Unlock Colossal Health Care Tax Savings Under the TCJA
Unlock Colossal Health Care Tax Savings Under the TCJA
Use of a Health Savings Account (HSA) is still one of the most powerful tax saving and tax deferral strategies available. An HSA is meant to be a tax-free supplement to your regular insurance coverage and to be used for the periodic payment of unreimbursed or out-of-pocket medical expenses (i.e., co-pays, deductibles, prescription drugs, medical equipment, ambulances, smoking cessation programs, and/or other preventative care activities like attending a conference on approaches to a chronic illness like diabetes or cancer).
An HSA is a triple-threat that provides at least three different kinds of tax savings. First, the pre-tax contribution doesn’t count as income and thereby reduces your total taxable income and what tax bracket you fall under (and these pre-tax contributions are not subject to payroll tax either). Second, unused amounts roll over from year-to-year which provides a “deferral” or “savings” of that money, shielding it from both tax and inflation, while accrued interest, investment gains, and dividends from reinvestment of the contributed funds are all tax free! Third, distributions are tax free as well (as long as they are used for qualified healthcare expenses). There are currently about $52bn in HSA’s for American taxpayers.
If you didn’t know, healthcare costs are the biggest financial challenge for the American taxpayer and for our country at large. According to the most recent studies, the average American spends $10,345 in healthcare costs per year, which is expected to increase by 50% in the next few years. This is an increase of almost 10 times in the cost of healthcare since 1960, when the average cost of healthcare in today’s dollars was only $146 per person per year.
The IRS recognizes that under our current health insurance system, out-of-pocket medical costs are a reality for most Americans and publishes under the National Standards For Out-of-Pocket Healthcare that regular expected out-of-pocket medical costs are $56 per person per month for individuals under age 65 and $114 per person per for individuals over age 65. Other studies have revealed that the average American worker in 2018 will actually pay more than $2,500 in out-of-pocket healthcare costs. Of course, with insurance being what it is, a legitimate healthcare tragedy is the kind of unexpected and unreimbursed expense that can have life-altering ramifications and can reap financial devastation and even thrust a family into bankruptcy. In our practice, we see it every day. The #1 reason that healthcare emergencies are so challenging is they affect everything else. They reduce that taxpayer’s ability to earn a living. They eat up a family’s savings. They push a family into financial hardship precisely at the moment they are least well equipped to rally and increase their earnings to meet their new financial obligations. There truly is no way to weather such an financial storm with the ship intact other than with advanced planning.
Healthcare costs remain the single greatest challenge for individuals and families. One peer-reviewed Harvard study, whose findings are widely accepted, found that a whopping 62% of all bankruptcies are the result of medical bills. More to the point, 72% of those who went bankrupt due to medical bills, did so despite having full health insurance. There is also ample evidence that many Americans (over 25%) put off needed but unaffordable medical treatment for themselves and their family and of those American families that don’t file for bankruptcy, a large number deplete all of their savings to deal with unexpected non-elective emergency medical treatments. One study estimated that middle income families regularly faced at least a minor savings-busting medical event of $1,500 or more, at least once a year!
An HSA is a truly important tax planning tool because of the fact that the IRS imposes a hard floor that is currently at 7.5% of AGI before you can claim a deduction for any unreimbursed medical expenses as an itemized deduction on Sch. A of your 1040. You’ve got that right. Unless your unpaid medical bills are at least 7.5% of your total income, you have to foot the bill with after-tax dollars and don’t get a deduction for the costs! And it is getting worse. Beginning Jan. 1, 2019, taxpayers can only deduct the unreimbursed medical expenses they have incurred if they exceed 10% of the taxpayer’s gross income. We have one client who had income of about $100,000 in 2017 and had a $7,000 unreimbursed medical expense for a fertility program that wasn’t covered by his insurance. Under current law – Sec. 213 of the Internal Revenue Code (“IRC”) – there is a brief window to take medical deductions that exceed the 7.5% of AGI cap, but in 2019, expenses < 10% of AGI are not deductible. Thus, this client’s medical expenses didn’t exceed the $7,500 floor, and he wasn’t even close to the $10,000 floor that would take effect beginning in 2019. But, if he had set up an HSA, he could have used a distribution to pay for these expenses tax free. On the other hand, if this client had a $70,000 medical bill, and had a lot of income in 2017, he might not have wanted to use a distribution since distributions from an HSA can’t be used to do double duty and to count toward the AGI deduction floor.
Your contribution to the HSA is tax-free and adjusts your taxable income downward on line 25 of the first page of your Form 1040. This is the case even if the HSA re-invested the money and earned an investment gain. This is one of the few places where the ROI from investment activity is not taxed! Likewise, while your money is in the HSA, any interest, dividends or capital gains you earn are tax free in the year received.
Contributions and deductions from the HSA are reported on Form 8889. If you take a distribution to pay for unreimbursed medical expenses, you will receive a 1099-SA from your plan administrator, which you will then provide to your accountant at tax time.
The HSA is one of the best tax savings opportunities in 2018, because despite a low cap on contributions allowed, the HSA packs a huge bang for the buck. In 2018, individuals are capped at contributions of $3,450, and families are capped at contributions of $6,850 for family health plans. The time to make the contribution is extended up to the applicable April tax deadline for that year. So 2017 HAS contributions could be made up until the tax filing deadline last week, and you will have until next year’s tax filing deadline (Mon., April 15, 2019).
The ability to carryover the unused savings from year to year makes the HSA a better option than a Flexible Savings Account (FSA), which lacks this feature. HAS’s, however, aren’t available to all taxpayers. You must have a “high-deductible” health plan to qualify, which is defined as a policy with a deductible of at least $1,350 per individual or $2,700 per family, and whose out-of-pocket maximum is at most $6,650 per individual or $13,300 per family. Confused yet?
The TCJA repeals the individual mandate of Obamacare by reducing the penalties for not getting coverage to zero starting in 2019. For 2018, the penalty remains at $695 per adult or 2.5% of household income in excess of tax filing thresholds, whichever is higher. Chances are the repeal of the individual mandate doesn’t affect you much, since you probably have health insurance.
An often-overlooked aspect of HSA’s is that they permit distributions to cover certain other insurance premiums and include these within the definition of “qualified medical expenses.” For instance, you can use distributions from your HSA to cover long-term care insurance, health-care continuation coverage (COBRA), health-care coverage during periods of unemployment, and premiums for Medicare and Medicare Supplement Coverage [i.e., MediGap]).
If you have questions about healthcare savings accounts ("HSAs") or healthcare tax planning or your treatment under the new Tax Cut & Jobs Act, give us a call at (201) 529-8024 or e-mail me at [email protected]
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