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The Internal Revenue Service (IRS) reversed course this year, restoring the 2018 health savings account (HSA) family contribution limit to $6,900 and granting relief for taxpayers who may have been affected by an earlier announcement that reduced the contribution limit to $6,850.
The IRS issued Rev. Proc. 2018-27, restoring the contribution limit after determining that doing so was in the best interest of sound and efficient tax administration.
HSA contribution limits are subject to annual cost-of-living adjustments, and the IRS is required by law to publish the adjustments no later than June 1 of the preceding calendar year.
This earlier deadline gives health insurance providers time to design HSA-compatible high-deductible health plans (HDHP) for the following year and provides financial organizations time to modify their systems to reflect the new contribution limits. Employers also use the information to design and price their employee benefit plans.
On May 4, 2017, the IRS issued Rev. Proc. 2017-37, which provided the 2018 inflation-adjusted HSA contribution limits: $3,450 for single coverage and $6,900 for family coverage. In early March 2018, the IRS issued Rev. Proc. 2018-18, which retroactively reduced the 2018 HSA family contribution limit to $6,850. The single coverage limit was not reduced.
This retroactive reduction in the contribution limit was the result of a provision in the Tax Cuts and Jobs Act of 2017, which revised the formula used to compute the annual cost-of-living adjustments for HSA contributions and associated HDHP limitations. Use of the new formula going forward will result in annual contribution limits and other cost-of-living adjustments rising more slowly over time.
The agency’s decision to apply the new formula to previously calculated 2018 cost-of-living adjustments meant that the 2018 HSA family contribution limit would be reduced to $6,850. The IRS announcement of the reduction in the contribution limit—three months into the calendar year—created an administrative nightmare for employers, HSA owners, and HSA trustees and custodians.
In many cases, employers had already fully funded employees’ HSAs at the $6,900 family contribution limit or permitted employees to contribute up to the $6,900 limit through their cafeteria plans. Some HSA owners had also fully-funded their HSAs at the $6,900 limit. Plus, HSA trustees and custodians had modified their systems to accept up to $6,900 in HSA contributions and had communicated the 2018 contribution limits to their HSA owners.
Employers that fully funded their employees’ HSAs were concerned about the tax implications and whether they could take steps to reduce employee contributions to avoid exceeding the new lower contribution limit. HSA owners were faced with either removing the excess contributions or leaving them in the HSA and paying the excise tax. HSA trustees and custodians scrambled to notify HSA owners and front-line staff of the reduced contribution limit.
Stakeholders informed the IRS that implementing the $50 reduction in the HSA family contribution limit—three months into the year—would cause unanticipated administrative and financial burdens. They informed the IRS that in many cases employers and HSA owners had already made the maximum family contribution of $6,900, or had made salary reduction elections through their employers’ cafeteria plans based on the $6,900 limit. And, HSA trustees and custodians informed the IRS that notifying HSA owners and helping them identify and remove excess contributions would be administratively burdensome.
Citing stakeholder concerns, the IRS reversed its decision and issued Rev. Proc. 2018-27 to restore the 2018 HSA family contribution limit to $6,900 and provide relief for taxpayers affected by the reduction in the contribution limit.
The guidance allows any HSA owner who removed an excess contribution from their HSA, because of the reduction in the contribution limit to $6,850, to repay the distribution to the HSA before April 15, 2019, and treat it as a return of a mistaken distribution. In such a case, the distribution is not included in the HSA owner’s gross income or subject to the additional 20%, and the repayment is not subject to the 6% excise tax on excess contributions.
HSA trustees and custodians are not required to allow HSA owners to repay mistaken distributions—including distributions taken because of the reduction in the contribution limit.
But if they do, the mistaken distributions and their subsequent repayments are not reported as distributions on Form 1099-SA; distributions from an HSA, Archer MSA, or Medicare Advantage MSA; or contributions on Form 5498-SA, HSA, Archer MSA, or Medicare Advantage MSA Information.
If an HSA owner who removed an excess contribution from their HSA—because of the reduction in the contribution limit—chooses not to repay the distribution to the HSA, the distribution is treated as the removal of an excess contribution before the tax return due date.
In such a case, the excess contribution is not included in the HSA owner’s gross income and is not subject to the additional 20% tax provided the distribution is received on or before the due date (including extensions) for filing the HSA owner’s 2018 federal income tax return. This option does not apply to employer contributions (including contributions made through a cafeteria plan) unless the employer includes the contribution in the employee’s taxable income.
Confusion exists with any regulatory change, but even more so in this case with the IRS decision to reverse its previous position.
Following are five steps you can take to ensure you’re prepared to assist HSA owners with this change:
While the IRS chose not to apply the new formula for cost-of-living adjustments to the 2018 HSA contribution limits, the 2019 contribution limits ($3,500 for single coverage and $7,000 for family coverage) recently announced in Rev. Proc. 2018-30 reflect the new formula for determining cost-of-living adjustments.
DENNIS ZUEHLKE is compliance manager for Ascensus. Contact him at 608-229-1875.