HSA Compliance Requirements for Employers and Plan Administrators

Health Savings Accounts (HSAs) have become a cornerstone of modern employee benefits, offering a powerful, tax-advantaged way for employees to save for medical expenses when paired with a high-deductible health plan (HDHP). While HSAs are owned by the individual, employers play a crucial role in facilitating contributions, educating employees, and ensuring the entire process adheres to strict Internal Revenue Service (IRS) regulations. Proper administration is critical; a misstep in managing eligibility, contributions, or reporting can lead to compliance failures and costly penalties for both the employer and the employee.

Managing HSAs correctly protects your organization from costly IRS penalties. This comprehensive guide provides HR professionals, benefits leaders, and plan administrators with a detailed roadmap to HSA compliance, covering everything from core IRS rules and administrative challenges to best practices and training solutions. Our HSA Certification Program is designed to help you stay compliant and informed, transforming a complex administrative task into a strategic asset for your benefits program.

What Is a Health Savings Account (HSA)?

A Health Savings Account is a tax-advantaged savings and investment account, similar to a 401(k) but exclusively for healthcare expenses. It is not a health plan itself, but a financial account that must be paired with a qualified high-deductible health plan (HDHP).

Understanding the IRS Rules for HSA Compliance

The tax advantages of HSAs are contingent upon strict adherence to rules set forth by the IRS, primarily in Section 223 of the Internal Revenue Code.

Contribution Limits

The IRS sets annual limits on the total amount that can be contributed to an HSA. These limits are indexed for inflation and are announced annually. There are two main tiers: one for individuals with self-only HDHP coverage and a higher limit for those with family HDHP coverage. These limits apply to the combined contributions from both the employee and the employer.

Individuals age 55 or older are also eligible to make an additional "catch-up" contribution each year. This allows them to accelerate their savings as they approach retirement. Contributions for a given tax year can generally be made up to the tax filing deadline for that year. Employers making contributions outside of a cafeteria plan must follow strict comparability rules, meaning they must make comparable contributions for all similarly situated employees. If contributions are made through a Section 125 cafeteria plan, the plan's own nondiscrimination rules apply instead.

Eligibility Requirements

To be eligible to open and contribute to an HSA, an individual must meet several criteria:

• They must be covered by a qualified high-deductible health plan (HDHP) on the first day of the month.
• They cannot have any other disqualifying health coverage. This includes coverage under a spouse's non-HDHP plan, a general-purpose Health FSA or HRA, or most on-site medical clinics.
• They cannot be enrolled in any part of Medicare (Part A, B, D, etc.).
• They cannot be claimed as a dependent on someone else's tax return.

It is possible to have an HSA alongside a limited-purpose FSA (which only covers dental and vision expenses) or a post-deductible FSA/HRA (which only provides reimbursement after the HDHP deductible has been met).

Qualified Medical Expenses

HSA funds can be withdrawn tax-free to pay for qualified medical expenses as defined by the IRS. A comprehensive list can be found in IRS Publication 502, but it generally includes:

• Deductibles, copayments, and coinsurance.
• Prescription medications.
• Dental and vision care, including exams, glasses, and orthodontia.
• Chiropractic care and acupuncture.
• Medical equipment and supplies.

Thanks to the CARES Act, over-the-counter (OTC) medications (like pain relievers and cold medicine) and menstrual care products are also considered qualified medical expenses without a prescription. Using HSA funds for non-qualified expenses has significant tax consequences.

Withdrawals and Tax Implications

The tax treatment of HSA withdrawals depends on the account holder's age and the purpose of the withdrawal.

• Before Age 65: Withdrawals for qualified medical expenses are 100% tax-free. Withdrawals for any other reason are subject to regular income tax plus a 20% additional tax penalty.
• At or After Age 65: Withdrawals for qualified medical expenses remain tax-free. If funds are withdrawn for non-medical reasons, they are taxed as regular income, but the 20% penalty no longer applies. This effectively allows the HSA to function like a traditional IRA or 401(k) in retirement.

While the employer is not responsible for policing withdrawals, it is crucial to educate employees on these rules and the importance of keeping records and receipts to substantiate tax-free distributions in the event of an IRS audit.

Rollover and Portability

Unlike FSAs, HSAs have no "use-it-or-lose-it" rule. All unused funds automatically roll over from one year to the next, allowing the balance to grow indefinitely. Because the account is owned by the individual, it is fully portable. When an employee leaves their job, the HSA and all its funds go with them. They can continue to use the funds for medical expenses or perform a trustee-to-trustee transfer to move the balance to a different HSA custodian of their choice. The IRS also permits a one-time, tax-free transfer from a traditional or Roth IRA to an HSA, known as a Qualified HSA Funding Distribution.

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HSA Administration Challenges for Employers

While HSAs are employee-owned accounts, employers face several administrative challenges in facilitating them.

Compliance and Regulation

Employers are responsible for ensuring their process for facilitating HSA contributions is compliant. This includes verifying that the employee is enrolled in a qualified HDHP sponsored by the employer. If the employer contributes, they must follow either the comparability rules (for non-cafeteria plan contributions) or the Section 125 nondiscrimination rules. Employers also play a role in helping employees correct excess contributions?contributions made over the annual IRS limit?which must be corrected before the tax filing deadline to avoid penalties.

Employee Education and Communication

Many employees are unfamiliar with the nuances of HSAs and HDHPs. A significant challenge for employers is providing clear, effective education. This goes beyond simply stating the contribution limits. It involves explaining the triple tax advantage, the difference between an HSA and an FSA, the types of eligible expenses, the importance of recordkeeping, and the long-term investment potential. Effective communication during open enrollment is critical to drive adoption and ensure employees use their accounts correctly.

Integration with HDHPs

Seamless integration between the HSA program and the company's HDHP is essential. This includes aligning plan effective dates, waiting periods, and payroll deduction schedules. A common challenge arises when there are retroactive coverage changes. For example, if a new hire's coverage is effective May 1st but this isn't processed until the May 15th payroll, the employer must ensure the HSA contribution is calculated correctly for the partial period.

Recordkeeping and Reporting

Employer responsibilities for reporting are specific. The primary duty is to report the total employer and employee contributions made through the employer's payroll on the employee's Form W-2, using Box 12 with Code W. This amount is informational and does not add to taxable wages. The HSA custodian (the bank or financial institution holding the account) is responsible for issuing Form 5498-SA (reporting contributions) and Form 1099-SA (reporting distributions) to the account holder. However, employers often need to reconcile their W-2 reporting with the custodian's records to resolve employee inquiries.

Fraud Prevention and Security

While the HSA custodian is primarily responsible for account security, employers handle a significant amount of personally identifiable information (PII) and protected health information (PHI) during the enrollment and contribution process. Protecting this data is a critical responsibility. Employers should also educate employees on best practices for safeguarding their HSA, such as creating strong passwords and being wary of phishing attempts related to their account.

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Common Errors in HSA Administration

Mistakes in HSA administration can be costly for both employers and employees. Here are some of the most common errors:

• Excess Contributions: Allowing employees to contribute more than the annual IRS limit, often due to a mid-year change in coverage status (e.g., from family to self-only) or failing to account for employer contributions.
• Eligibility Mistakes: Allowing an employee to contribute to an HSA when they are not eligible, such as after they have enrolled in Medicare or while also being covered by a spouse's general-purpose FSA.
• Non-Qualified Expenses: While this is an employee error, lack of education from the employer can contribute to employees using funds for ineligible items, leading to taxes and penalties for the employee.
• Improper Documentation: Employees failing to keep receipts to substantiate their tax-free withdrawals, putting them at risk in an IRS audit.
• Incorrect Reporting: Employers making errors on the W-2 Code W reporting, which can cause confusion and mismatches when employees file their taxes.
• Investment Mismanagement: Employees not understanding the investment options available in their HSA, leading to either overly conservative or overly risky allocations.
• FSA Incompatibility: A common error is allowing an employee to be covered by both a general-purpose Health FSA and an HSA, which is prohibited.
• Late Employer Funding: Delays in transmitting employer or employee payroll contributions to the HSA custodian can be a violation of ERISA's rules on timely remittance of plan assets.
• Misunderstanding the Last-Month Rule: Incorrectly applying this rule, which allows an individual who becomes eligible late in the year to make a full year's contribution, without understanding the 13-month "testing period" that requires them to remain eligible.
• Comparability Rule Failures: Employers making non-comparable contributions to employees outside of a Section 125 plan, a violation that carries steep excise tax penalties.

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Best Practices for Effective HSA Administration

An effective HSA program is built on a foundation of proactive audits, strong partnerships, and continuous education.

Conduct Regular Compliance Audits

Don't wait for the IRS to find a problem. Conduct periodic internal audits of your HSA processes. Review your eligibility verification procedures, check the timing of your contribution funding, audit your W-2 reporting for accuracy, and ensure your Section 125 cafeteria plan documents are up-to-date and properly integrated with your HSA offerings.

Partner With a Trusted Administrator or Vendor

The quality of your HSA custodian or TPA is paramount. When selecting a vendor, perform due diligence on their fee structure, technology platform (including the employee portal and mobile app), investment options, customer support quality, and data security protocols. A strong partner acts as an extension of your benefits team, providing robust reporting and responsive support.

Train HR Teams and Employees

Role-based training is essential. Your HR and payroll teams need deep technical training on the IRS rules for eligibility, contributions, and reporting. Employees need clear, simple, ongoing education about how to use their HSA effectively. Use a mix of communication channels?webinars, short videos, infographics, and detailed guides?and offer sessions during open enrollment and for new hires.

Integrate HSAs with Cafeteria Plans and HDHPs

The most tax-advantaged way to make employee HSA contributions is through a Section 125 cafeteria plan. This allows for pre-tax deductions that save both the employee and employer on FICA taxes. It's critical that the cafeteria plan document explicitly includes the HSA contributions. This setup also allows the plan to be governed by the Section 125 nondiscrimination rules instead of the stricter comparability rules. Ensure your plan design also correctly coordinates the HSA with any other offerings, like a limited-purpose FSA.

Review IRS Guidance Annually

The IRS releases updates to HSA rules every year, typically in late spring. These include the inflation-adjusted contribution limits, HDHP minimum deductibles, and out-of-pocket maximums for the following year. Assign responsibility within your team to monitor these updates and ensure your systems, communications, and plan documents are updated in a timely manner.

Recommended HSA Training and Certification Programs

Professional training is the most effective way to ensure your team has the expertise to manage your HSA program compliantly.

HSA Training & Certification Program

This comprehensive program covers every aspect of HSA compliance, including the detailed IRS rules for eligibility, contribution limits, qualified expenses, and employer reporting requirements. It is the ideal course for any professional seeking to become a Certified HSA Administrator.

Cafeteria Plan Training & Certification Program

This course is essential for understanding how to properly integrate HSA contributions within a Section 125 plan. It covers the nondiscrimination rules and documentation requirements needed to offer HSAs on a pre-tax basis.

Certified Administrator & Certified TPA Designations

These credentials validate expertise in benefits compliance. Earning a certification demonstrates a commitment to professional excellence and provides a competitive advantage for both in-house professionals and Third-Party Administrators.

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FAQ: Health Savings Account Compliance

What are the current HSA contribution limits?

The IRS adjusts the HSA contribution limits for inflation each year, typically announcing the next year's limits in the spring. There are separate limits for individuals with self-only HDHP coverage and for those with family HDHP coverage. Individuals age 55 and over can also make an additional "catch-up" contribution. It's essential to refer to the current year's IRS guidance for the exact dollar amounts.

Who qualifies for an HSA under IRS Section 223?

To be an "HSA-eligible individual," a person must be covered by a qualified high-deductible health plan (HDHP), must not have any other disqualifying health coverage (like a traditional health plan or a general-purpose FSA), must not be enrolled in Medicare, and cannot be claimed as a dependent on someone else's tax return.

What medical expenses are HSA-eligible?

HSA funds can be used for a wide range of "qualified medical expenses" as defined in IRS Publication 502. This includes costs for medical, dental, and vision care, such as deductibles, copayments, prescriptions, glasses, and orthodontia. Over-the-counter medicines and menstrual care products are also eligible.

What happens if I over-contribute to an HSA?

Excess contributions (amounts over the annual IRS limit) are subject to a 6% excise tax for each year they remain in the account. To avoid the tax, the excess amount plus any earnings on it must be withdrawn before the individual's tax filing deadline for that year.

How should employers report HSA contributions?

Employers must report the total amount of contributions (both employee and employer) made to an employee's HSA through their payroll on the employee's Form W-2 in Box 12, using the code "W." This is an informational code and does not affect the employee's taxable income.

Can employees have both an HSA and an FSA?

Generally, no. An individual cannot contribute to an HSA if they are covered by a general-purpose Health FSA that reimburses all medical expenses. However, they can have an HSA alongside a limited-purpose FSA (which only covers eligible dental and vision expenses) or a post-deductible FSA (which only pays benefits after the HDHP deductible is met).

Glossary of HSA Compliance Terms

• HDHP (High-Deductible Health Plan): A health insurance plan with a higher deductible and lower premiums that meets specific IRS requirements to be HSA-compatible.
• Section 223: The section of the Internal Revenue Code that governs the rules for Health Savings Accounts.
• Catch-Up Contribution: An additional contribution amount that individuals age 55 and older can make to their HSA each year.
• Qualified Medical Expenses: The specific expenses defined by the IRS (in Publication 502) that can be paid for tax-free with HSA funds.
• Last-Month Rule: An IRS rule that allows an individual who becomes HSA-eligible late in the year to make the full year's contribution, provided they remain eligible for a 13-month "testing period."
• Testing Period: The 13-month period following the use of the last-month rule, during which an individual must remain HSA-eligible to avoid tax penalties.
• Comparability Rules: IRS rules requiring employers who contribute to HSAs outside of a cafeteria plan to make comparable contributions for all similarly situated employees.
• Trustee-to-Trustee Transfer: A tax-free transfer of funds directly from one HSA custodian to another.
• Qualified Funding Distribution: A one-time, tax-free transfer of funds from a traditional or Roth IRA to an HSA.
• Limited-Purpose FSA: A Flexible Spending Account that can be paired with an HSA because it only reimburses for eligible dental and vision expenses.
• Post-Deductible HRA: A Health Reimbursement Arrangement that only reimburses medical expenses after the HDHP deductible has been satisfied, making it compatible with an HSA.
• Code W: The code used in Box 12 of Form W-2 to report total employer and employee contributions to an HSA made through payroll.
• Forms 5498-SA / 1099-SA: IRS forms issued by the HSA custodian to the account holder, reporting annual contributions and distributions, respectively.

Download our HSA Compliance Glossary & Contribution Limits Chart (PDF).

How to Stay Compliant With IRS Section 223 HSA Rules

Staying compliant with Section 223 requires a proactive, detail-oriented approach. First, you must have a clear process for determining and documenting employee eligibility at the beginning of each plan year and for new hires. Second, your payroll system must be configured to handle contribution limits, including catch-up contributions, and to stop contributions if an employee's status changes mid-year. Third, if you make employer contributions outside of a Section 125 plan, you must have a rigorous process for ensuring you meet the comparability rules. Finally, a commitment to annual training for your HR/payroll team to review IRS updates is essential.

HSA vs. FSA vs. HRA ? Key Differences

These three tax-advantaged accounts are often confused.

• HSA (Health Savings Account): Owned by the employee, portable, requires an HDHP, and funds roll over year to year. Can be invested.
• FSA (Flexible Spending Account): Owned by the employer. Funds are generally subject to a "use-it-or-lose-it" rule each year. Does not require an HDHP.
• HRA (Health Reimbursement Arrangement): Owned and funded solely by the employer. The employer sets the rules for reimbursement. It is not an employee savings account.

How Employers Can Simplify HSA Recordkeeping

While the HSA custodian and the employee hold the primary recordkeeping responsibilities for distributions, the employer's main duty is to accurately track and report contributions made through its payroll. The best way to simplify this is to use a payroll system that is specifically designed to manage HSA deductions. It should be able to track year-to-date contributions against the annual limits and automatically code the total on the W-2. For employer contributions, keeping a clear log of all contributions made on behalf of each employee, including dates and amounts, is critical for reconciling with payroll reports and proving compliance with comparability rules if audited.

Common Myths About HSA Eligibility

Education is key to dispelling common myths that lead to compliance errors.

• Myth: "If my company offers an HDHP, I'm automatically eligible for an HSA." Fact: You must actually be enrolled in the HDHP and have no other disqualifying coverage.
• Myth: "My spouse has an FSA, but it won't affect my HSA." Fact: If your spouse's FSA is a general-purpose Health FSA, it is considered "other coverage" that makes you, the employee, ineligible to contribute to an HSA.
• Myth: "I can contribute to an HSA as soon as I turn 65." Fact: Enrolling in any part of Medicare makes you ineligible to contribute to an HSA. Since Medicare Part A is often retroactive, individuals should stop HSA contributions several months before their 65th birthday if they plan to enroll in Medicare.

How to Handle HSA Contribution Corrections

If an employer or employee discovers that contributions have exceeded the annual IRS limit, the error must be corrected to avoid a 6% excise tax. The employee must notify the HSA custodian to request a "return of excess contributions." The custodian will distribute the excess amount, plus any earnings attributable to that amount. The employee must report both the excess contribution and the earnings as "other income" on their tax return for the year the contribution was made. This correction must be completed by the employee's tax filing deadline.

What to Know About HSA Investment Options

A key advantage of HSAs is the ability to invest the funds for long-term growth. Most HSA custodians offer a menu of investment options, typically mutual funds, similar to a 401(k). Employers should choose an HSA vendor that offers a solid lineup of low-cost, diversified investment options. While employers cannot provide investment advice, they have a responsibility to educate employees that these options exist and to provide resources (from the HSA vendor) that explain investment principles and risk tolerance.

How to Prevent HSA Fraud and Misuse

While the employee is ultimately responsible for how they use their HSA funds, employers can help prevent misuse through education. Regularly remind employees to use their HSA only for qualified medical expenses and to keep all receipts and EOBs. On the employer side, preventing fraud involves securing employee data used for enrollment and funding, and ensuring that any employer contributions are made according to a clear, non-discriminatory, and well-documented policy to prevent claims of favoritism or improper use of company assets.

Employer HSA Responsibilities Under the IRS Code

The employer's core responsibilities are narrow but critical. The IRS holds the employer responsible for:

1. Confirming the employee is covered by a qualified HDHP before facilitating contributions.
2. Ensuring total contributions made through payroll do not exceed the annual limits.
3. Following the comparability rules for employer contributions made outside a cafeteria plan.
4. Accurately reporting total payroll contributions on the employee's Form W-2 (Box 12, Code W).

The employer is not responsible for verifying that an employee has no other disqualifying coverage, for substantiating an employee's medical expense withdrawals, or for tracking an employee's age for catch-up contributions (though payroll systems should be configured to allow it).

The Role of HR in HSA Education and Oversight

HR plays the central role in the success of an HSA program. This function is not just administrative; it is strategic. HR is responsible for selecting the HSA vendor, designing the communication and education campaign, and training managers on the basics. During open enrollment, HR must be able to explain the HDHP/HSA model clearly and help employees make informed decisions. On an ongoing basis, HR serves as the primary point of contact for employee questions and is responsible for overseeing the payroll and contribution process to ensure compliance.

Preparing for an IRS HSA Audit

An IRS audit of your HSA process will focus on documentation and procedural consistency. To prepare, ensure you can readily produce:

• Your Section 125 cafeteria plan document if you offer pre-tax contributions.
• The policy or document outlining your employer contribution strategy.
• Payroll records demonstrating correct W-2 reporting (Box 12, Code W).
• If you are subject to the comparability rules, documentation proving that your contributions were comparable for all eligible employees.
• Evidence of your process for communicating eligibility and other plan features to employees.

How to Transition From FSA to HSA Programs

Transitioning employees from a familiar FSA to an HSA model requires a carefully planned change management and communication strategy. Start communicating months in advance. Emphasize the key benefits of the HSA: portability, rollover of funds, and investment potential. Create comparison charts that clearly illustrate the differences. Be very clear about the "use-it-or-lose-it" FSA rule and advise employees to spend down their FSA balances before the new plan year begins. A common transition strategy is to offer a limited-purpose FSA alongside the new HSA, which allows employees to continue saving for dental and vision expenses while getting comfortable with the HSA.

HSA Compliance Checklist for HR and Benefits

A compliance checklist is an essential tool for managing your annual HSA process. It should include:

• Q2: Confirm next year's IRS limits for contributions and HDHP design.
• Q3: Prepare open enrollment communication materials with updated limits.
• Q4 (Open Enrollment): Collect employee elections; confirm eligibility (enrollment in HDHP).
• Year-End: Ensure final payroll contributions are transmitted on time. Reconcile annual contributions for W-2 reporting.
• Q1 (New Year): Verify W-2s are correct (Box 12, Code W). Distribute any required notices.
• Ongoing: Process new hire enrollments and contribution changes due to status changes. Monitor for potential excess contributions.

In the landscape of employee benefits, the Health Savings Account offers unparalleled tax advantages and flexibility. However, harnessing its full potential requires a commitment from employers and administrators to navigate its rules with precision and care. By investing in deep knowledge, implementing robust administrative processes, and prioritizing clear employee education, you can ensure your HSA program is not only a powerful tool for your employees but also a model of compliance and best practice for your organization.

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