Your IRA isn’t an HSA. Last week I was asked whether there was a penalty for taking money from an Individual Retirement Account to pay for surgery. I said there was no penalty, but that it was taxable income. The person who asked was surprised and confused, thinking that penalty and taxation are the same thing. They aren’t.
The Tax Court faced a similar question yesterday. A 47 year-old taxpayer took money from her IRA to pay medical expenses for her non-dependent son. The IRS noticed, presumably via a computer match, and assessed her a 10% early withdrawal penalty, as well as regular income tax. Judge Guy explains the issue:
Generally, if a taxpayer receives a distribution from a qualified retirement plan before attaining age 59-1/2, section 72(t) imposes an additional tax equal to 10% of the portion of the distribution which is includible in the taxpayer’s gross income. Sec. 72(t)(1) and (2). The additional tax is intended to discourage taxpayers from taking premature distributions from retirement plans — actions that frustrate public policy encouraging saving for retirement…
Section 72(t)(2)(B) provides an exception to the imposition of additional tax to the extent that retirement plan distributions “do not exceed the amount allowable as a deduction under section 213 to the employee for amounts paid during the taxable year for medical care (determined without regard to whether the employee itemizes deductions for such taxable year).” Section 213 in turn allows as a deduction “the expenses paid during the taxable year, not compensated for by insurance or otherwise, for medical care of the taxpayer, his spouse, or a dependent…
The “dependent” part was bad news:
The record reflects that petitioner did not claim her son as a dependent for the year in issue and fails to demonstrate that her son met the definition of a dependent provided in section 152. Consequently, we conclude that petitioner is not eligible for the exception under section 72(t)(2)(B) — even assuming that she used the funds in question to pay her son’s medical expenses.
But even if she did qualify to avoid the 10% tax (she didn’t), the withdrawal would still have been subject to income tax.
Health Savings Accounts look a lot like IRAs — they allow tax-free build-up, and they can be tapped penalty free like IRAs for retirement income. But HSA funds withdrawn for medical expenses are tax-free — not just penalty free. As with the IRA, though, the medical expenses have to be the taxpayers, the spouse’s, or a dependent’s. This extra flexibility makes HSAs a better savings vehicle than an IRA for those who qualify.
Not everybody qualifies. You need a “high deductible” health insurance policy to qualify for an HSA. For 2015 a “high deductible plan” is one with an annual deductible of at least $1,300 for single coverage and $2,600 for family coverage. Annual out-of-pocket costs can’t exceed $6,450 for single coverage and $12,900 for family coverage. The 2015 contribution limits are $3,350 for single coverage and $6,650 for family coverage.
Unlike employer “flex-plan” arrangments, there is no “use it or lose it” feature in HSAs. You can accumulate contributions and save them for a year with large medical expenses, or for retirement. You don’t have to withdraw the funds in the same year as the medical expenses, either; if you had medical expenses in year 1, you can wait until year 2 to withdraw the amount and still have it tax-free.
Maria Koklanaris, ConAgra Foods, Winner of Largest-Ever Nebraska Incentive Package, Moving to Illinois (Tax Analysts, subscriber link):
ConAgra Foods Inc., recipient of the largest tax incentive package ever awarded in Nebraska, announced October 1 that it would move its corporate headquarters from Omaha to Chicago, cutting at least 1,500 jobs in the process.
As I’ve said before, incentive tax credits are like taking your wife’s purse to the bar to buy drinks for the girls. It cheats the person who’s paying, the girls aren’t impressed, and if you leave with one, she’s not the type to be faithful.
It’s Friday! It’s Buzz Day for Robert D. Flach. Trumpmania figures prominently.
Jason Dinesen, How to Protect a Deceased Person’s Identity. “Thankfully, Congress has now limited access to the Death Master File, which was the cause of much of the identity theft relating to deceased people.”
Paul Neiffer, Form 1099-G Does Not Always Require Schedule F Reporting. “The key thing to remember is just because USDA or a cooperative issues a Form 1099 does not mean the income has to be fully reported on Schedule F and subject to full self-employment tax.”
Jim Maule, Taxation of Prizes, Question Three. “The question, however, also referred to the local or state sales tax. The awarding of a prize is not a sale, so the sales tax ought not apply.”
Kay Bell, Hurricane Joaquin intensifies, threatens East Coast…maybe. Maybe you should dust off your disaster recovery plan once in awhile.
Leslie Book, Restitution Based Assessment and Tax Return Preparers: An Uneasy Mix (Procedurally Taxing). On the problems the IRS has in getting restitution from crooked preparers.
Robert Wood, Marijuana Goes Native American And Tax Free
Herbert Hoover, in the midst of the Great Depression, more than doubled the top [income-tax] rate to 63 percent and increased the bottom rate by more than nine times to 4 percent. He did this in spite of the fact that raising income tax rates during a depression lengthens the depression. Franklin Roosevelt carried on Hoover’s policy throughout the 1930s and increased tax rates further. By 1940, he had raised the top tax rate to 81.1 percent on incomes over $5 million.
Putting the “great” in the Great Depression.
Stephen Entin, Expensing: The Right Tax Treatment for All Investment Regardless of Financing Arrangements (Tax Policy Blog)
Howard Gleckman, How Investment Managers (And Maybe You) Would Benefit From Trump’s Tax Plan (TaxVox).
Cara Griffith, Idaho Legislators Shamed Into Good Behavior (Tax Analysts) Politicians, bureaucrats and cockroaches prefer darkness.
Carl Davis, Michigan Becomes the 26th State Where Online Retailers like Amazon Must Collect Sales Tax (Tax Justice Blog).
TaxProf, The IRS Scandal, Day 876. Lois Lerner and the Wisconsin witch hunt.
The Critical Question. Is Technology Making Accountants Dumb and Lazy? (Chris Hooper, Going Concern).