By Rich Glass, Mercer Health & Benefits LLC

Disqualification is a concern for athletes in many competitions, before (a false start), during (a soccer red card), and after (a failed drug test) the event.

The same holds true for eligibility for health savings accounts (HSAs). Disqualification is an ongoing concern, and there are many ways individuals can make themselves ineligible for HSA contributions. Reminding employees how they can remain HSA eligible is especially important this time of year, as we enter open enrollment season for calendar-year plans. But before providing a Top 10 list of HSA disqualifications, let’s address three preliminary matters.

1. The HSA Eligibility and Distribution Rules Are Different.

One can get the proverbial red card and become disqualified, yet still be able to receive tax-free HSA distributions for medical care expenses, as defined in Code Section 213(d). Also, a spouse can be HSA ineligible, and the employee’s HSA still can provide tax-free distributions for the spouse’s out-of-pocket medical care expenses.

2. Corrective Distributions Are a Viable Solution.

When disqualification comes to light and an individual has contributed too much to an HSA, a corrective distribution is often a viable solution. The corrective distribution is equal to the amount that should not have been contributed, plus any earnings on the amount. It must be taken before the individual tax filing deadline for the tax year in which the excess contributions occurred, generally April 15 of the following year.

A corrective distribution avoids having to report the excess contribution as taxable income, plus a 6% excise tax for each year that the contribution remains in the HSA. The downside of a corrective distribution is that you no longer have the triple tax advantage that HSAs offer:

• Tax-free contributions
• Tax-free earnings on contributions
• Tax-free distributions (if these funds reimburse qualified medical care expenses)

In some cases, a corrective distribution may not be necessary if an employee has been contributing less than the maximum amount to the HSA each month. HSA eligibility is determined monthly. Thus, if an employee’s monthly HSA contribution was, for example, $200 less than the maximum allowed, and in November the employee became HSA ineligible, then 2 months of HSA ineligibility would not matter. The 10 months of HSA eligibility are more than enough to cover it.

3. Employers Are Not Responsible for Guarding Against Disqualification.

In 2004, the Internal Revenue Service (IRS) confirmed that an employer only has three responsibilities regarding HSA eligibility and communicating this to the HSA custodian:

• Ensure the employee is covered by an HSA-eligible high-deductible health plan (HDHP) sponsored by the employer;
• Confirm that the employee is not covered by any non-HDHP coverage sponsored by the employer; and
• Provide the employee’s age (for purposes of the catch-up contribution).

So why should employers care about HSA disqualification if it is primarily an employee concern? The reason is simple. Employers normally want to make HSAs as easy and accessible as possible because the HSA-HDHP model presents an increasingly affordable option as healthcare costs continue to outpace inflation.

The Top 10 List

Without further delay, here is the Top 10 list of HSA disqualifications:

1. General-purpose health flexible savings account (FSA) or health reimbursement arrangement. This is among the most common disqualifications. It’s not that the employee’s employer allowed them in the general-purpose account, which reimburses any and all medical care expenses. These days employers will set up eligibility rules that only allow HSA-eligible employees in a limited purpose (dental, vision, preventive care only) or post-deductible health FSA or HRA (or a combination of the two). Instead, it is the employee’s spouse or domestic partner who has a general-purpose health FSA that covers the employee. It does not matter if the employee’s expenses are never reimbursed from the spouse’s general-purpose health FSA. That coverage is a disqualifier.
2. Medicaid. Medicaid coverage is first-dollar medical coverage for low-income individuals. It is generally a payer of last resort, such that a low-paid new hire still might qualify for Medicaid and be eligible for employer-sponsored coverage. The HSA rules do not provide an exception for Medicaid.
3. Medicare. Medicare enrollment, not eligibility, disqualifies a person from HSA contributions, starting on the first of the month in which Medicare begins. Age-based, disability-based, and end-stage renal disease-based Medicare all make one HSA ineligible. One rule often catches retirees by surprise. If someone retires within 6 months after reaching age 65, Medicare enrollment is retroactively effective to the first day of the birthday month. This means several months of HSA contributions could be reclassified as HSA-ineligible months.
4. Indian Health Service (IHS) and U.S. Department of Veterans Affairs (VA) coverage. These two benefits have a lot in common when it comes to HSA eligibility. For one thing, IHS and VA coverage is based on your status (tribe membership and military service, respectively); they are not based on any type of election. Eligible individuals have this coverage whether they use it or not. Recognizing this fact, an individual can have either type of coverage and be HSA-eligible as long as they have not received care from IHS or received any VA benefits in the prior 3 months.

   There are exceptions. For IHS benefits, if an individual receives dental, vision, or preventive care—even in the prior 3 months—he or she is still HSA-eligible.

5. TRICARE. This coverage pays benefits before the HDHP deductible is met and clearly makes one ineligible for HSA contributions. TRICARE coverage is available to active duty military personnel, including members of the Coast Guard, retired military veterans, their families, and survivors. TRICARE’s effect on HSAs is especially important to communicate for employers that hire veterans in large numbers.
6. On-site medical clinics. This type of coverage is appealing to employers with large populations at one or more work locations. Time off can be minimized when the healthcare provider is on premises. However, clinics can jeopardize HSA eligibility, unless they do not provide significant benefits in the nature of medical care. The challenge is that the term has not been fully defined.

   IRS confirmed that these services are insignificant for HSA eligibility purposes:

   • Physicals
   • Immunizations 
   • Antigen injections/allergy shots
   • Aspirin and other over-the-counter pain relievers
   • Medical care resulting from workplace accidents

   On the other hand, a hospital charging less than fair market value for a wide range of medical services will be deemed to be operating an on-site clinic that makes its employees HSA-ineligible.

   Between those two ends of the spectrum is a gray area. The safe route is to charge participants in an HSA-eligible HDHP the fair market value (FMV) of services that are not included in the above list.

7. Telemedicine. This add-on service (also known as telehealth) has increased in popularity, particularly with employers in rural worksites where access to care may be limited. The standard telehealth offering is charged at simple copay and can be used for a lot of different medical treatments and diagnoses, including the issuance of prescription drugs. It is hard to argue that this is not a significant benefit in the nature of medical care, especially when telehealth is promoted as having a significant impact on medical plan costs.

   Unfortunately, the IRS has not officially carved out a specific HSA exception for telehealth. So, the prevailing wisdom is to borrow some wood from a neighbor’s wood pile, so to speak. That neighbor is the on-site medical clinic. As long as the telehealth benefit charges HSA participants FMV for its services, the benefit should allow for continued HSA eligibility. We have seen FMV estimates in the range of $40 to $50 per visit.

8. Mini-med coverage. Mini-med plans became popular with the Affordable Care Act (ACA) individual mandate that took effect in 2014. The idea was that employers with a good many part-time employees might want to provide some level of basic coverage that would be more affordable than what they could obtain on the health insurance marketplace. The IRS said that mini-med plans invariably do not mix with HSA eligibility, particularly if they provide fixed-amount payments for office visits, outpatient treatment, or ambulance use. Bottom line: mini-meds are not HDHPs, and an individual must have an HDHP to be HSA-eligible.
9. Incentivized HDHP coverage. Here is a riddle: when is an HDHP not an HDHP? The answer is when an employer can receive some type of incentive during the plan year that changes a fundamental characteristic of the HDHP. Here are two examples:
   • Wellness incentives. An employer offers a series of wellness incentives to participants in any of the medical plan options, including an HDHP. One incentive is a tobacco surcharge that adds to the employee contribution if an employee uses tobacco and does not satisfy the reasonable alternative standard. Another wellness incentive provides reduced cost-sharing (it could be in the form of a number of waived copayments or a deductible reduction) for completing several participatory wellness incentives.
   • Health insurance marketplace cost-sharing reductions. If someone enrolls in marketplace coverage, chances are they will qualify for some type of subsidy that eases the burden of out-of-pocket medical expenses. Based on household income, about five in six marketplace participants qualify for a premium reduction. There are no HSA issues there. However, about three in five marketplace participants also qualify for cost-sharing reductions.

   In both cases, the adjustments to cost-sharing can result in either payment of medical care benefits before the deductible has been met or a decrease in deductible below the statutory minimum annual deductible ($1,350 (self-only)/$2,700 (family) in 2018).

10. Business travel accident (BTA) insurance. This is not among the “usual suspects” when it comes to making an individual ineligible for HSA contributions. That is because accident coverage is one of the listed benefits in the category of permitted coverage. A typical BTA policy will cover a certain amount of medical care expenses related to an accident while engaged in business travel. But beware: There are still policies that may provide additional medical coverage beyond what is accident-related, especially if the BTA policy is primarily designed for international travelers. If medical care is not tied to an accident, it is incompatible with HSA eligibility.

This could have been a Top 11 List. One disqualifier that did not make the cut is student health insurance. It typically provides coverage before the deductible is met. However, this is rarely a concern. Individuals who can be claimed as a tax dependent on someone else’s tax return are already HSA-ineligible.

In the final analysis, disqualification is an important concern for employees. There are serious tax consequences for contributions to an HSA when ineligible. Employers can and should help employees avoid disqualification at all stages of coverage—before, during, and after—in order to help them successfully reach the finish line.