer-established benefit plans. These may be offered in conjunction with other employer-provided health benefits. Employers have complete flexibility to offer various combinations of benefits in designing their plan. You do not have to be covered under any other health care plan to participate.

Self-employed persons are not eligible for an HRA.

HRAs are funded solely through employer contributions and may not be funded through employee salary deferrals under a cafeteria plan. These contributions are not included in the employee's income. You do not pay federal income taxes or employment taxes on amounts your employer contributes to the HRA.

Distributions from an HRA must be paid to reimburse you for qualified medical expenses you have incurred. The expense must have been incurred on or after the date you are enrolled in the HRA. If any distribution is, or can be, made for other than the reimbursement of qualified medical expenses, any distribution (including reimbursement of qualified medical expenses) made in the current tax year is included in gross income.

Reimbursements under an HRA can be made to the following persons.

Qualified medical expenses.   Qualified medical expenses are those specified in the plan that would generally qualify for the medical and dental expenses deduction. These are explained in Publication 502, Medical and Dental Expenses. Examples include amounts paid for doctors' fees, prescription and non-prescription medicines, and necessary hospital services not paid for by insurance.

  Qualified medical expenses from your HRA include the following.

• Amounts paid for health insurance premiums.

• Amounts paid for long-term care coverage.

• Amounts that are not covered under another health plan.

If you are covered under both an HRA and a health FSA, see Notice 2002-45, Part V, which is on page 93 of Internal Revenue Bulletin 2002-28 at www.irs.gov/pub/irs-irbs/irb02–28.pdf

  

You cannot deduct qualified medical expenses as an itemized deduction on Schedule A (Form 1040) that are equal to the distribution from the HRA.

Amounts that remain at the end of the year can generally be carried over to the next year. Your employer is not permitted to refund any part of the balance to you. These amounts may never be used for anything but reimbursements for qualified medical expenses.

For an HRA to maintain tax-qualified status, employers must comply with certain requirements that apply to other accident and health plans. Chapters 1 and 2 of Publication 15-B, Employer's Tax Guide to Fringe Benefits, explain these requirements.