What Constitutes HSA Fraud and What Are the Penalties?
Navigate Health Savings Account rules by understanding the important distinction between a simple spending error and intentional, fraudulent misuse of funds.
A Health Savings Account (HSA) offers a tax-advantaged way to pay for medical costs. It allows individuals with high-deductible health plans to contribute pre-tax dollars that can grow and be withdrawn tax-free for eligible expenses. The use of HSAs is governed by strict Internal Revenue Service (IRS) regulations. Intentionally misusing these funds for personal benefit through deceptive means is considered HSA fraud, which involves a deliberate intent to deceive.
Defining Prohibited HSA Uses
The proper use of an HSA is based on the definition of a Qualified Medical Expense (QME). The IRS defines a QME as a cost for the diagnosis, cure, mitigation, treatment, or prevention of disease. This covers a wide range of healthcare needs, including doctor visits, prescription medications, hospital services, and vision care. The definition also includes over-the-counter medicines and menstrual care products.
Spending HSA funds on items not meeting the QME criteria is a non-qualified distribution. Examples of non-qualified expenses relate to general wellness or cosmetic purposes, such as gym memberships, vacations, or non-essential cosmetic surgery. Using HSA funds for these purposes results in tax consequences that vary based on the account holder’s age.
After an HSA holder reaches age 65, the rules for non-qualified distributions change. The withdrawn amount is still treated as taxable income, but the 20% penalty is waived. This allows the HSA to function like a traditional retirement account for non-medical expenses. Distributions for QMEs remain completely tax-free.
Actions Constituting HSA Fraud
One form of HSA fraud is creating fake documentation. This includes fabricating invoices for medical services that were never rendered or for products that were never purchased. An individual might create a false receipt from a medical provider to justify a withdrawal while using the funds for personal, non-medical expenses.
Another fraudulent activity is seeking reimbursement for an expense already covered by another source. For example, an individual might get paid by their health insurance for a procedure and then use their HSA to reimburse themselves for the same expense. This practice, known as “double-dipping,” results in a tax-free financial gain.
Fraud can also occur with contributions. An individual must be enrolled in a qualifying High-Deductible Health Plan (HDHP) to contribute to an HSA, and knowingly making contributions while ineligible is fraudulent. Using HSA funds for someone who is not a tax dependent and misrepresenting their status is also fraud.
Consequences of Improper HSA Use and Fraud
For a standard non-qualified distribution by an individual under age 65, the consequences are financial. The withdrawn amount is included in the individual’s gross income and is subject to ordinary income tax. The IRS also imposes an additional 20% penalty on the distributed amount.
When the IRS determines that an improper use of HSA funds constitutes fraud, the consequences are more severe. Proven fraud can trigger a full IRS audit. If substantiated, the IRS can impose penalties for civil fraud, which are much higher than the 20% penalty, and the individual will be liable for back taxes and interest.
In cases of willful tax evasion, the matter can be referred for criminal investigation. A conviction for tax fraud can lead to significant fines, restitution, and imprisonment. These outcomes are reserved for cases involving large sums, elaborate schemes, or a pattern of deceptive behavior.
IRS Oversight and Reporting
The main tool for IRS oversight is Form 8889, Health Savings Accounts (HSAs), filed with an individual’s annual Form 1040 tax return. On this form, taxpayers must disclose all HSA activity for the year. This includes contributions, distributions, and continued eligibility.
Taxpayers use Form 8889 to report all contributions, including their own and those from an employer. The form also addresses distributions, requiring the user to report the total amount withdrawn and specify how much was for QMEs. Any amount not used for QMEs is calculated as a taxable distribution and is subject to the 20% additional tax if applicable.
To support the figures on Form 8889, careful recordkeeping is necessary. The burden of proof is on the taxpayer to prove that distributions were for legitimate medical expenses. This requires keeping receipts, invoices from medical providers, and Explanation of Benefits (EOB) statements from insurance companies.
The IRS uses information from Form 8889 and other tax documents like Forms 1099-SA and 5498-SA to identify compliance issues. Data analysis can flag suspicious patterns, such as distributions that are high relative to income or contributions that exceed legal limits, which may trigger an audit.