Do HSA Accounts Get Audited by the IRS?

Health Savings Accounts (HSAs) offer a tax-advantaged way for individuals to manage healthcare costs. These accounts provide a triple tax benefit: contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are tax-free. They serve as a flexible savings and spending vehicle, allowing account holders to save for current and future medical needs.

HSA Audit Scrutiny

HSAs are not audited in isolation; instead, they are subject to review as part of an individual’s overall tax return. The Internal Revenue Service (IRS) employs data matching programs to compare information reported by HSA custodians with the details taxpayers provide on their Form 8889, Health Savings Accounts (HSAs). Discrepancies between these forms, such as Form 5498-SA for contributions and Form 1099-SA for distributions, can draw IRS attention.

Certain activities might increase the likelihood of IRS scrutiny. Reporting unusually high HSA deductions that appear disproportionate to income could be a red flag. Distributions that seem non-qualified, especially large or frequent withdrawals without corresponding qualified medical expenses, may also trigger a review. Additionally, contributing to an HSA without meeting eligibility requirements, such as not being enrolled in a high-deductible health plan (HDHP), can lead to issues. Errors or omissions on Form 8889 are another common trigger for IRS inquiry.

Essential Record Keeping for HSAs

Maintaining thorough and accurate records is important for HSA compliance and can help address any potential IRS inquiries. Individuals should keep proof of their eligibility, such as documentation of enrollment in a high-deductible health plan and confirmation of no other disqualifying health coverage.

Detailed records of all contributions made to the HSA are also necessary. This includes payroll stubs showing HSA deductions or confirmations from the HSA custodian for direct contributions. For all distributions from the HSA, individuals should retain bank statements or custodian statements indicating withdrawals.

Most importantly, detailed receipts or itemized statements for all qualified medical expenses paid with HSA funds are required. These receipts should clearly show the date of service, the type of service, and the amount.

Copies of all relevant tax forms, including Form 1099-SA, Form 5498-SA, and Form 8889, should be kept with other tax records. Taxpayers should retain these records for at least three years from the tax filing date. Records can be maintained physically or digitally, ensuring their accessibility and integrity.

Consequences of Non-Compliance

Issues identified during an IRS review of HSA activity can lead to specific financial consequences. If HSA funds are used for non-qualified expenses, the distributed amount becomes taxable income. In addition to income tax, a 20% penalty applies to the unqualified amount if the account holder is under age 65 and not disabled. However, this penalty is waived if the account holder is age 65 or older, disabled, or if the distribution occurs due to death.

Excess contributions, which are amounts contributed beyond the annual IRS limits, are subject to a 6% excise tax each year they remain in the account. This tax applies annually until the excess amount is corrected. To avoid this penalty, excess contributions and any attributable earnings should be withdrawn by the tax filing deadline, including extensions. Beyond specific HSA penalties, general IRS penalties for underpayment of tax due to inaccuracies or negligence may also apply, along with interest on underpaid taxes. Accurate reporting on Form 8889 is therefore important to avoid these financial ramifications.