IRS Relents on Contribution Limit for Health Savings Accounts

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By Keith Hill and Michael Trimarchi

Employees may treat $6,900 as the maximum deductible health savings account contribution for 2018 instead of $6,850, the Internal Revenue Service said April 26.

The change addresses concerns that a recently announced lower 2018 contribution limit for HSAs would overly burden payroll operations.

Relief for tax-free health savings account contribution limits was provided to employers with employees who have family coverage under a high-deductible health plan.

The American Payroll Association, in a letter to the agency dated April 6, sought transition relief in 2018 for the HSA contribution limit that was reduced March 5 under the new tax law (Pub. L. 115-97), which was signed Dec. 22, 2017, by President Donald Trump. The maximum contribution was reduced by $50 to $6,850 because of a change in the inflation adjustment calculations, the IRS said in Revenue Procedure 2018-27. The change was applied retroactively to Jan. 1, 2018, which the association said put an administrative strain on employers.

The $50 change had to be reported as taxable income, which would require an adjustment by payroll departments at a cost to employers that far exceeds $50, the association said. The change and retroactive application complicated payroll operations because contributions are paid in full by employees at the start of the year or spread throughout the year, the APA said. “A surprising number of accounts were fully funded” at the $6,900 level by Jan. 1, 2018, the letter said.

About 21.8 million Americans had an HSA and a high-deductible health plan in 2017, up from 20.2 million in 2016, America’s Health Insurance Plans said April 12 in a survey. The group is an advocacy and trade association with headquarters in Washington.

To contribute to an HSA, employees must participate in a high-deductible health plan. High-deductible plans generally have lower premiums and higher deductibles than traditional health insurance plans. For 2018, high-deductible plans have an annual deductible of at least $1,350 for self-only coverage and $2,700 for family coverage.

Health-savings accounts are linked to high-deductible health plans that allow employees to contribute pretax dollars to pay for some medical expenses. These tax-favored accounts that may be opened by an employer, an employee, or a combination of both, may be created without permission from the IRS.

Payroll System Adjustments Take Time

Transition relief was needed “to significantly reduce the administrative burden on employers and their payroll departments,” the association said. For example, employers have to notify employees of the change and make adjustments to payroll systems, the APA said.

“When adjusting their payroll systems to accommodate the change, employers must notify employees of the changes that affect their HSA contributions,” the association said. “For large employers, especially those with remote employees, making the adjustment is not a small task.”

Cost estimates were difficult to assess because there is disagreement under Labor Department rules for the Employee Retirement Income Security Act and safe-harbor for HSA plans “about whether the plan sponsor can unilaterally make the necessary changes or whether the employee must actively request a corrective return for excess contributions,” the association said in the letter.

“Some practitioners have estimated costs at $150 per affected account. This may be conservative,” the APA said. “If an employee needs to actively make the request to the employer, continuing rounds of correspondence are bound to ensue, which creates additional expense to the employer.”

New Tax Law Led to Recalculation

The IRS first released the 2018 contribution limits May 4, 2017, in Revenue Procedure 2017-37, but the new tax law changed how those limits were calculated. The guidance generally is issued by midyear to give employers time to adjust payroll operations, the association said. Revisions to the amounts were announced March 5 by the agency in Revenue Procedure 2018-18.

After the announcement, employers and holders of health-savings accounts told the Treasury Department and the IRS that the $50 reduction would impose unanticipated administrative and financial burdens because some employees had family coverage under a high-deductible health plan and had made the maximum contribution before the reduction took effect, the agency said. Other account holders made salary-reduction elections based on the $6,900 limit, it said.

Contributions and withdrawals related to an HSA to pay for covered medical expenses are not considered taxable income to employees. This arrangement makes the accounts different from other tax-advantaged benefit accounts. Employer contributions to HSAs are not subject to federal income tax withholding, Social Security tax, Medicare tax, or contributions under the Federal Unemployment Tax Act if it is reasonable to believe at the time of payment of contributions that they will be excluded from employee income.

Funds that remain in an HSA at the end of the year roll over tax free to the next year. Contributions by employers and employees belong to the employee account holders. Employees changing employers may take the account with them to the new job.

With the change in policy, the Treasury Department and the IRS allowed taxpayers to treat the $6,900 annual limitation originally published in Revenue Procedure 2017-37 as the 2018 inflation-adjusted limit on HSA contributions for eligible individuals with family coverage under a high-deductible health plan because “it is in the best interest of sound and efficient tax administration,” the IRS said.

Taxpayers who contributed an amount in excess of $6,850, up to the $6,900 maximum, and who received as a distribution the difference between the two amounts, may treat the distribution as a mistake and repay the health-savings account without tax or reporting consequences, the IRS said. The revenue procedure also clarified how to treat the distribution of an excess contribution and earnings based on the $6,850 deduction limit, the agency said.

To contact the reporter on this story: Keith Hill in Washington at khill@bloombergtax.com and Michael Trimarchi at mtrimarchi@bloombergtax.com. To contact the editor responsible for this story: Michael Baer at mbaer@bloombergtax.com.

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