IRS Letter Explains Effect of Retroactive Medicare Coverage on HSA Contribution Limit

The IRS has released an information letter affirming that health savings account (HSA) holders cannot make contributions for months of retroactive Medicare coverage. As the letter notes, Medicare coverage typically begins with the month an individual turns age 65, but the actual commencement date depends on when the individual applies for Medicare (or Social Security or Railroad Retirement benefits that trigger Medicare coverage). Individuals who delay applying for free Medicare Part A are covered retroactively to the month they attained age 65 or for six months, whichever is less. The letter explains that the Code sets a zero-contribution limit for months of Medicare coverage and that rule has no exceptions, so months of retroactive Medicare must also reduce HSA contributions.

According to the letter, an HSA account holder who overcontributes because of retroactive Medicare coverage may avoid the 6% excise tax under Code § 4973 by withdrawing the excess contributions by the federal tax return filing deadline (including extensions) for the contribution year. Timely withdrawals of excess contributions are not subject to the 20% additional tax for non-medical distributions. That tax also does not apply to distributions made after an HSA account holder attains age 65, so even if the excess is not timely withdrawn, it can be withdrawn later without incurring the additional tax. In either case, however, the distributions must be included in income for federal tax purposes unless they were timely withdrawn and previously treated as taxable income.

EBIA Comment: Medicare’s interaction with HSA eligibility can be complex (see our Checkpoint article), and Medicare retroactivity, in particular, is a trap for the unwary. For example, an HSA holder who files a Medicare application in July and is credited with six months of retroactive coverage will be unable to make any HSA contribution for that tax year; a November application will limit annual contributions to four-twelfths of the applicable annual limit (assuming the individual is otherwise HSA-eligible through April of that year). Fortunately, as the letter notes, the 6% excise tax and the 20% additional tax for non-medical distributions can be avoided if the excess is timely distributed. Although not mentioned in the letter, earnings on excess contributions must also be distributed and reported as taxable income to avoid the excise tax, which generally continues until the excess is either distributed or deemed contributed tax-free in a later year. The latter correction is only possible if contributions for the later year are less than the maximum allowable, so it is unavailable to individuals who are covered by Medicare (and therefore not HSA-eligible)—their maximum allowable will be zero. Later distributions to correct the excess and stop the excise tax will be taxable income, but should not be subject to the 20% additional tax because an individual who is over age 65 can take non-medical distributions without paying the extra tax. For more information, see EBIA’s Consumer-Driven Health Care manual at Sections IX.C (“An Individual Who Is Entitled to Medicare Is Not HSA-Eligible”) and XII.N (“What Happens If Too Much Is Contributed to an HSA?”). See also EBIA’s Group Health Plan Mandates manual at Section XXIV.C.1 (“Entitlement to Medicare Part A”).

Contributing Editors: EBIA Staff.