What is an HSA deduction?

An HSA deduction refers to the pre-tax contribution made by an employee (or employer) to a Health Savings Account (HSA). This deduction is designed to help employees save for qualified medical expenses by allowing them to set aside money in a tax-advantaged account. HSAs are paired with high-deductible health plans (HDHPs) and allow both employees and employers to contribute to the account. Contributions to an HSA are tax-deductible, meaning they reduce taxable income and can lower the employee's overall tax liability.

In addition to being tax-deductible, HSA contributions grow tax-free and can be withdrawn tax-free when used for qualified medical expenses. These features make HSAs a valuable tool for both managing healthcare costs and saving for future medical needs. For employers, offering HSA deductions can be an attractive employee benefit that supports overall healthcare savings and wellness.

Why HSA deductions matter for employers

HSA deductions are not only beneficial for employees but also offer advantages for employers. Offering this benefit can improve employee satisfaction, reduce overall healthcare costs, and support tax savings for both parties. Here's why HSA deductions matter:

1. Employee savings and healthcare costs

The ability to make pre-tax contributions to an HSA allows employees to save for future medical expenses, including doctor visits, prescriptions, dental care, and even some over-the-counter items. This can reduce the financial burden of medical costs, especially for employees with high-deductible health plans, which are often a part of the benefits package.

2. Tax advantages for employees

Employees benefit from HSA deductions by reducing their taxable income, which in turn lowers their overall tax liability. As the money in the account grows tax-free, employees can continue to accumulate funds for healthcare expenses in retirement, where they may face higher medical costs.

3. Employer tax benefits

Employers who contribute to an employee’s HSA can deduct these contributions from their own taxes. This makes HSA deductions a win-win for both parties. Employers can offer this benefit without increasing taxable wages, reducing their overall payroll tax liabilities.

4. Attracting and retaining talent

Offering an HSA as part of a benefits package can be an attractive incentive for potential employees, particularly those who are health-conscious or looking to save for future healthcare needs. It’s an effective way to compete with other businesses offering similar benefits.

How HSA deductions work

HSA deductions operate through both employee and employer contributions. Employees can elect to have a portion of their pre-tax wages withheld and deposited into their HSA. Employers can also contribute to their employees' HSAs, though this is not mandatory. Here’s how it works:

1. Employee contributions

Employees can choose to contribute up to the annual maximum contribution limit set by the IRS. The maximum limit depends on the employee’s age and coverage type (individual or family plan). For 2025, the contribution limits are:

• $3,850 for individual coverage
  
  
• $7,750 for family coverage
  
  
• An additional $1,000 in “catch-up” contributions for employees aged 55 or older

These contributions are deducted from the employee’s paycheck before taxes are applied, reducing their taxable income.

2. Employer contributions

Employers may contribute to their employees' HSAs as well. While employer contributions are not required, many employers offer this as a part of their benefits package. Employer contributions also qualify as tax-deductible, which can help reduce the company’s overall tax burden.

3. Qualified expenses

The funds in an HSA can be used to pay for a wide variety of qualified medical expenses, including doctor’s visits, prescription medications, and even some dental and vision care. If the funds are used for non-qualified expenses, however, the employee may face penalties and taxes on the amount withdrawn.

4. Carryover of funds

One of the significant advantages of an HSA is that it’s not a "use-it-or-lose-it" account like some flexible spending accounts (FSAs). The money in an HSA rolls over year after year, and there is no deadline for spending. This makes it an excellent long-term savings tool for healthcare.

Legal and compliance considerations

There are several legal and compliance considerations for employers offering HSA deductions. These include:

• Eligibility requirements: Employees must be enrolled in a high-deductible health plan (HDHP) to contribute to an HSA. Employers must verify that employees meet these requirements before allowing contributions to an HSA.
  
  
• Contribution limits: The IRS sets annual limits on how much employees can contribute to their HSAs. Employers should monitor contributions to ensure they do not exceed the annual maximum, which could lead to penalties.
  
  
• Tax reporting: Employers must report employee HSA deductions on their Form W-2. The deductions should be listed in Box 12 with code "W," and any employer contributions should be properly reflected as well.
  
  
• Non-qualified expenses: If employees use HSA funds for non-qualified expenses before age 65, they will incur both income taxes and an additional 20% penalty on the withdrawn amount. After age 65, the penalty is waived, but income taxes still apply.

Common mistakes to avoid

Understanding and managing Health Savings Account (HSA) contributions correctly is essential to stay compliant with IRS regulations and avoid costly penalties.

Exceeding contribution limits

Employers should ensure that employee contributions do not exceed the IRS annual limits for HSA deductions. Over-contribution can lead to penalties for both the employee and employer.

Failing to verify eligibility

Before offering HSA deductions, employers must confirm that the employee is enrolled in an eligible high-deductible health plan (HDHP). If the employee isn’t eligible, contributions to an HSA are not permitted.

Not tracking employer contributions

Employers must track the amount they contribute to employee HSAs to ensure they don’t exceed the annual limits. The IRS has separate limits for total contributions from both the employer and employee, so it’s essential to monitor both sources of funding.

Misreporting deductions

Accurate reporting on Form W-2 is crucial. Employers should ensure that employee and employer HSA contributions are accurately reflected in tax documents to avoid compliance issues or IRS penalties.

How Homebase helps manage HSA deductions

Homebase Payroll makes it easy to manage HSA deductions, ensuring both employee and employer contributions are tracked, reported, and compliant with IRS regulations. With Homebase, you can:

• Automatically calculate employee and employer HSA deductions
  
  
• Verify eligibility for HSA contributions
  
  
• Ensure contributions do not exceed annual limits
  
  
• Seamlessly integrate HSA contributions with payroll processing
  
  
• Report HSA deductions correctly on Form W-2
  
  

Explore Homebase Payroll to streamline HSA deductions, stay compliant, and maximize savings for your employees.