Health Savings Accounts (HSAs) are a popular way to help finance the ever-increasing costs of medical care.
They essentially work like this: Individuals and businesses buy less expensive health insurance policies with high deductibles. To qualify in 2022, participants must be enrolled in plans that require them to pay at least the first $1,400 of medical expenses, $2,800 for a family before the insurance begins to pick up the tab (unchanged from 2021). The high deductible health plan is then combined with an HSA.
Contributions to the accounts are made on a pre-tax basis. The money can accumulate year after year tax-free, and be withdrawn tax-free to pay for a variety of medical expenses including doctor’s visits, prescriptions, chiropractic care and premiums for long-term care insurance.
Participating employers can also contribute to accounts on behalf of employees. In the case of a law firm partnership (or an LLC that is treated as a partnership for tax purposes), the firm can make HSA contributions on behalf of a partner (or LLC member) who is eligible to make contributions. According to the IRS, these partnership-paid contributions can be treated as either:
- A generally tax-free cash distribution to the partner.
- A guaranteed payment to the partner in exchange for services rendered to the firm.
If guaranteed payment treatment applies, the HSA contribution amount is subject to both income and self-employment tax at the recipient partner level, but the amount is deductible by the partnership.
The treatment that is selected by the partnership should be reflected on the partner’s Schedule K-1. Under either treatment, the partners can then claim an above-the-line deduction for the HSA contribution amount on page 1 of their individual Form 1040s. The partners must also file Form 8889 with their returns. Above-the-line treatment means the partners do not have to itemize deductions to reap the tax-saving benefits. (IRS Notice 2005-8)
Of course, an eligible partner is also allowed to make HSA contributions with his or her own funds. The partner can then claim an above-the-line deduction on page 1 of Form 1040 (the partner must also file Form 8889 with the return).
If the firm is run as an S corporation, similar treatment applies to HSA contributions made on behalf of or by more-than-2% shareholder-employees.
HSA Contribution Basics
Eligible individuals can cut their federal income tax bills by making deductible HSA contributions themselves or by having their employers make contributions on their behalf. This includes partnerships and LLCs, which are treated as partnerships for tax purposes.
Even better, partners can qualify for the HSA tax break regardless of income. There are no phaseout rules for high earners like the ones that apply to deductible IRA contributions.
However, partners are only allowed to make HSA contributions (directly or via the partnership) if they are covered by a high-deductible health plan. Assuming a partner is covered for all of 2022, the maximum HSA contribution for the year is:
$3,650 for self-only coverage (up from $3,600 in 2021) and $7,300 for family coverage (up from $7,200 in 2021).
Essentially, the same rules apply if the individual is a more-than-2% shareholder employee of an S corporation, rather than a partner (the federal tax rules treat more-than-2% S-corp shareholder-employees as partners for these purposes).
Please contact Judith Barnhard via our online contact form for more information.
Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from offices in Bethesda, MD and Washington, DC.