Know Which Family Members' Expenses Are HSA-qualified

By William G. Stuart | Originally posted on LinkedIn for Health Savings Academy

This column is an excerpt (Question 102) from a book to be published later this year to help guide account owners, employers, benefits managers, and administrators understand Health Savings Account compliance issues. The format consists of a common question, an explanation in easy-to-understand English (often with an appropriate example), and citation from government documents to support the answer. The book is designed to inform. It is not a legal document, and the contents should not be construed as legal advice.

Question: Whose expenses can I reimburse tax-free from my Health Savings Account?

Answer: You can withdraw funds tax-free from your Health Savings Account to reimburse all qualified expenses that you, your spouse, and your tax dependents incur.

Note that this list may be different from the family members whom you cover on your medical plan. Coverage on your medical plan isn’t relevant when determining whose expenses you can reimburse tax-free from your Health Savings Account. Nor is whether a family member enrolled on your plan is eligible to fund a Health Savings Account. Eligibility to enroll in medical coverage is determined by federal and state laws, insurer rules, and employer choices.

In contrast, the federal tax code alone determines whose expenses you can reimburse tax-free from your Health Savings Account.

You may cover on your HSA-qualified medical plan a domestic partner, an ex-spouse, or a child who’s under age 26 and no longer your tax dependent. But you can’t reimburse their qualified expenses tax-free from your account.

What matters is the tax relationship when determining whose expenses you can reimburse tax-free from your Health Savings Account. If the family member is your spouse or qualifies as a tax dependent at the time the qualified expense is incurred (regardless of when you reimburse the qualified expense), you can reimburse the expenses tax-free from your account. This holds true whether the family member is enrolled on your medical coverage or is HSA-eligible herself.

Example: You cover yourself, your domestic partner, your 14-year-old daughter and your 25-year-old banker son on your medical plan. You can reimburse tax-free your own and your daughter’s qualified expenses from your Health Savings Account. You cannot reimburse tax-free any expense incurred by your domestic partner or your son who’s no longer a tax dependent. You can continue to cover them on your medical plan, but their qualified expenses aren’t eligible for tax-free distribution from your Health Savings Account. If you subsequently marry your domestic partner, all her qualified expenses incurred on or after the date of the marriage qualify for tax-free distribution from your account.

You don’t face a time limit to withdraw funds tax-free from your Health Savings Account to reimburse these family members’ qualified expenses.

Example: Your daughter is now 28 years old. A dozen years ago, you paid for her orthodontic care through a combination of dental insurance ($1,000), your Health FSA ($2,300), and $2,000 of personal funds. You had already established your Health Savings Account, but you didn’t realize that you could reimburse her orthodontic expenses tax-free. You can withdraw tax-free an additional $2,000 at any time from your Health Savings Account and match the distribution with those orthodontic expenses that you paid at the time with personal funds, even though your daughter hasn’t qualified as your tax dependent for years. If she was your tax dependent when she incurred the qualified expense, you can reimburse it from your account at any point in the future.

IRS Notice 2004-2:

Q-25. How are distributions from an HSA taxed?

A-25. Distributions from an HSA used exclusively to pay for qualified medical expenses of the account beneficiary, his or her spouse, or dependents are excludable from gross income. In general, amounts in an HSA can be used for qualified medical expenses and will be excludable from gross income even if the individual is not currently eligible for contributions to the HSA. However, any amount of the distribution not used exclusively to pay for qualified medical expenses of the account beneficiary, spouse or dependents is includable in gross income of the account beneficiary and is subject to an additional 10% tax on the amount includable, except in the case of distributions made after the account beneficiary's death, disability, or attaining age 65.