MSA eligibility. To be eligible for an MSA, you must be under age 65 and work for a "small" employer, one that had an average of 50 or fewer employees during either of the two preceding years. You must be covered by a high deductible health plan, which by law must have a deductible of $1,500 and no more than $2,250 for individual coverage or at least $3,000 and no more than $4,500 for family coverage.

The Internal Revenue Service has ruled that a high deductible family plan may not set the lower deductible for individual family members. For example, the plan does not qualify if it sets an overall annual family deductible of $3,000 but allows an individual who occurs expense exceeding $1,500 to receive benefits.

Out-of-pocket costs must be limited to $3,000 per individual plans and $5,500 for family coverage.

Generally, you are not eligible for an MSA if you any other health insurance in addition to the high deductible plan coverage, except for policies covering only disability, vision or dental care, long-term care, accidental injuries, or plans that may pay a flat amount during hospitalization. If you are a Medicare beneficiary, you are not eligible for an MSA. However, under the law, starting in 1999, Medicare beneficiaries may be able to combine a "Medicare plus MSA" with high deductible insurance as an alternative to traditional Medicare coverage.

There are employer contribution limits. Your employer's contribution to your MSA are tax-free up to an annual limit the of 65 percent of the plan deductible if you have individual coverage and 75 percent of deductible for family coverage. The limit is reduced on a monthly basis if you are not covered for the entire year. If your employer makes any contribution to your account, you may not make any contribution for that year. In addition, if your spouse's employer contributes to his or her MSA, you cannot contribute to your medical savings account. If your employer (or spouse's employer) does not contribute, you may make deductible contributions up to the above employer contribution limits. Your deductions claimed on line 24 form 1040. If it is more than the prescribed annual limit unity penalized the six percent penalty.

Self-employed individuals are eligible. The self-employed person may make deductible contributions to an MSA up to the employer contribution limits discussed above. For those individuals that are incorporated, then one must look to whether the amount is considered subject to payroll tax or self-employment tax. If, you have no income subject to self-employment tax or subject to payroll taxes, that you have no basis to use for deducting contributions to the medical savings account.

If you desire to establish an MSA, you must weigh the costs of the payroll taxes (or self-employment tax) against the tax reduction by establishing and contributing to a qualified MSA (subject to limits described above).

Publication 969 (10-97)

MEDICAL SAVINGS ACCOUNTS (MSAs)

 

Introduction

This publication explains a new program called Medical Savings Accounts (MSAs). It was created to help self-employed individuals and employees of certain small employers meet the costs of medical care.

MSAs are a "pilot project." The pilot project is scheduled to end in the year 2000; however, the ability to establish MSAs generally will end earlier if the number of taxpayers contributing (or receiving employer contributions) to an MSA exceeds certain statutory limits for 1997, 1998, or 1999.

You do not need IRS approval to start your MSA. You will have to complete Form 8853, Medical Savings Accounts and Long-Term Care Insurance Contracts, and attach it to your Form 1040 each year you (or your spouse if you file jointly) have an MSA. You will have to file Form 1040, not Form 1040A or Form 1040EZ. Form 8853 will be available from IRS in January of 1998.

This publication will explain what an MSA is, who can set one up, how to make contributions to an MSA, and how to treat distributions from it.

Understanding MSAs

To understand MSAs, you will want to know what an MSA is and what the benefits are of having one. You will also need to know whether you meet the rules for starting an MSA. If you meet the rules, then you will want to read the section titled Setting Up the Account.

What is an MSA? An MSA is a tax-exempt trust or custodial account with a financial institution (like a bank or an insurance company) where you can save money for future medical expenses. This account must be used in conjunction with a high deductible health plan. See High Deductible Health Plan, later.

What are the benefits of an MSA? You may enjoy several benefits from having an MSA:

• The interest or other earnings on the assets in your MSA are tax- free.

• You can have a tax deduction without having to itemize your deductions on Form 1040.

 

• The contributions remain in your MSA from year to year until they are used.

 

Rules for Starting an MSA

You need to meet the following conditions before you can start an MSA.

You must work for a small employer or be self-employed.

2) You must have a high deductible health plan.

 

Who is a Small Employer?

A small employer is an employer who had an average of 50 or fewer employees during either of the last two calendar years. The definition of small employer is modified for new employers and growing employers.

New employer. A new employer is also considered a small employer for MSAs if he or she reasonably expects to employ 50 or fewer people this year.

Growing employer. A small employer may begin high deductible health plans and MSAs for his or her employees and then grow beyond 50 employees. The employer will continue to meet the requirement for small employers if he or she:

• Had 50 or fewer employees when the MSAs began,

• Made a contribution for the last year the employer had 50 or fewer employees, and

• Had an average of 200 or fewer employees each year after 1996.

 

High Deductible Health Plan

To be eligible for an MSA, you must have a high deductible health plan. If you are an employee, the plan must be through your small employer. You generally cannot have another health insurance plan.

Definition. A high deductible health plan has:

A higher annual deductible than typical health plans, and

2) A maximum limit on the annual out-of-pocket medical expenses that you must pay for covered expenses.

 

Limits. The following table shows the limits for annual deductible amounts and the maximum out-of-pocket expenses for high deductible health plans.

Maximum

Minimum Maximum annual

Type of annual annual out-of-pocket

coverage deductible deductible expenses

___________________________________________________________________

Self-only $1,500 $2,250 $3,000

 

Family $3,000 $4,500 $5,500

 

Family plans that do not currently meet the high deductible rules. There are some family plans that have deductibles for individual family members. These deductibles are less than the annual deductible for the family plan. Under these plans, if you meet the individual deductible for one family member, you do not have to meet the annual deductible amount for the family plan. These plans do not qualify as a high deductible health plan.

Example. Mr. Wilber has health insurance with company A. The annual deductible amount for the family plan is $3,000. This plan also has individual deductible amounts of $1,500 for each family member. Mr. Wilber's wife had $1,700 of covered medical expenses this year. They had no other medical expenses for the year. The plan paid $200 to Mr. Wilber because Mrs. Wilber met the individual deductible amount of $1,500, even though the Wilbers did not meet the $3,000 annual deductible for the family plan. The plan does not qualify as a high deductible health plan.

Grace period. If your health plan is not a high deductible health plan because it has individual deductibles, you may be able to continue to make deductible contributions to an MSA and receive tax-free distributions during a grace period. The individual deductible amount for each family member must be at least $1,500 and no more than $2,250. The grace period will extend until the time your plan comes up for its first renewal date on or after December 31, 1997. In no event will this grace period extend beyond December 31, 1998.

TIP: Insurance companies that have family plans with individual deductibles may change these health plans to meet the high deductible rules. Check with your insurance company if you have such a plan to see if they are going to change the plan to meet the rules.

Other health Insurance. You (or your spouse if you file jointly) generally cannot have any other health plan that is not a high deductible health plan. However, this rule does not apply if the other health plan(s) only cover the following items.

Accidents.

2) Disability

3) Dental care.

4) Vision care.

5) Long-term care.

6) Benefits provided by insurance:

a) Related to worker's compensation laws, tort liabilities, or ownership or use of property,

b) For a specific disease or illness, or

c) That pays a fixed amount per day (or other period) of hospitalization.

 

 

Setting Up the Account

When you set up an MSA, you will need to work with a trustee and know the rules for contributing and withdrawing money from the account.

MSA trustee. The person or business you set up your MSA with is called a trustee. A trustee can be a bank, insurance company, or anyone already approved by the IRS to be a trustee of Individual Retirement Accounts. You employer may already have some information on MSA trustees in your area.

Who can contribute to my MSA? Your employer may decide to make contributions to an MSA for you. You do not pay taxes on these contributions. If your employer does not make contributions to your MSA, you can make your own contributions to your MSA and deduct these amounts on your tax return without itemizing deductions. Both you and your employer cannot make contributions to your MSA in the same year. There are limits to the amounts that can be contributed to your MSA. See Making Contributions, later. You do not have to make contributions to your MSA every year.

CAUTION: If your spouse is covered by your high deductible health plan and receives contributions to an MSA from an employer, you cannot make contributions to your MSA that year.

How can I make withdrawals from my MSA? You can make tax-free withdrawals from your MSA to pay for qualified medical expenses (discussed later). If you make withdrawals for other reasons, the amount you withdraw will be subject to income tax and may be subject to an additional excise tax as well. See Receiving Distributions, later. You do not have to make withdrawals from your MSA each year.

Changing employers. If you change employers and still meet the rules for having an MSA, you can continue to use that MSA. However, you may not make additional contributions unless you are otherwise eligible.

Making Contributions

There are two limits to the amount you can contribute to your MSA. One is based on the annual deductible amount of your high deductible health plan. The other is based on your wages or compensation if you are an employee, or your net self-employment income if you are self-employed.

Annual deductible amount. You can contribute up to 75% of the amount of your annual health plan deductible (65% if you have a self-only plan) to your MSA. You must have the insurance all year to deduct the full amount.

Reduce the amount you can contribute by one-twelfth for each full month you did not have a high deductible health plan.

Example 1. You have a high deductible health plan for your family all year. The annual deductible is $3,000. You can contribute $2,250 ($3,000 x 75%) to your MSA for the year.

Example 2. You have a high deductible health plan for your family for the entire months of July through December (6 months). The annual deductible is $3,000. You can contribute $1,125 ($3,000 x 75% + 12 x 6) to your MSA for the year.

TIP: If both you and your spouse have a family plan, you are treated as having family coverage with the lower annual deductible. The contribution limit is split equally between you unless you agree on a different division.

Wages or compensation. You cannot contribute more than you earned for the year from the employer through whom you have your high deductible health plan. If you are self-employed, you cannot contribute more than your net self-employment income. This is your income from self- employment minus expenses (including the one-half of self-employment tax deduction).

Example 1. Bob Smith earned $25,000 from ABC Company for the year. He had a high deductible health plan for his family at ABC. He had the plan all year. His annual deductible is $4,000. He can contribute $3,000 to his MSA (75% x $4,000). He can contribute the full amount because he earned more than $3,000 at ABC.

Example 2. Joe Craft is self-employed. He had a high deductible health plan for his family for the entire year and the annual deductible was $3,000. After the deducted his expenses, Joe's net self-employment income was $1,500 for the year. He is limited to a contribution of $1,500 to his MSA.

Worksheet to figure your MSA contribution. Use the following worksheet to figure how much you can contribute to your MSA for the year.

CAUTION: You must figure your limit separately for each employer with whom you have had a different high deductible health plan.

MSA Contribution Limits Worksheet

1. Enter the annual deductible amount of your

high deductible health plan _______

2. Multiply line 1 by .75 (.65 if you have

self-only insurance) _______

3. Divide line 2 by 12 _______

4. Enter the number of months you have had a

high deductible health plan in 1997 _______

5. Multiply line 3 by line 4 _______

6. Enter the amount of wages you earned while

working for the employer with whom you had the

high deductible health plan. (If you were self_

employed, substitute your net self-employment

income.) _______

7. Enter the smaller of line 5 or 6. This is the

most you can contribute to your MSA in 1997. _______

 

Reporting contributions on your return. Report you contributions to your MSA on Form 8853. Follow the instructions for the form and attach the form to your Form 1040. Do not include any contributions made by your employer.

You should receive Form 5498-MSA, Medical Savings Account Information from the trustee showing the amount you contributed during the year. You can make contributions to your MSA until April 15, 1998, and deduct them on your 1997 Form 1040 to the extent

your total contributions for 1997 do not exceed your 1997 limitation.

CAUTION: You must pay a 6% excise tax on contributions that you or your employer makes to your MSA that are greater than the limits discussed earlier. You will not have to pay the excise tax if you withdraw these excess contributions (and associated earnings) before the time that your tax return is due (generally April 15).

Receiving Distributions

You will generally pay medical expenses during the year without being reimbursed by your high deductible plan until you reach the annual deductible. When you pay medical expenses during the year that are not reimbursed by your high deductible health plan, you can ask the trustee of your MSA to send you a distribution from your MSA.

A distribution is money you get from your MSA. The trustee will report any distribution to you and the IRS on Form 1099-MSA, Distributions From Medical Savings Accounts.

How to report distributions on your tax return. How you report your distributions depends on whether or not you use the distribution for qualified medical expenses.

• When you use a distribution from your MSA for qualified medical expenses, you do not pay tax on the distribution. You do have to report the distribution on Form 8853. Follow the instructions for the form and attach it to your Form 1040. You cannot file Form 1040A or Form 1040EZ.

• When you do not use a distribution from your MSA for qualified medical expenses, you must pay tax on the distribution and report the amount on Form 8853. Follow the instructions for the form and attach it to your Form 1040. You must also report and pay an excise tax on your Form 1040 unless you meet one of the exceptions listed later.

 

TIP: You do not report and pay tax on any excess contributions you make and withdraw before the due date of your tax return (generally April 15). You will have to pay tax on any earnings associated with the excess contributions you withdraw. You do, however, report and pay tax on any excess contributions an employer makes and you withdraw before the due date of your tax return. You will also have to pay tax on any earnings associated with the excess contributions the employer makes that you withdraw. If the employer did not add the excess contributions and associated earnings to the box 1 amount on your Form W-2, include them in your gross income on your Form 1040.

CAUTION: If an amount is contributed to your MSA this year, you also must report and pay tax on a distribution you receive from your MSA this year that is used to pay for medical expenses of someone who is not covered by a high deductible health plan, or is also covered by another health plan that is not or is also covered by another health plan that is not a high deductible health plan, when the expenses are incurred. See the instructions for Form 8853 for more information.

Reporting and paying an excise tax. There is a 15% excise tax on the part of your distributions not used for qualified medical expenses. You report the excise tax on line 53 of your Form 1040.

Exceptions to excise tax. There is no excise tax if you are disabled, age 65 or older, or die during the year.

Death of the MSA holder. You should choose a beneficiary when you set up your MSA. What happens to that MSA when you die depends on who you designate as the beneficiary.

Spouse is the designated beneficiary. If your spouse is the designated beneficiary of your MSA, it will be treated as your spouse's MSA after your death.

Spouse is not the designated beneficiary. If someone other than your spouse is the designated beneficiary of your MSA after your death:

The account stops being an MSA on the date you die, and

2) The fair market value of the MSA becomes taxable to the designated beneficiary.

 

No designated beneficiary. If you have no beneficiary, the fair market value of the MSA will be included on your final income tax return after your death.

Qualified Medical Expenses

Qualified medical expenses are explained in Publication 502, Medical and Dental Expenses. Examples include amounts paid for doctors' fees, prescription medicines, and necessary hospital services.

CAUTION: You cannot deduct qualified medical expenses as an itemized deduction on Schedule A, (Form 1040), if you pay for them with a tax- free distribution from your MSA. You also cannot use other funds equal to the amount of the distribution and claim a deduction.

Special rules for insurance premiums. Generally, you cannot treat insurance premiums as qualified medical expenses for MSAs. You can, however, treat premiums for long-term care or health care coverage while you receive unemployment benefits as qualified medical expenses for MSAs. This includes COBRA-type continuation coverage required under any Federal law.

RECORDKEEPING: For each qualified medical expense you deduct or pay with a distribution from your MSA, you must keep a record of the name and address of each person you paid and the amount and date of the payment. Do not send these records with your tax return. Keep them with your tax records.

Filing Form 8853

You must file Form 8853 and attach it to Form 1040 if you (or your spouse, if married filing a joint return) had an MSA during the year. You must file the form even if your employer or your spouse's employer made the contributions to the MSA.

Employer Participation

This section contains the rules that employers must follow if they decide to make MSAs available to their employees. Unlike the previous discussions, "you" refers to the employer, and not to the employee.

Health plan. If you want your employees to be able to have an MSA, you must make available to them a high deductible health plan. You can provide no additional coverage other than those exceptions listed previously. See High Deductible Health Plan, earlier.

Contributions. You can make contributions to your employees' MSAs. You deduct the contributions on the "Employee benefit programs" line of your business income tax return for the year you make these contributions.

Comparable contributions. If you decide to make contributions, you must make comparable contributions to all comparable participating employees' MSAs. Your contributions are comparable if they are either:

• The same amount, or

• The same percentage of the annual deductible limit under the high deductible health plan covering the employee.

 

Comparable participating employees. Comparable participating employees:

• Are covered by your high deductible health plan and eligible to establish an MSA,

• Have the same category of coverage (either self-only or family coverage), and

• Have the same category of employment (either part-time or full-time).

 

Additional tax. If you made contributions to your employees' MSAs that were not comparable, you must pay an additional tax of 35% of the amount you contributed. See Form 5330, Return of Excise Taxes Related to Employee Benefit Plans to report and pay this tax.

Employment taxes. Amounts you contribute to your employees' MSAs are generally not subject to employment taxes. You must report the contributions in box 13 of the Form W-2, Wage and Tax Statement, you file for each employee during the calendar year. Enter Code "R" in box 13.

How To Get More Information

You can get help from the IRS in several ways.

Free publications and forms. To order free publications and forms, call 1-800-TAX-FORM (1-800-829-3676). You can also write to the IRS Forms Distribution Center nearest you. Check your income tax package for the address. Your local library or post office also may have the items you need.

For a list of free tax publications, order Publication 910, Guide to Free Tax Services. It also contains an index of tax topics and related publications and describes other free tax information services available from IRS, including tax education and assistance programs.

If you have access to a personal computer and modem, you also can get many forms and publications electronically. See Quick and Easy Access to Tax Help and Forms in your income tax package for details.

Tax questions. You can call the IRS with your tax questions. Check your income tax package or telephone book for the local number, or you can call 1-800-829-1040.

TTY/TDD equipment. If you have access to TTY/TDD equipment, you can call 1-800-829-4059 to ask tax questions or to order forms and publications. See your income tax package for the hours of operation.