PUB. 11 2021-2022 Issue 2

coloradobankers.org 18 Avoid Negative HSA Balances and their Negative Tax Consequences By Dennis Zuehlke, CISP Ascensus T here’s a humorous saying, “I can’t be overdrawn; I still have checks.” There’s nothing funny, however, about overdrawing your health savings account (HSA) and the negative tax consequences that follow. HSAs are subject to the same prohibited transaction rules as IRAs, which means that an HSA owner may not enter into a prohibited transaction involving his HSA and/or the financial organization that administers it. The prohibited transaction rules broadly include activities between an account and another party that may include selling, exchanging or leasing assets or property, furnishing goods, or the extension of credit. However, the transactional nature of HSAs makes an extension of credit more likely to occur than might be the case with an IRA. If your financial organization allows HSA owners to use checks or debit cards to withdraw HSA assets, it risks extending credit to the HSA owner and, thereby, creating a prohibited transaction. For example, if an HSA owner uses an HSA debit card to pay an amount that exceeds the HSA balance, the HSA ends up with a negative balance. A prohibited transaction has occurred if your financial organization covers the transaction, which is an extension of credit to the HSA. The same outcome may result if it does not cover the transaction but imposes an overdraft fee that causes the HSA balance to go negative. When a prohibited transaction occurs, the account ceases to be an HSA as of the first day of the year in which the prohibited transaction occurred. The financial organization must report the Jan. 1 account balance on IRS Form 1099-SA, Distributions From an HSA, Archer MSA, or Medicare Advantage MSA, using code 5, Prohibited transaction. Any contributions to – or distributions from – the account after the account ceases to be an HSA are not reported. And amounts treated as distributed due to a prohibited transaction cannot be treated as a distribution used to pay qualified medical expenses. When an HSA does have a negative balance, your financial organization should contact the HSA owner and inform him that the account has ceased to be an HSA and that it may no longer accept HSA contributions. To make HSA contributions going forward, potentially for the same tax year, the individual would need to open a new HSA. If the HSA was receiving employer contributions, your organization should also inform the employer that, unless a new HSA is opened, future employer contributions for this employee will not be accepted.