QUESTION: Our company is a Subchapter S corporation. Until now, our owners have been unable to participate in our cafeteria plan, but we have heard that they can contribute to HSAs. If we offer our employees the opportunity to make HSA contributions on a pre-tax basis through our cafeteria plan, will the owners also be able to do so?
ANSWER: The short answer is that the owners of your company can have HSAs, but they will not be able to make HSA contributions through your cafeteria plan if they are more-than-2% Subchapter S corporation shareholders. To be eligible to contribute to an HSA, an individual must—
have qualifying HDHP coverage;
not have impermissible non-HDHP coverage;
not be entitled to Medicare; and
not be a tax dependent of another taxpayer.
Any individual who meets these criteria is eligible to make HSA contributions (or have them made on his or her behalf). If the contributions are not made on a pre-tax basis and do not exceed the applicable limit, the individual can take an “above-the-line” federal income tax deduction on those contributions. Because there is no requirement that an individual be an employee to contribute to an HSA, this applies to any HSA-eligible taxpayer, including a more-than-2% Subchapter S corporation shareholder.
The eligibility rules for participation in a cafeteria plan differ from the HSA eligibility rules. Only employees can participate in a cafeteria plan; self-employed individuals cannot participate. More-than-2% Subchapter S corporation shareholders are treated as self-employed individuals for this purpose and thus cannot participate in a cafeteria plan. Because of certain ownership attribution rules, a more-than-2% shareholder’s spouse, children, parents, and grandparents who are employees of the Subchapter S corporation are also ineligible to participate in its cafeteria plan.
If you offer employees the opportunity to make pre-tax HSA contributions through the company’s cafeteria plan, the company’s more-than-2% shareholders (and any employee-relatives described above) will not become eligible for the cafeteria plan just because they are eligible for HSA contributions. They will, however, be able to establish their own HSAs and make contributions outside the workplace with after-tax dollars, and their contributions will be deductible from their income, above-the-line, when they file their federal income tax returns. State income tax treatment will depend on applicable state law. And if your company intends to make contributions to the HSAs of its owners (outside the cafeteria plan), note that special rules determine the tax treatment of HSA contributions made by Subchapter S corporations on behalf of their more-than-2% shareholders (see our Checkpoint article).
For more information, see EBIA’s Consumer-Driven Health Care manual at Sections IX (HSAs: Who Is Eligible?”), XII.L (“Tax Treatment of HSA Contributions”), and XVIII.B (“HSAs Offered Through Cafeteria Plans”); see also EBIA’s Cafeteria Plans manual at Sections IX.B.4 (“More-Than-2% Shareholders in a Subchapter S Corporation Cannot Participate (Nor Can Their Employee-Spouses or Certain Other Family Members Who are Employees)”) and XVI.K (“Special Considerations for HSAs Offered Through Cafeteria Plans”).
Contributing Editors: EBIA Staff.