Scott E. Vincent
Vincent & Fontg LLC
Kansas City

The IRS continues to provide additional guidance encouraging employers to implement Health Savings Accounts. As the IRS clarifies rules for using these health care related savings mechanisms, HSAs are becoming more and more popular. CCH recently noted that "HSAs will account for more than 10 percent of insured individuals by 2010 . . . and that there may well be 15 to 25 million individual HSAs holding more than $75 billion in assets within five years." CCH Federal Tax Weekly, Sept 1, 2005, quoting DiamondCluster.

The latest IRS question and answer release encourages this growth by explaining in more detail the requirements for making comparable contributions, and when certain employees can be treated differently. Employers can rely on the new IRS information until future changes are made.

Background

HSAs have beneficial tax treatment: contributions are both tax-free to the employee and deductible as compensation by the employer. Employees later may make withdrawals tax free to cover medical expenses. These tax benefits are available to any HSA that is paired with high deductible health plan (HDHP) coverage.

Unlike many other tax-favored employee benefits, the HSA rules do not have non-discrimination rules restricting benefits provided to highly compensated employees. The HSA statute, however, does require that all employer pre-tax contributions to employee HSAs be comparable. Contributions are comparable if they are either the same amount or the same percentage of the insurance deductible for employees who are eligible individuals within the same category of coverage. The comparable participating employees are eligible individuals who have the same category of HDHP coverage (e.g. individual or family coverage).

Violations

Violating the comparability rules can result in an excise tax of 35 percent on the employer. An employer can request waiver of the 35 percent penalty if its failure to comply with the new regulations is due to reasonable cause and not willful neglect (the normal reasonable cause standard for avoiding IRS penalties). If reasonable cause can be established, the portion of the penalty relating to reasonable cause may be avoided.

Exceptions to Comparability Rules

The new IRS guidance also helps clarify certain categories of non-employees who are not covered by the comparability rules. These non-employees include:

• Independent contractors. Contri-butions to HSAs of independent contractors do not trigger comparable contribution requirements for employees.

• Sole proprietors. Sole proprietors are not employees for HSA purposes. Contributions made by a sole proprietor to his or her HSA are not taken into account when applying the comparability rules.

• Partners. Contributions to a partner's HSA may be treated as either guaranteed payments under Code Sec. 707(c) or distributions under Code Sec. 731, but do not affect the comparability rules.

Employee Categories

The comparability rules apply independently to the following specific categories of employees (these are exclusive categories - no others can be applied):

• Full-time employees (30 or more hours per week);

• Part-time employees; and

• Former employees.

Employer HSA contributions for any employee in one of these categories require comparable HSA contributions for all other employees in that category. Also, if an employer contributes only to the HSAs of employees with coverage under the employer's HDHP, the employer is not required to make comparable contributions for employees who are not covered by the HDHP.

Conclusion

The IRS continues to define the rules for use of HSAs, and insurance companies continue to develop high deductible health plans to pair with these unique savings plans. The release noted here further encourages employer use of these accounts. With even more clarification that employers can provide differing benefits to different categories of workers, expect to see more and more of these accounts over the next few years. And, of course, we all need to determine if they are beneficial for our own practices.