HSA Penalties

What kind of trouble do you suppose a person would be in if he/she contributed to a health savings account with full knowledge that he/she was not eligible? Big trouble in River City, eh? Well, you would be wrong, according to just-released IRS Information Letter 2017-0003.


IRS Code §223 states that eligible individuals may make deductible contributions to an HSA and enjoy employer contributions, that are excluded from taxable income. To be eligible to participate in an HSA, a person must….

  • Be covered by a qualified high-deductible health plan;
  • Not be covered by any other coverage that is not an HDHP, with exception of certain permitted benefits;[1]
  • Not be enrolled in Medicare;
  • And not being claimed as a dependent on another’s tax return

Disbursements for qualified medical expenses are excluded from taxable income. If the HSA disburses funds for other than qualified medical expenses, the individual pays ordinary income tax on the disbursement plus a 10% fine.

The Case at Hand

An individual retired from his place of employment and enrolled in Medicare. He subsequently went back to work at a company that offered an HDHP and employer contributions to an HSA. He was aware that his enrollment in Medicare disqualified him from having an HSA[2] but set one up regardless to receive the employer contributions, as well as his own on a pre-tax basis. Alas, he was caught red handed on a random audit. IRS ruled that all funds must be withdrawn and taxed, but no 10% fine would be applied in this circumstance. Rather surprising result; worthy of IRS making the rule public.

[1] Dental, vision, hospital indemnity, workers comp, property & casualty liability, disability income, long-term care, specific disease, etc.

[2] He even had written to Medicare asking if his election could be voided, but had received no response; serving as evidence of his full awareness of ineligibility.

Not everyone is an expert on health care reform. But the folks at J. Smith Lanier, one of our endorsed services providers, are. For this reason they created a publication called the Health Care Reform Alert. J. Smith Lanier has been providing these to its clients since 2010 when the bill was passed and now offers it to the members of ABA. It is J. Smith Lanier’s intention in the alerts to take the many pages generated by the Centers for Medicare and Medicaid Services, U.S. Department of Labor or Treasury and filter them down into terms that all can understand. For more information on how J. Smith Lanier can help your bank, contact Tom Younger at (256) 890-9027.