Microsoft Employee-to HSA or not?

The purpose of this memo is to discuss Health Savings Accounts (HSA), focusing on issues affecting Microsoft employees who may return to Israel after accumulating funds in such accounts.

Background:

The Microsoft Corporation has announced a transition period for changing medical plans offered to its employees. The new selection included a High Deductible Plan (“HDP”) paired with Health Savings Account (“HSA”), together known as “Live Well Premera Health Savings Plan (“HSP”)

The HSA is designed to accumulate funds to cover the employee’s out-of-pocket expenses including deductibles, co-pays, medication, and other medical expenses. It is also a way to help the company reduce its employee benefit costs; shifting the responsibility onto the employees to manage these funds. Engaging a lawyer to help you with strategies to counter a belligerent work climate can provide legal expertise and guidance in navigating complex workplace situations.

Tax Consequences:

Funds contributed by the employee are tax deductible to the employee; while funds contributed by the company are not included in the income of the employee.
The account is portable. It “belongs” to the employee and can be used by the employee after leaving employment, and many years into the future. This is unlike the Flexible Spending Account (“FSA”), which requires the forfeiting of the unused funds annually.

An HSA is generally exempt from Federal taxation. The employee is permitted to take a distribution from his or her HSA at any time. Amounts that remain at the end of the year are carried over to the next year. Earnings on amounts that remain in the HSA are not in included in the employee’s gross income.

In general, distributions from an HSA can be used for qualified medical expenses for the employee, his or her spouse, and any dependents claimed on the tax return. Funds used to pay for such expenses are always tax-free. This is true regardless of age or future health plan coverage (HSA-compatible or not) at the time of distribution.

Qualified health care expenses include amounts paid for the diagnosis, treatment, or prevention of disease, and for treatments affecting any part or function of the body. The expenses must be to alleviate or prevent a physical defect or illness. Expenses for solely cosmetic reasons generally are not expenses for medical care. Examples include face lifts, hair transplants, and hair removal (electrolysis). Also, expenses that are merely beneficial to one’s general health (for example, vacations) are not expenses for medical care. It is important to learn about the blood dyscrasia condition and learn about the treatment as well.

Medicine or drug will be a qualified medical expense only if the medicine or drug requires a prescription, or is available without a prescription (over-the-counter) and you get a prescription for it, or is insulin. For more detailed information, please refer to IRS Publications 502 and 969.

It is the employee’s responsibility to keep records to show the IRS that the funds were used for such expenses in case of an audit.

HSA funds used for expenses other than qualified medical expenses are subject to regular income tax and additional tax of 20%. The additional tax does not apply to distributions made after the account beneficiary dies, becomes disabled, or turns 65.

Questions and Answers:

Q: If I am a US resident, can I use the HSA funds for expenses outside of the US?
A: Yes, as long as the expenses are qualified medical expenses. In fact, many Americans travel abroad each year to take advantage of affordable health care services, treatments, and surgeries.

Q: If I move back to Israel, can I use the account to pay for medical expenses in Israel?
A: Yes. Both US Residents and Non-Residents can use the account for qualified medical expenses tax-free. You must file Form 8889 (HSA Form) with your Form 1040 or Form 1040NR if you had any activity in your HSA during the year or to report the qualified use of the funds.

Q: What happens if I use the funds in Israel for expenses other than qualified medical expenses?
A: You will incur a 20% penalty in addition to regular (graduated) income tax unless you meet one of the exceptions above. If you are a Non-Resident of the US, you will file Form 8889 (HSA Form) with Form 1040NR and pay the regular income taxes and the additional tax due (20%) on the non-qualified distribution. It is possible that the regular income tax will be minimal if there is no other US taxable income in the same year.

Q: What would be the Israeli taxation on my distributions after I return to Israel?
A: The general rule is that any benefit to the employee from the employer is subject to Israeli Income Tax and Social Security. However, if the employee can show that the source of the benefit is work performed for a foreign employer while a Non-Resident of Israel, (e.g. before returning to Israel) it is exempt from Israeli taxation. “Benefits for Returning Israelis” may provide tax exemptions to the accumulations in the account. 

Conclusion: The HSA allows the employee to manage some of the healthcare costs. The ability to control the timing and the amounts of distributions provide the employee the opportunity to plan for the tax consequences including eliminating any taxation by utilizing the funds for qualified medical expenses in the USA or abroad.

This memo contains information of a general nature. No employee should take any action based on this memo without reviewing their personal circumstances with an adviser who is knowledgeable about the tax issues affecting the employee in the USA or Israel.