Originally published August 31, 2005
The IRS has proposed regulations describing the rules that must be met for employer contributions to eligible employees’ health savings accounts (HSAs) to be treated as comparable. Under Internal Revenue Code section 4980G, if an employer makes contributions to employees’ HSAs that are not comparable, the employer is subject to an excise tax. However, the comparability rules do not apply to contributions made through a cafeteria plan. The proposed rules clarify and expand upon the comparability rules in IRS Notice 2004-2 and 2004-50. The regulations, which were issued on August 26, 2005, are proposed to be effective when published in final form, but may be relied upon in the interim.
Overview. Under the proposed rules, employers that elect to make contributions to their employees’ HSAs are required to make comparable contributions for all employees who (1) are eligible individuals enrolled in a high deductible health plan (HDHP), (2) are in the same category of employment and (3) have the same category of coverage. The three employment categories are:
- Current full-time employees
- Current part-time employees
- Former employees (excluding individuals on COBRA coverage).
The two categories of coverage are:
- Self-only coverage
- Family coverage.
To be considered comparable, an employer’s contributions to an HSA for any eligible employee who is in the same category of employment and has the same category of coverage must be the same dollar amount or the same percentage of the HDHP deductible for other eligible employees in that category of employment and who have that same category of coverage. However, because each category of employment and coverage is tested separately for comparability, the employer can differentiate among the categories in any manner. For example, the employer could:
- contribute the same amount for all employees who are eligible,
- contribute only for full-time employees with family coverage, or
- contribute 25% of the HDHP deductible for part-time employees and 50% of the HDHP deductible for full-time employees.
Eligible Employees. To be an eligible individual for any month, an employee must be enrolled in an HDHP as of the first day of the month and not have other medical coverage, except for certain limited types, such as dental or vision coverage. The proposed regulations make clear that independent contractors, sole proprietors and partners are not treated as employees for purposes of these rules. As a result, an employer may contribute to an independent contractor’s HSA, for example, without becoming obligated to contribute for any employees. An example also confirms that an individual enrolled in Medicare has medical coverage of a type that will preclude the employee from contributing to an HSA. Accordingly, employers are not required to contribute to an HSA for employees who are enrolled in Medicare.
Differentiating Categories of Employment and Coverage. As noted above, the comparability rules apply separately to each category of employment and each category of coverage. Thus, for example, the employer may contribute for employees with self-only coverage, but not family coverage or vice versa, or the employer may contribute different percentages or dollar amounts for each of these groups. Similarly, the employer could contribute for full-time, but not part-time or former employees or only for former employees, or could vary contributions for each category.
Reflecting the rule in the Code, the regulations define full-time employees as those who work 30 hours or more per week. Part-time employees are those who work fewer than 30 hours per week. The rules do not define when an individual will be treated as a former employee. As a result, it is unclear what rules must be applied to determine whether individuals, e.g., on certain types of leave, salary continuation or disability are current or former employees.
The proposed rules emphasize that the three categories of employment and two categories of coverage are the only basis for differentiating the levels of an employer’s contributions. Therefore, an employer cannot contribute different amounts or percentages for:
- different collective bargaining groups;
- management or non-management groups;
- employees who participate, e.g., in disease management or wellness programs; or
- employees based on age or service criteria.
Despite these restrictions, the proposed regulations permit employers to limit HSA contributions to the accounts of those employees who have coverage under the HDHP offered by the employer, but not another HDHP, such as an HDHP of a spouse’s employer. If the employer contributes for any employee in a category who has coverage under an outside HDHP, however, the employer must contribute for all employees in that category who have other HDHP coverage.
A special rule also applies for spouses who both work for the same employer and have family HDHP coverage through only one of the employees. In this situation, the employer may contribute to the HSA of the employee who elected HDHP coverage and need not contribute to his or her spouse’s HSA, as long as the employer generally limits HSA contributions to those employees who have employer-provided HDHP coverage. If, however, the employer also contributes to HSAs for employees who have outside HDHP coverage, the employer must contribute to the HSAs of both spouses, up to the maximum annual contribution permitted under Code section 223(b).
Timing of Contributions and Testing. Generally, the comparability rules apply, and compliance is tested, based on the entire calendar year. However, an employee’s eligibility to make HSA contributions is determined as of the first day of each month, and an employer may only make contributions for eligible individuals. To coordinate these requirements, the IRS has proposed three methods for the timing of contributions that will satisfy the comparability rules: (1) pay-as-you go, (2) look-back, and (3) pre-funding.
- Pay-as-you-go contributions can be made one or more times per year based on employees’ eligibility for each month of the year. The contributions must be made at the same time for all employees in the relevant categories, but are considered made at the same time if based on regular payroll cycles. For instance, even if hourly and salaried employees have different pay periods, if contributions are made each payroll period for the hourly and salaried employees, the contributions are considered made at the same time. Also, the employer can change the level or amount of pay-as-you-go contributions or discontinue them mid-year.
- Look-back contributions are made once per year at the end of the year for each employee who was eligible in any month of the year, but only for the number of months he or she was eligible.
- Pre-funded contributions are made at the beginning of the year for all employees who are eligible at that time. Because the HSA is nonforfeitable, however, prefunded contributions cannot be recouped if an employee terminates employment during the year. For employees hired during the year, the employer may pre-fund for them (on the basis of the number of months remaining during the year) or may elect to use the pay-as-you-go or look-back method to fund their HSAs. The same method must be used for all employees in the same category of employment with the same category of coverage hired after the initial pre-funding.
As for the other comparability rules, the proposed regulations indicate than an employer can use different contribution methods for different categories of employees and employees who have different categories of coverage.
Miscellaneous Rules. If employees are required to establish their own HSAs, an employer is not obligated to contribute for an employee who has not yet established an HSA when the employer funds the accounts. The employer is required to make up any missed contributions if the employee establishes an HSA by December 31st of the relevant year, but not if the employee sets up an account after that date.
If employer contributions are determined as a percentage of the HDHP deductible, the percentage is to be rounded to the nearest 1/100th of a percentage point (e.g., 33.33%). The dollar amount of a contribution determined in this manner is the nearest whole dollar amount.
The comparability rules do not apply to contributions made through a cafeteria plan. These contributions include an employee’s salary reduction contributions, employer matching contributions that an employee may elect to receive in cash, and any other employer contributions that an employee may receive in cash or have contributed to an HSA. Cafeteria plan contributions are subject to nondiscrimination rules under Code section 125, but not the comparability rules. Any after-tax contributions made by employees or contributions rolled over from another HSA or an Archer Medical Savings Account (MSA) are also exempt from the comparability rules.
Although similar comparability rules apply to employer contributions to an MSA, contributions to MSAs and HSAs are tested separately. If an employee has both types of accounts, however, the employer may not contribute to both.
For purposes of the comparability rules, the employer includes all members of a controlled group, all business under common control and all affiliated service group members.
Excise Tax. The excise tax that applies if employer contributions do not satisfy the comparability rules is 35% of the aggregate contributions that the employer has made to employees’ HSAs for the year. If an employer determines after the end of a year that its contributions are not comparable, the employer cannot recoup any amount from its employees’ HSAs. The employer may, however, make additional contributions up until April 15thto bring contributions to the appropriate dollar amount or percentage. In this case, a contribution must also be made to make up for interest on the delayed contribution, but the maximum required to be contributed is the annual contribution limit.
The proposed rules also specify that a portion of the excise tax can be waived if the employer’s failure to meet the comparability rules results from a reasonable cause and not willful neglect. The portion that will be waived is the amount that would be excessive relative to the failure.
© 2005 Sutherland Asbill & Brennan LLP. All Rights Reserved.
This article is for informational purposes and is not intended to constitute legal advice.