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Ask The Specialist: Common HSA Tax Benefit Questions

September 03, 2021

For more on this and other useful insights you can use with clients, check out the latest issue of Current from the Nationwide Retirement Institute.

More clients are strategically using HSAs, and it’s important they understand the rules to follow. Learn more about how HSAs can affect taxes and some common questions that clients may ask.

Q. What can be considered a qualifying medical expense to be eligible for tax-free reimbursement using an HSA?

A. The IRS defines qualified medical expenses to generally include the costs of diagnosis, cure, mitigation, treatment or prevention of disease, and for the purpose of affecting any part or function of the body. Transportation costs primarily for, and essential to, medical care may also qualify as medical expenses, as do amounts paid for qualified long-term care services, and limited amounts paid for long-term care insurance contract premiums. This description is quite broad and includes many medical, prescription drug, dental and vision-related expenses.

Due to the COVID-19 pandemic, a few new pieces of beneficial guidance on this topic have come out. First, in March 2020, the passage of the Coronavirus Aid, Relief and Economic Security Act (CARES Act) restored the ability for individuals to use their HSA to purchase over-the-counter drugs and medicines (e.g., aspirin, pain and allergy medication, etc.) without a doctor’s prescription. The CARES Act also changed the law to make it possible for menstrual care products to be considered qualified medical expenses for the first time. This expansion of qualified medical expenses applies to amounts paid for or incurred on or after January 1, 2020.

Another expansion of qualified medical expenses attributable to the COVID-19 pandemic came earlier this year. On March 26, 2021, the IRS issued Announcement 2021-7 to notify taxpayers that amounts for personal protective equipment, generally known as “PPE,” such as masks, hand sanitizer and disinfectant wipes, are also now considered to be qualified medical expenses, as long as those expenses were incurred on or after January 1, 2020.

Despite these recent additions to the list of qualified medical expenses, keep in mind that there are some limitations. Remember that qualified medical expenses must still be used primarily to alleviate or prevent a physical or mental disability or illness. Expenses that benefit general health and well-being, such as dietary supplements or membership at a local gym, are not generally considered qualified medical expenses.

Q. Are HSAs protected from creditors?

A. The short answer is no. However, there may be limited protection in certain states.

HSAs are not qualified retirement plan accounts protected from creditors by the Employee Retirement Income Security Act of 1974, as amended (ERISA), nor are they individual retirement accounts (IRAs) that are also partially exempted (up to $1,362,800 in 2021) from creditors under federal bankruptcy law. A small number of states have passed legislation to exempt deposits in HSAs from property of a debtor’s bankruptcy estate, which allows the debtor to retain the funds in the HSA; however, the majority of states have not addressed this issue, so there is uncertainty throughout most of the country on this question. Absent specific state law protections, an HSA does not have similar creditor protections as either an ERISA-covered retirement plan or an IRA.

Q. Can HSAs be split in a divorce settlement?

A. Yes. Like a retirement plan account or an IRA, a court order or other appropriate legal documentation can require an HSA custodian to transfer funds to an account for the benefit of a former spouse. In the case of divorce, the removal of funds from the HSA would not be a taxable distribution to the account holder even though this removal of funds is not to pay for a qualified medical expense.

Q. Can I use my HSA to pay for the qualified medical expenses of my adult child whom I still cover on my health insurance?

A. Yes, but only if the adult child is also your tax dependent. The IRS allows parents to claim children as tax dependents until age 19 in most circumstances, or age 24 if the child (1) is a full-time student, (2) does not provide more than half of their own financial support, (3) lives with their parent(s) more than half the year (exceptions allowed for education, military service, etc.), and (4) does not file a joint return with their spouse for the year.

This means that even though the Patient Protection and Affordable Care Act requires plans that cover dependent children to cover those individuals up to age 26, you are not necessarily able to use your HSA to pay for the medical expenses of those adult children covered by your high-deductible health plan. This is one rule to be aware of if you are covering young adult children.

Sources / Disclaimers

  • 1

    Internal Revenue Code Section 213(d)(1).

  • 2

    IRC Section 213(d)(1).

  • 3

    IRS Publication 502 (2020).

  • Federal income tax laws are complex and subject to change. The information in this publication is based on current interpretations of the law and is not guaranteed. Neither Nationwide nor its employees, agents, brokers or registered representatives give legal or tax advice. You should consult an attorney or competent tax professional for answers to specific tax questions.