Health Savings Accounts and Taxes

Tip! State and Local Taxes: Depending on where you live, you will face a variety of state and local tax requirements. All but nine states (Alaska, Wyoming, Nevada, Florida, Tennessee, South Dakota, New Hampshire, Texas, and Washington) have state personal-income taxes.

HSAs have a “triple” tax advantage from a federal tax standpoint. Individuals receive full tax advantages for HSAs on their Federal Income Tax return (or through a salary reduction program in certain employer-sponsored settings) regardless of particular state’s tax treatment of HSAs.

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An account beneficiary may take an above-the-line deduction (i.e. the amounts may be used to determine the individual’s adjusted gross income before any itemized or standard deductions are considered) for contributions made to an HSA during any month of the individual’s taxable year that the individual is eligible. The permitted deduction cannot exceed the sum of the “monthly limitations” for such months. In 2006, the monthly limitation for any month is 1/12th of the following amounts:

- For those with single coverage on the first day of the month, the lesser of the annual deductible under the HDHP or $2,700.

Tip! Participate in company retirement plans. Every dollar you contribute will reduce your taxable income and thus your income taxes.

- For those with family coverage on the first day of the month, the lesser of the annual deductible under the HDHP or $5,450.

Funds in an HSA grow on a tax-deferred basis, and distributions from an HSA are tax-free so long as the funds are used for qualified (as defined by Section 213d of the IRC) health care expenses.

How does state tax treatment of HSAs differ from federal tax treatment?

HSAs (and the enabling legislation) are federal. As a federal program, each state decides whether to: a) comply with the federal guidelines, or; b) establish their own state guidelines regarding the tax treatment of HSAs. As a result, some income that may be tax-free at the federal level may not be tax-free at the state level.

Tip! Invest in your children’s names. Your kids can each earn up to $700 in investment income without paying any taxes if they are over fourteen.

Many states harmonize their tax treatment with the federal government. Those states include Arizona, Arkansas, Colorado, Connecticut, Delaware, Georgia, Hawaii, Idaho, Iowa, Indiana, Kansas, Kentucky, Louisiana, Maryland, Missouri, Mississippi, New York, Montana, Nebraska, New Mexico, Oklahoma, North Carolina, North Dakota, Pennsylvania, South Carolina, Oregon, Rhode Island, Virginia, Utah and Vermont.

Other states, however, treat HSAs differently from the federal government, at least for tax purposes. The following states have indicated that legislation must be passed at the state level before HSAs receive a tax benefit at the state level: California, Illinois, Maine, Massachusetts, Michigan, Minnesota, New Hampshire, New Jersey, Ohio, Washington DC, Wisconsin, West Virginia and Tennessee. New Hampshire and Tennessee do not tax income, but do tax dividends and interest. Alabama has not indicated their position regarding state-level tax benefits for HSAs.
Finally, some states are not affected by federal income tax guidance vis-�-vis HSAs: those states include Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming.

Tip! Donate your old clothes and furniture to your favorite charity. Cleaning out the attic, the closets, that spare room, and the garage is not only purifying but will help to decrease your taxes.

Kurt Stammberger is VP, Marketing at Healthia Inc. Healthia provides integrated comparison-shopping information on health care products and services, doctors and health insurance plans to empower the drive towards Consumer-Driven Health Care.

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Tags: taxes, tax, income tax