Health Insurance Group Requests Guidance on HSAs

Dear Mr. Reeder:

America's Health Insurance Plans (AHIP) is writing to request guidance regarding the application of Internal Revenue Code section 223 concerning health savings accounts (HSAs). AHIP is the national trade association representing the private sector in health care and our nearly 1,300 member companies provide health, long-term care, dental, vision, disability, and supplemental coverage to more than 200 million Americans.

Many AHIP member health insurance plans are actively involved in the HSA market. According to a 2006 AHIP survey, almost 3.2 million Americans are enrolled in an HSA product offered by one of our members.

To help resolve administrative concerns and to advance employer and consumer acceptance of HSAs as a viable health insurance option, we have identified a range of issues that would benefit from additional guidance. Our specific recommendations are set forth in more detail below.

Clarify the Date a Health Savings Account is "Established"

Section 223(d) of the Internal Revenue Code (IRC) defines a "health savings account" as a "trust created or organized in the United States as a health savings account exclusively for the purpose of paying the qualified expenses of an account beneficiary. . . ." Notice 2004-2 (Q-1) explains that an HSA is "a tax-exempt trust or custodial account established exclusively for the purpose of paying qualified medical expenses of the account beneficiary who, for the months for which contributions are made to an HSA, is covered under a high-deductible health plan." The guidance further provides that the account may be used to pay for or reimburse any qualified medical expenses, "incurred only after the HSA has been established." (Notice 2004-2, Q-26)

Questions have been raised regarding the determination of the date on which an HSA is established in order to pay medical expenses incurred after that date. As an example, an employer may contract with one or more financial institutions to provide trust or custodial accounts for purposes of creating employee HSAs. The employer and the financial institution execute an agreement establishing a trust for the benefit of the employees. In some cases, the employer may also forward the employer's contributions to the financial institution that is acting as a trustee for the employees' HSAs.

The individual employees are asked to complete signature cards by the financial institution to collect information needed to comply with state and federal banking requirements (e.g., tax identification information, signature authority to execute checks, etc.). Some employees may not complete the signature cards until weeks or months after the employer and the financial institution have created the HSA trust. The question arises whether the "account" is created at the time the original trust agreement was executed or later when the signature card is completed and returned to the financial institution.

We believe the employer and the designated financial institution have the ability to agree when the trust is created because a beneficiary's (i.e., the employee's) consent is not required to create a trust. While the ability of the employee to access the funds in the HSA may depend on the individual's execution of the signature card or other documentation, there is nothing in IRC section 223 preventing the employer and financial institution from agreeing that the account is created when the trust agreement is executed by the employer and the financial institution as trustee. As a result, the employee may use the account to pay for or reimburse medical expenses occurring after the date the agreement is executed (if coverage under the high deductible health plan (HDHP) has begun).¹

To address this issue, AHIP recommends that guidance be issued to explain that Internal Revenue Code section 223 does not prevent an employer and a trustee for an HSA from concluding that a health savings account is "established" when the trust agreement between the parties is executed, regardless of whether the employee has completed documentation such as a signature card permitting access to funds in the account. As a result, qualified medical expenses incurred on or after the date the trust agreement is executed may be reimbursed from the account if coverage under a qualified HDHP has begun.

Allow Debit Card Payments for Medical Services

As noted above, IRC section 223 permits the use of HSA funds for qualified medical expenses. Notice 2004-50 (Q-79) makes clear that the "HSA trust or custodial agreement may not contain a provision that restricts HSA distributions to pay or reimburse only the account beneficiary's qualified medical expenses."

Many HSAs are established in conjunction with a debit card which permits an individual to use the card to pay for qualified medical expenses. Individuals enrolled in HSA products find debit cards an attractive option because:

• Debit cards offer consumers a convenient payment method at the point-of-sale without requiring them to pay out-of-pocket and waiting to receive reimbursement.

• Electronic processing ensures that any available contract discounts for health care services or items will be calculated at the time of the transaction.

• Payment processing is a secure, efficient method of withdrawing and tracking funds.

We believe the use of a debit card that may only be used to pay for qualified medical expenses from an HSA should be allowed if the individual is not restricted from accessing funds in the account through another means. Such an arrangement would continue to place responsibility on the individual to determine whether account distributions are "made exclusively for qualified medical expenses and are therefore excludable from gross income" (Notice 2004-2, Q-29) but permit the plan administrator flexibility in the use of debit card arrangements.³

AHIP recommends that IRS guidance clarify the ability of plan administrators to assign debit cards that restrict payments for medical items or services, as long as the plan establishes a process for withdrawal of funds from the HSA through another means (e.g., following an individual's written request to access the funds or through a checking account).

Allow Transfers of HSA Balances

Notice 2004-50 (Q-55) explains that an individual can make one rollover contribution to an HSA from either another HSA or an Archer MSA during a 1-year period, as long as the individual receives the distributed amount and deposits it into an HSA within 60 days. Transfers between HSA trustees and custodians are also permitted, however, trustees and custodians are not required to accept such transfers. (Notice 2004-50, Q-56 and Q-78)

The roll-over provisions are set out in IRC section 223(f)(5) which states as follows:

The guidance contained in Notice 2004-50 (Q-55) may be read as restricting transfers into an individual's HSA from only one other HSA or MSA during a 12-month period. A better reading of section 223(f)(5) is that an individual may transfer balances from multiple existing HSAs or MSAs into an HSA on an annual basis so long as the individual makes only one rollover from each account.

The IRS should make clear that individuals are permitted to consolidate HSAs and MSAs and may make rollover contributions if they: (a) make only one such transfer from each HSA or MSA during a 12-month period; and (b) put the funds into the account within 60 days after the distribution.

Using a Limited-Purpose HRA for to Pay for HDHP Coverage

Revenue Ruling 2004-45 explains that Health Reimbursement Arrangements (HRAs) and health Flexible Spending Accounts (FSAs) may be offered in conjunction with an HSA in limited circumstances. The following are examples of permissible health benefits arrangements:

• Limited-purpose FSAs and HRAs that restrict reimbursements to certain permitted benefits such as vision, dental or preventive care benefits.

• Post-deductible FSAs or HRAs that only provide reimbursements after the minimum annual deductible has been satisfied.

• Suspended HRAs where the employee has elected to forgo health reimbursements for the coverage period.

AHIP recommends that guidance be issued allowing individuals to use a limited-purpose HRA to pay premiums for HDHP coverage while still being eligible for HSA coverage.

Encourage Use of On-Site Medical Clinics and Other Wellness Programs

To encourage health and wellness among employees, some employers may offer free flu shots, onsite health clinics or "wellness days" during business hours at their worksites to make the services convenient and accessible for employees. These services are often free-of-charge, on a voluntary participation basis, and do not take into consideration whether or not a participating employee has coverage through a health benefits plan.

When employers offer these on-site health services, such services are generally not intended to replace health insurance coverage. In many cases, the services provided often mirror free health services that are offered to the general public. Such services should not be considered "other health coverage" that would disqualify an individual from participating in a HSA.

Free health services or events provided by an employer to employees do not constitute "health plan coverage." The IRS should issue guidance which states that an employee is not disqualified from participating in an HSA if he or she also takes advantage of a free health service or event offered at the worksite such as an on-site medical clinic.

Correcting Administrative Errors

On July 31, 2006, the IRS issued final regulations governing comparable contribution requirements for employers' contributions to employees' HSAs. (71 Fed. Reg. 43056) The regulations prohibit an employer from recouping any excess amounts from an employee's HSA. The regulations allow the employer to correct administrative errors and satisfy the comparability rules by making additional contributions to the HSAs of comparable participating employees up until April 15th of the calendar year following the date that non-comparable contributions were made. (See: 26 C.F.R. § 54.4980G-4, Q-12)

Employers should be allowed to correct errors and recover funds in situations where the error is due to administrative mistake (e.g., the employee is not participating in an HSA or there is a duplicate entry or a misplaced decimal place).

AHIP recommends that guidance be issued clarifying that an employer may recover amounts contributed into an employee's HSA due to an administrative error -- for example, where the employee is not participating in the employer's HSA.

HSA Trustee or Custodian Fees Excludable From Gross Income

Notice 2004-50 (Q-69) states that amounts withdrawn from an HSA for administration and account maintenance fees will not be treated as a taxable distribution and will not be included in an employee's gross income. In addition, the Notice explains that administration and account maintenance fees paid directly by the account beneficiary or employer will not be considered contributions to the HSA and an individual's maximum annual HSA contribution limit is not affected by the payment of the administration fee. (See: Notice 2004-50, Q-71) However, existing IRS guidance has not addressed whether fees paid directly by an employer to an HSA trustee or custodian are excludable from an employee's gross income. Because the employee's use of HSA funds to pay administrative and account maintenance fees is not considered a taxable event, the use of employer funds for this purpose should similarly not have negative tax consequences for the employee.

AHIP recommends that guidance clarify that administration and account fees paid by an employer to an HSA trustee or custodian are excludable from an employee's gross income.

AHIP believes that providing additional guidance clarifying these issues will encourage further expansion of the market for HSAs among individuals and employers. We look forward to working with you on a resolution of these concerns.

Please feel free to contact me at (202) 778-3255 or twilder@ahip.org if you have any questions.

² Such debit card restrictions are typically offered in conjunction with Flexible Spending Arrangements (FSAs) or Health Reimbursement Arrangements (HRAs) which require the plan administrator to "substantiate" that the account funds are used for qualified medical expenses. (See: Revenue Ruling 2003-43 and Notice 2006-69.)

³ HSA trustees or custodians "may place reasonable restrictions on both the frequency and the minimum amount of distributions from an HSA." (Notice 2004-50, Q-80)