HSA: Accounting & Payroll
Rules For Reporting Premium Costs and HSA Contributions
Contributions into an HSA can be made either by an individual or by an employer. If the individual makes the contribution, the amount is DEDUCTIBLE from the individual’s TOTAL INCOME (Line 22 on the current version (2004) of Form 1040).
If the employer makes the contribution, the amount is EXCLUDABLE from the employee’s WAGES (Line 7 on the current version (2004) of Form 1040). The excluded amount is supposed to be noted on the employee’s W-2 paperwork.
If the employer pays for all of the employees’ high-deductible insurance premiums, only the employer is entitled to deduct this sum as a business expense.
LLC (Limited Liability Companies) and LLP (Limited Liability Partnerships)
Small organizations often operate as an LLC. Under the current tax laws, single-owner LLCs are taxed as if they were sole proprietorships. LLCs with multiple owners get the same tax treatment as a partnership unless they elect to be treated as a corporation. LLPs get the same tax treatment as a partnership. Thus, there are no special tax advantages between LLCs or LLPs under the HSA program.
C and S Corporations
With a “regular” or C Corporation, your business must pay its own income tax on the taxable profits of your corporation. The tax rate for corporations varies by a few percentage points from what is due from married or single taxpayers. Personal service corporations (doctors, lawyers, engineers, architects, etc) are taxed at a flat rate of 35 percent of their net profit for the year. If you and others pay yourselves a salary from a C corporation, your health insurance premium costs are a business deduction for the corporation. If you and others are drawing a salary from the income that derives from your corporate business, each of you have to pay a personal income tax on that income. After-salary profits are taxed to the corporation. Upon eventual distribution of the profits you and others pay tax again – the dreaded “double tax” on the distributed profits on your personal tax return.
Tax rules for a “special” or S Corporation are similar to those for a partnership, i.e., you pay tax on your salary and your share of after-salary profits. If an individual’s shareholding in an “S” Corporation is more than 2 percent, that person is eligible to deduct the cost of company-paid health insurance premiums as a gross income “adjustment” on the Form 1040. Other shareholders are treated as employees in the manner of C Corporations.
Corporations reporting taxable income (profits) of less than $100,000 qualify for a significantly lower corporate tax rate. Many small corporations therefore strive to find as many business deductions as possible, to get under the $100,000 limit.
HSAs are a new way to get there. Because owner salaries and compensation are deductible as a corporate business expense, contributions into an HSA can cut both the corporate tax and income tax at the same time.
Because of the non-discrimination rules for HSA contributions, a corporation with many employees will set a practical limit on contributions to all its employees, large and small.
Excluding Contributions From An Employee's Taxable Income
On a payroll you must calculate withholding in accordance with government tables to cover the employee’s income tax. Federal Income Tax requires this withholding, as do the majority of states that have State and/or Local Income Tax. Contributions to HSAs on behalf of employees are exempt from these taxes, and join the list of other forms of worker compensation that are not taxed:
More Tax Relief for Employers
- Generally all health coverage policy premiums
- Generally all employer contributions to employee retirement plans
- All worker’s compensation premiums or benefits
- Extra sick pay or disability (after the first six months)
- Reimbursements for moving expenses, parking garages, public transit (subject to certain limits)
- Reimbursements for business expenses by employees (T & E) when these are accounted for to the employer
In addition to withholding for income tax, you must withhold a percentage of each employee’s pay for Social Security and Medicare under The Federal Insurance Contributions Act (otherwise known as FICA) towards the benefits they will one day receive from Social Security and Medicare.
In tax year 2004, the tax rate of a paycheck is 7.65%:
- 6.20 percent for Social Security
- 1.45 percent for Medicare
But wait, there’s more: an employer must also pay an equal amount of taxes to the government on behalf of the employee. And, pay the employer's share of FICA on behalf of each worker.
For highly paid employees, there is a FICA ceiling. For tax year 2004, the company does not have to pay FICA once it has paid the first $87,900 in wages per person. There is no Medicare ceiling; no matter what the company pays its highest-paid worker, the company still has to take out the Medicare tax.
Under the HSA program, employer contributions to worker HSAs are not subject to any of these taxes, nor are they considered to be gross wages when calculating a variety of other taxes, such as Withholding Unemployment Tax (FUTA). Unemployment tax benefits are regulated by a combined state and federal program. Just like income tax, the company has to withhold both a federal tax (FUTA) and a state unemployment tax. The current percentage for federal withholding for FUTA is 6.2%. It is a single flat rate, paid up to a ceiling on the first $7,000 of a worker’s pay.
The company’s state unemployment tax rate will vary from state to state. The company may also have to pay Disability Insurance Tax. In certain states (notably New York and California) this is a tax that pays for a mandated state disability insurance program must be paid and/or withheld by the employer. Under current federal rules, employer contributions to worker HSAs are exempted from these taxes as well.
|Setting Up Your Payroll For HSAs
Basic First Steps (Checklist)
___ Obtain Employer Identification Number (EIN) for your business. You must do this if you plan to pay wages to at least one other person beside yourself. To apply for a number, use IRS form SS-4. You can do this online.
___ Decide how frequently you’ll issue paychecks (Weekly? Biweekly? Monthly?).
___ Decide which of your workers are full time employees. Some of your help may wish to be paid as independent contractors, if eligible.
___ Obtain a completed withholding application (W-4 form), Social Security Number, for each employee.
___ Make a note to file 1099s for each independent contractor you expect to pay more than $600 in this tax year.
Working With the W-2
Each employee gets a W-2 by January 31st for the previous tax year. Copies of each employee’s form are also sent to the IRS in early February, along with a summary sheet, the Transmittal of Wage And Tax Statements, also known as IRS Form W-3. Employees who leave your company before the tax year is over may also request a copy of their W-2 earlier, so they can see what the total taxes were relating to their employment.
Wages (plus tips and compensation) for each employee are totaled for the year in Box 1. The amount of wages subject to Social Security (the first $87,900 of wages) goes into Box 3. The amount of wages subject to Medicare tax (everything after the first $400) goes into Box 5.
The amount of withholding for each tax (Box 2, 4, 6) should equal the amount you’ve already paid in monthly and quarterly installments. For how to calculate withholding, see IRS publication #15-T.
Not everyone will use Boxes 7-11. These report Social Security paid on tips and gratuities, hardship advances for those who will qualify for the Earned Income Tax Credit (EIC).
“Non-Qualified Plans” are other payouts made by the employer on behalf of the employee that may not be tax-exempt from FICA or other payroll taxes. These include distributions from pension plans, IRAs, and profit-sharing plans. For example, if an employee leaves and “cashes out” vested pension funds, the sum is noted on the W-2, and the employee will be responsible for the taxes.
Where then, are the deductions for a company’s contributions to an employee’s HSA? They are tucked away in Box 12, and identified with a special code “W.”
Under Code “W”
Box 12 is the section reserved for payments that generally will be tax-exempt from gross income, and hence from gross income taxes. These include income deferred via a 401(k) plan (Code “D”), Moving Expenses (Code “P”) and salary reductions to a SIMPLE (Code “S”).
Employer contributions to a Health Savings Account are Code “W.” So, in Box 12, if you made a $200 contribution to a worker’s HSA, you’ll indicate this by “200.00 W”.
If you do a W-2 for yourself or a spouse, this is where you will indicate your contribution to your own HSAs. If you contributed $4,500 to your HSA, write down “4500.00 W”.
On the employee’s tax return, any figure that appears in Box 12 must be matched up as a pre-tax adjustment on the 1040. This is how the IRS will track HSA deductions. This is how they make sure that when the employer makes the contribution, only the employer gets the tax benefits.
Box 13 requires you to check off squares if the worker was exempt from any withholding (part time worker or agent paid only by commissions), or “actively participated” in any qualified pension, profit-sharing, or stock-bonus plan, including 401(k) SEP or SIMPLE plans. (Again, this is an IRS match point.)
Box 14 is reserved for other adjustments, which are non-elective, such as required employer-employee matching contributions to pension plans. Another match point. Boxes 15-20 are where you report wages and withholding payments for state and local tax.
This should get your company’s accounting and payroll up to speed on HSAs.