Wealth

VOL. CLXXXIX– NO.11 – INDEX 929 SEPTEMBER 10, 2007 ESTABLISHED 1878

Management
to an HSA, and section 223(d) defines an
HSA as a “trust created or organized in the
Cutting Health Plan Costs United States as a health savings account
exclusively for the purpose of paying the
H e a l t h S a v i n g A c c o u nt s m a y he l p s m a l l qualified medical expenses of the account
beneficiary.”
An HSA must be combined with an

P
HDHP. An HDHP is defined as a health
b u s in e s se s r e d u c e h e a lt h c a r e e x p e n se s
the passage of the Medicare plan, which has an annual deductible not
Prescription Drug, Improvement, and less than $1,100 for self-only coverage (or
By Michael P. Spiro

roviding employees with health Modernization Act of 2003 (Medicare $2,200 for family coverage) and for which
care can be one of the most oner- Act), which added new section 223 to the sum of the annual deductible and other
ous expenses of operating a small the Internal Revenue Code, and the pas- out of pocket expenses that must be paid for
business. The expenses of health sage of the Tax Relief and Health Care the plan (exclusive of premiums) does not
care coverage have been increasing at a Act of 2006 (TRHCA), which modified exceed $5,500 for self-only coverage
breakneck pace. Indeed, it has been certain provisions of section 223. ($11,000 for family coverage). While in
reported that the United States spends Section 223 introduced a new form of general an HDHP is best understood as “cat-
an aggregate of $1.7 trillion per year on tax advantaged savings vehicle for astrophic coverage,” an HDHP may provide
health care, which represents 15 percent health care costs: the Health Saving first-dollar coverage for preventative care.
of total economic output. In recent Account (HSA). HSAs are tax-free The amount that an individual may
years, Congress has attempted to stem accounts established by individuals, contribute to an HSA in any given year is
the rising costs of health care by the which, when combined with a High limited to $2,850 for self-only coverage or
introduction of “consumer driven health Deductible Health Plan (HDHP), allow $5,650 for family coverage. Upon reach-
plans” (CDHP). The theory behind the individual to save pretax dollars in a ing the age of Medicare enrollment, an
CDHP is that by providing for tax- private account and have such savings individual will no longer be permitted to
advantaged individual savings for accrue earnings on a tax-free basis. To the make contributions to an HSA. Also,
health care, market forces may be har- extent that amounts saved in an HSA are employers may contribute to the HSAs of
nessed to contain health care costs. used to pay for “qualified medical expens- employees. To the extent that an employ-
Two of the Congress’s most aggres- es,” withdrawals from an HSA are also er does so, the contribution will not be
sive moves towards CDHPs have been tax-free. In the right circumstances, HSAs subject to the Federal Insurance
can potentially provide small business Contributions Act (FICA), the Federal
Spiro, a member of the taxation, cor- employers with substantial health care Unemployment Tax Act (FUTA) or the
porate and estate planning practice savings, in a manner that is both attractive Railroad Retirement Tax Act, thus engen-
groups at Flaster/Greenberg, focuses his and beneficial for employees. dering substantial payroll tax savings for
practice on providing advice in the areas Code section 223(a) provides for the employers. If an employer elects to con-
of tax and business planning. general deductibility of cash contributions tribute amounts to the HSAs of its

This article is reprinted with permission from the SEPTEMBER 10, 2007 issue of the New Jersey Law Journal. ©2007 ALM Properties, Inc. Further duplication without permission is prohibited. All rights
2 NEW JERSEY LAW JOURNAL, SEPTEMBER 10, 2007 189 N.J.L.J.929

employees, it is not permitted to discrimi- ignate a beneficiary in the event of his or are in good health who do not intend to use
nate among nonhighly compensated her death. If, upon the death of the account significant HSA moneys for medical care.
employees, but may make lower contribu- holder, the account holder has designated a Retirement benefits provided. For
tions to the HSAs of highly compensated spouse as the beneficiary of the HSA, the employers that do not provide significant
employees (HCEs). Employers must make HSA will simply become the HSA of the retirement savings to workers in the form
available comparable contributions on surviving spouse. In all other cases, upon of qualified plans, HSAs present an
behalf of all nonhighly compensated the death of the account holder, the HSA opportunity to provide retirement savings
employees with comparable coverage. will cease to be considered an HSA. All in the context of the employer’s health
Distributions from an HSA are treated HSA assets will be included in the gross plan. An employer may make tax-
as follows: if HSA moneys are used for estate of the account holder for purposes of deductible contributions to HSAs of
qualified medical expenses, the amount the federal estate tax, and all funds held by employees, which, upon retirement, may
distributed is not included in gross income. the HSA will be immediately taxable to the be used by employees either tax-free for
Qualified medical expenses include pay- designated beneficiary as “income in health expenses, or, like an IRA or quali-
ments “1) for the diagnosis, cure, mitiga- respect of a decedent” (IRD) under section fied retirement plan, for ordinary living
tion, treatment, or prevention of disease, or 691. However, the amount included in expenses as ordinary taxable income.
for the purpose of affecting any structure gross income will be reduced, for the pay- HSAs can allow an employer who is not
or function of the body; and 2) for trans- ment within one year of death, of any of providing employees with other retire-
portation primarily for and essential to the decedent’s predeath medical expenses. ment or pension plans with the opportuni-
medical care … or for qualified long-term Given this rather complex set of rules, ty to provide two benefits at once, as
care services.” a small business owner should consider the HSAs are essentially hybrid products
As a result, the funds accumulated and following factors in determining whether offering health coverage and retirement
utilized are effectively sheltered from any to implement HSAs as an option for savings. Moreover, HSAs are far less
taxation. Generally, payments for insur- employee health coverage. expensive and complex to administer than
ance may not be made from an HSA, but Age and health of employees. Younger qualified retirement plans.
certain payments for insurance for taxpay- employees may find HSAs more attractive, Cost of insurance. For some small
ers who have reached the age of Medicare as the time value of tax deferral allows employers, traditional group health insur-
enrollment are permitted (viz., Medicare them to benefit the most from the tax-free ance can be significantly more expensive
premiums, Medicare HMO premiums, and nature of the accounts. It has been estimat- than HDHPs — even if the employer con-
individual health care premiums but not ed that a 35-year-old individual employee, tributes the maximum to the HSAs of its
premiums for Medigap policies that sup- who begins making contributions to an employees. Thus, an analysis should be
plement the benefits provided by HSA in 2006 in an account equal to the done of relative costs.
Medicare). To the extent that distributions maximum allowable contribution (i.e., These are only a few of the factors
are made from an HSA for expenses other $2,700 adjusted annually for inflation) and that should impact whether a small busi-
than qualified medical expenses, such dis- never withdraws any money from the ness owner should consider implementing
tributions are subject to normal income HSA, will have accumulated $300,000 HSAs for employee health benefits.
tax, as well as an additional excise tax of upon reaching the age of 65. Assuming a While for many, traditional insurance will
10 percent. However, the excise tax will 30 percent average rate of taxation, upon remain more desirable, those with young
not apply to distributions to a beneficiary reaching the age of 65 that individual will healthy workers without retirement sav-
who has reached the age of Medicare eligi- have saved or deferred approximately ings may find that HSAs offer a valuable
bility or to distributions upon the death or $90,000 in taxes. Thus, HSAs represent a retention and compensation option that
disability of a beneficiary. substantial savings opportunity for saves on the spiraling costs of employee
HSAs allow the account owner to des- younger workers — particularly those who health care. ■