HSA for Employees? Beat the Dreaded 35 Percent Penalty Tax
The Affordable Care Act (ACA) changed the landscape for small businesses that offered health benefits for their employees.
Before the ACA, many small businesses reimbursed some or all of their employees’ individually purchased health insurance.
The ACA makes that illegal and imposes a $100-a-day, per-employee penalty for such reimbursements without using one of the newer health reimbursement accounts—namely the ICHRA or the QSEHRA.
That brings us to two other choices:
- As a small employer with fewer than 50 employees, you can offer no health benefits and face no federal law penalties.
- You can use the health savings account (HSA) to help employees with their health benefits without facing the hurdles of the Affordable Care Act.
But here’s the kicker: The one thing you need to consider when you make these contributions is the discrimination rules (which are called “comparability” rules in the HSA world). If you violate these rules, the IRS forces you to pay a draconian tax of 35 percent of your total HSA contributions.
Fortunately, it’s easy to avoid discrimination—even when you favor one group of employees over another—when you follow three simple rules. Here’s an example to help you understand.
Is This Discriminatory?
Bill creates a reward program for his employees in which he contributes to the HSAs of his top three salespeople.
He contributes $6,000 to the winner, $3,000 for second place, and $1,000 for third place.
Do these payments meet the HSA comparability rules?
Believe it or not, Bill might be in compliance with tax law, depending on the health insurance situation of his employees. We’ll revisit this example at the end of the article, but you should already see that the HSA rules give you a lot of flexibility to avoid discrimination. You do not have to give equal amounts to all employees.
What happens if the payments are not comparable? Bill faces a big penalty if he fails the tax law rules. He would have to pay a 35 percent excise tax on his total HSA contributions. In this example with three employees, the penalty tax would be $3,500 (35 percent x $10,000).
What Employers Must Know
The general rule to know as an employer is that you have to make “comparable” contributions to all employees who have a high-deductible health plan (HDHP). (Employees are not eligible for HSA contributions unless they have an HDHP.)
What if some employees have an HDHP and some don’t? You don’t have to give any benefit to the non-HDHP employees. For purposes of HSA tax law, you can simply give them nothing and ignore them.
But for your HDHP employees, you have to make comparable contributions. You do that by following the three rules below.
Rule 1—Determine the Categories of Your HDHP Employees
You have to make comparable contributions only to employees who are in the same “category.”
For two or more employees to fall into the same category, they must have identical answers to both of the following questions:
- Is the employee a full-time, part-time, or former employee?
- How many dependents are covered under the employee’s HDHP?
Full time versus part time. Part-time employees are those working fewer than 30 hours per week, and full-time employees are those working 30 hours or more per week.
Number of dependents covered. The HSA rules provide four options:
- Self-only HDHP
- Family HDHP covering the employee plus one dependent (“self plus one”)
- Family HDHP covering the employee plus two dependents (“self plus two”)
- Family HDHP covering the employee plus three or more dependents (“self plus three or more”)
Examples
Example 1. You have three full-time employees:
- Sam has a self-only plan.
- Joe has a family plan covering himself and his son.
- Kim has a family plan covering herself and her husband.
Only Joe and Kim are in the same category, because they both have self-plus-one HDHP coverage. Sam is in a different category because he has coverage for himself only.
Example 2. In addition to the three employees above, you have a part-time employee named Barbara who has a family plan covering herself and her husband. Barbara is in a category separate from Joe and Kim. Even though she has self-plus-one coverage, she is part time, whereas Joe and Kim are full time.
Some Bonus Categories
The law actually allows extra discrimination depending on whether your employees
- get their HDHP insurance through your employer-provided group plan or from a different source (such as individually purchased insurance);
- are covered by a collective bargaining agreement; or
- are highly compensated. You can give bigger contributions to non-highly compensated employees than to highly compensated employees (but not the other way around).
The regulations have special rules for these types of discrimination, so be sure to check the rules if you want to make different contributions based on these categories.
Rule 2—Calculate a Comparable Amount
Contributions are comparable if you give each employee in the same category either10
- the same amount of money, or
- the same percentage of the plan’s deductible.
You make this determination each month.
Example. At the beginning of the year you have two employees, and you hire a new employee who begins work on May 1. All three employees have the same HDHP.
You decide to contribute $100 per month to each employee’s HSA. For the two employees who are with you for the full year, you contribute $1,200 total to each of their HSAs. For the new employee, you contribute a total of $800, since that employee worked only eight months of the year.
Rule 3—Treat Yourself Differently
Unless you operate your business as a C corporation, tax law does not treat you as a normal employee with regard to the contributions your business makes to your personal HSA.
If you’re a sole proprietor, you simply take the deduction on your Form 1040.
If you operate as an S corporation, you treat the S corporation contribution as compensation, and then you take the deduction on your Form 1040.
A Second Look at the Example
Now that you know the rules, let’s take a second look at the example from the beginning of this article (repeated below).
Bill creates a reward program for his employees in which he contributes to the HSAs of his top three salespeople.
He contributes $6,000 to the winner, $3,000 for second place, and $1,000 for third place.
What does Bill need to think about?
The biggest issue for Bill is rule number one—are any of the employees in the same category?
If all the employees are in separate categories, Bill can contribute a different amount to the HSA of each employee without violating the comparability rules.
But if any employees are in the same category, Bill must contribute a comparable amount on behalf of those employees. This would be bad news for Bill’s reward program and would require him to pay the $3,500 penalty tax (35 percent x total contributions of $10,000).
Caution. For employees with family HDHPs, you cannot contribute higher amounts to employees with two dependents than to employees with one dependent, or a higher contribution to employees with three dependents than to those with two or fewer dependents.
Takeaways
As an employer, you can contribute to your employees’ health savings accounts. Your employees will love you for this because the HSA allows them to pay for qualified health costs (not including insurance premiums) free of income taxes and payroll taxes.
There is no minimum amount you have to contribute, and you do not have to deal with the ACA rules that have added so many complications to employer-provided health insurance.
The only thing you need to think about is avoiding discrimination (and the 35 percent tax that comes along with it).
Avoid discrimination by following these three rules:
- Know the categories of your employees.
- Know how much to contribute.
- Treat yourself separately from your employees.
