(This is part of a series looking at various common 1040 questions. To go back to the summary page, click here)
Since Health Insurance is the political whipping boy du jour, it’s hard to predict exactly what will happen to our insurance plans over the next several years. But for now, one popular option is the High-Deductible Heath Insurance Plan, which has been given the clever acronym HDHP (sorry letter i, you’re not cool enough to hang out in this acronym). If you have an HDHP, you qualify for the potentially tax beneficial Health Savings Account, or HSA.
Here’s the idea of the whole package: a High Deductible Health Insurance Plan serves as a safety net of sorts, an insurance plan in place in case you or your family has a catastrophic medical emergency (Yes, by law they have to cover other treatments, but I’m a tax guy, not an insurance guy, so I’m not talking about those). Since the HDHP only covers the big medical bills, you’ll have to cover the day to day medical expenses without insurance. To help you with that, you can set up a Health Savings Account to set aside money for those ordinary doctor appointments and medical procedures.
With the HSA, you’re potentially entitled to the Health Savings Account Deduction. This deduction allows you to lower your taxable income for the amount of money you put into your savings plan, up to a certain limit. Even better, the Health Savings Account Deduction is one of those so-called “above the line” items, meaning you get to deduct the amount pretty much no matter what, even if you’re not itemizing your tax deductions
Before you try to take your Health Savings Account Deduction like a kid reaching their hand into the bulk candy container, you’ll have to make sure you meet the requirements. First, you have to be covered by ONLY a qualified HDHP, meaning you can’t be covered by any other health insurance plan (including Medicare). You have to remain only covered by that plan for the entire year.
If that’s the case, you can contribute a maximum of $3,330 for yourself, or $6,550 for your family, with an additional $1,000 if you’re over 55 (based on 2014 limitations).
The information for your Health Savings Account must be entered into Form 8889. The form breaks out everything into several wordy lines, such as contributions made by you, made by your employer, etc. This all goes into Part I and is added together to give you a net number to stick on your 1040 Line 25 as your Health Savings Account Deduction.
I’m not going to pretend like this part of Form 8889 is clearly written and easy to understand, because it’s not. The IRS instructions should help, though like all IRS instructions they read like they were written by a committee of pompous lawyers commissioned by the National Society to Knock Out Insomniacs. My best advice here is that if you don’t know what something is, you probably don’t have it. For more details about your particular HDHP or HSA, contact your company’s HR department or, if you’re self employed, whoever runs your Health Savings Account.
Part II of Form 8889 is to insure that all distributions from your Health Savings Account are qualified medical expenses. If you took money out for a non-qualified reason, you not only have to include that amount in income (on your 1040 “Other Income” line), you’ll have to pay an additional 20% penalty.
Finally, Part III of Form 8889 only needs to be completed if you no longer meet the requirements to take a Health Savings Account Deduction during the year. For example, if you switched off a High Deductible Health Insurance Plan midway through the year, you lose your qualified status for the whole year. Similar to Part II, if you’re no longer qualified, you’ll have to pay taxes on your Health Savings Account contributions by reporting it in Other Income, along with taking an additional 20% penalty on the HSA amount.
So that’s it. The logistics of the process are always more confusing than they seem to need to be, but the overall summary isn’t too hard to grasp: if you have a High Deductible Health Insurance Plan, you can get a Health Savings Account deduction if you contribute to an HSA. Unfortunately, this is one of those cases where the government has taken the saying “it’s easier said than done” and turned it into a motto.
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Picture by Sean Lucas