Medical Savings Accounts

Medical Savings Accounts

by Bernard Fruchtman, Esq.
(This article is excerpted from TaxTalk – Plain & Simple)

Background:

Since Jan 1, 1997 small businesses and self-employed persons have been allowed to establish Medical Savings Accounts (MSAs).

MSAs are like IRA’s for medical expenses. Contributions are put into an account and invested. The money canbe withdrawn from the MSA to pay qualified medical expenses.

MSA’s can only be established by businesses with no more than 50 employees and self-employed persons. It’s a pilot program and only open to 750,000 taxpayers. It’s first come first served so the early bird will get the worm. No new MSA’s will be allowed after 750,000 are established

MSA Eligibility:

To be eligible for an MSA a person must be covered by a health plan with a high annual deductible. The high deductible medical insurance coverage is combined with contributions to the MSA account. A high deductible medical insurance plan is defined as one that has the following deductibles:

Individuals. Deductible must be between $1,500 and $2,250
Families: Deductible must be between $3,000 and $4,500

Maximum MSA Contributions

Annual MSA tax – favored contributions are limited to a percentage of the insurance plan deductible.

Individuals. 65%
Families. 75%

Thus, the maximum MSA contribution that an individual could make is $1,463 (Maximum deductible of $2,250 x 65%)

The maximum MSA contribution that can be made under family plan coverage is $3,375 (maximum deductible of $4,500 x 75%)

Tax-Free Contributions:

MSA’s are available to both employees and self-employed individuals. Employee and self-employed contributions are deducted like contributions to an IRA. The deduction is taken“above the line”. This means that you get to take the deduction even if you do not itemize your deductions.

Alternatively employers can contribute these amounts to a savings account for an employee and the employee will be able to exclude such amounts from his/her income.

TAX LOOPHOLE:

Contributions to an MSA can be made up to the due date of the return for which the deduction is claimed, excluding extensions. This is the same as the rules for IRA contributions. However, unlike IRA contributions, MSA contributions are deductible without regard to the earnings of the individual making the contribution.

Tax-Free Distributions

Distributions from an MSA to pay qualified medical expenses of the account owner, a spouse or a dependent is excluded from income.

TAX LOOPHOLE:

MSA accounts are not subject to the use it or lose it rule that applies to flexible spending accounts. Amounts left unspent at the end of the year can be left in the account and carried over to later years. Thus, funds that remain in an MSA at age 65 become extra retirement savings or death or disability payments.

TAX TRAP:

If MSA funds are withdrawn and used for non-medical expenses, the amount withdrawn is included in your income and subject to tax.In addition, a 15% penalty will be imposed on the distribution unless it was made after the age of 65 or upon the death or disability of the account owner.


Bernard Fruchtman, Publisher/Editor of TaxTalk – Plain & Simple. TaxTalk – Plain & Simple, is a monthly newsletter that helps you save money by reducing your taxes. An annual subscription is $48 per year. For more information and a FREE ISSUE see web page at: http://village.ios.com/~taxtalkorsend your regular name and address to TaxTalk, Inc., 1562 First Ave., New York, NY 10028