MSA Tax Rules for Contributions and Distributions

An Archer Medical Savings Account (MSA) is a tax-advantaged savings vehicle paired with a high-deductible health plan (HDHP), allowing individuals to set aside money for healthcare costs. New Archer MSAs can no longer be established, but individuals who had an account before they were discontinued can continue to use them. Existing account holders can still make contributions and take distributions, but must follow specific rules to maintain the account’s tax benefits.

MSA Contributions and Tax Deductions

To contribute to an existing Archer MSA, the account holder must be an employee of a small employer, defined as one with 50 or fewer employees, or be self-employed. A requirement is that the individual must be covered by an MSA-qualified high-deductible health plan (HDHP).

An MSA-qualified health plan must meet specific IRS thresholds. For self-only coverage, the plan must have an annual deductible between $2,800 and $4,150 and a maximum out-of-pocket expense of $5,550. For family coverage, the annual deductible must be between $5,550 and $8,350, with a maximum out-of-pocket expense of $10,200. The individual cannot have other health coverage.

The annual contribution limit for an Archer MSA is tied to the deductible of the associated HDHP. For individuals with self-only coverage, the maximum contribution is 65% of the plan’s annual deductible. For those with family coverage, the limit is 75% of the annual deductible. For example, if an individual has a self-only HDHP with a $4,000 deductible, their maximum MSA contribution for the year would be $2,600.

Contributions made by the account holder are tax-deductible. This is an “above-the-line” deduction, meaning the taxpayer can reduce their adjusted gross income (AGI) without itemizing. If an employer contributes to an employee’s MSA, those amounts are not included in the employee’s gross income, and the employee cannot make their own deductible contributions that year.

Tax Treatment of MSA Distributions

The tax treatment of MSA withdrawals depends on how the money is used. Distributions used for qualified medical expenses are tax-free at the federal level. Qualified medical expenses are defined by the IRS in Publication 502 and include most medical, dental, and vision care costs.

Distributions taken for any reason other than a qualified medical expense have tax consequences. These non-qualified distributions are included in the account holder’s gross income for the year and are subject to regular income tax. These withdrawals are also subject to an additional 20% penalty tax.

The 20% penalty is waived if the distribution is made after the account holder turns 65, becomes disabled, or dies. In these situations, the withdrawn amount is still added to the individual’s taxable income for the year, but the additional penalty is not applied.

Reporting MSA Activity on Your Tax Return

Financial institutions issue forms to report MSA activity. Account holders receive Form 1099-SA, which shows any distributions taken during the year. The institution also sends Form 5498-SA to report the total contributions made for the year.

The primary document for reporting MSA activity is IRS Form 8853, Archer MSAs and Long-Term Care Insurance Contracts. Taxpayers must file this form if any contributions were made to their Archer MSA during the year, including employer contributions.

Part I of Form 8853 is used to calculate the allowable MSA deduction based on total contributions and HDHP information. Part II is used to report distributions from Form 1099-SA and determine if any portion is taxable. This section is also where the 20% penalty on non-qualified distributions is calculated.

The figures from Form 8853 are transferred to Form 1040. The MSA deduction is reported on Schedule 1, reducing adjusted gross income. Any taxable income or penalties are carried over to the appropriate lines on Form 1040 and its schedules.

MSA Rollovers and Account Inheritance

Funds can be moved from one Archer MSA to another via a tax-free rollover, allowing an account holder to change financial institutions. The law also permits a one-time, tax-free rollover from an Archer MSA to a Health Savings Account (HSA). For a rollover to be tax-free, the funds must be deposited into the new account within 60 days of withdrawal.

The tax treatment of an Archer MSA upon the account holder’s death depends on the beneficiary. If the surviving spouse is the named beneficiary, the account is transferred to them and becomes their own Archer MSA. The spouse can then continue to use the account under the same tax rules.

If the beneficiary is not a spouse, or if no beneficiary is named, the account ceases to be an MSA on the date of the owner’s death. The fair market value of the account on that date must be included in the beneficiary’s gross income for that tax year. This amount is reported on the beneficiary’s tax return.