In tax, as in most contact sports, you’re penalized for going out of bounds, and the rules can be arcane. For example, if you have a health savings account (HSA), you may owe penalties for excess contributions, taxable distributions, or failing to maintain insurance coverage under a high deductible health plan.
Avoiding the penalty for excess contributions seems simple, since the IRS publishes inflation-adjusted contribution limits annually. However, contributions can be limited in some circumstances, such as when you’re eligible for Medicare. The maximum HSA contribution in that case is prorated based on the number of months you’re an eligible individual, whether you have self-only or other than self-only coverage, and the number of months you’re not enrolled in Medicare. In fact, you’re not eligible to open an HSA if you’re entitled to benefits under Medicare (internal revenue code section 223).
In addition, your contributions are limited if you delay applying for Medicare and are later covered retroactively to the month you turned 65. In that case, you can’t make contributions to your HSA for the period of retroactive coverage. There are no exceptions to this rule (information letter 2016-0082).
Of course, you can still avoid the penalty because the general rules for when penalties apply have exceptions. In the case of retroactive benefits, you’d have to withdraw from your HSA some or all of the excess contributions by the due date, including extensions, of your tax return for the year the contributions were made. You’ll also have withdraw the income you earned on the withdrawn contributions and include the earnings in “other income” on your tax return.
What happens if you’re already receiving Medicare and you establish an HSA? Will you have to pay a fine for excess contributions?
In information letter 2017-0003, the taxpayer retired from his job and enrolled in Medicare Parts A and B in September 2014. In February 2015, he returned to work for the same employer and enrolled in his employer’s health plan and was provided with an HSA to which his employer made contributions on his behalf. After learning that his Medicare enrollment disqualified him from eligibility for an HSA, he wrote to Social Security to request cancellation of his Medicare enrollment. He never received a decision on his request.
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Under Internal Revenue Code section 223, to be eligible for an HSA, an individual must:
–Be covered under a high-deductible health plan (HDHP) on the first day of the month
–Not be covered by any other health plan that is not an HDHP (with certain limited exceptions)
–Not be entitled to benefits under Medicare
–Not be claimed as a dependent on another person’s tax return.
“Entitled to benefits under Medicare” means enrolled in Medicare. Thus, if an individual is enrolled and receiving benefits from any part of Medicare, he or she cannot contribute to an HSA.
The taxpayer is correct that his Medicare enrollment disqualified him from establishing an HSA. He never had a valid HSA because he was never eligible to establish an HSA. Accordingly, he must withdraw the funds from his account and include them in his income. This withdrawal will not be subject to a fine, however.
The question of whether an employee enrolled in Medicare can withdraw from the program and thereby participate in an employer’s HSA program is not within the jurisdiction of the IRS. This question should be directed to the Social Security Administration.