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Taxation of HSA Contributions


 
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HSAs for Small Business Owners Special Issues for Business Owners
August 2006

Small business owners face special rules when making HSA contributions for themselves as compared to their employees. This newsletter addresses those issues. 
 
HSA Contributions Guide for Small Business Owners


Sole Proprietors
                                                                         


Partnerships, LLCs, and 2% Owners of S-Corps



                                                  
   

HSA Contributions Guide for Small Business Owners   
 
Use our Small Business Owner HSA Contribution Guide to explain the issues. 
This Guide provides detail on the treatment of HSA contributions for small business owners.  It is meant as a companion piece to our Employer guide and our HSA Employer Funding Guide which provides details on making HSA contributions for non-owner employees.    (Top of Page)                            
                                    
                               Download the Guide

Sole Proprietors

How are sole proprietors treated for HSA contributions? Sole proprietors are treated similarly to individuals making HSA contributions on their own, the sole proprietor (the owner) may deduct the amount of their HSA contributions and health insurance payments on their personal income tax (in 2006 HSA contributions were on Line 25 and health insurance payments were on Line 29 of the 2006 Form 1040). Sole proprietors are not allowed to deduct their own HSA contributions as a business expense; however, amounts contributed on behalf of employees may be deductible on line 14 of the 2006 Schedule C. The owners HSA contribution is not a deduction attributable to the self-employed individual’s trade or business so it is not taken as a deduction on Schedule C, nor is it taken into account in determining net earnings from self-employment on Schedule SE.

Can self-employed people make pre-tax contributions to their HSAs?
No. Self-employed people may not contribute to an HSA on a pre-tax basis. However, they may contribute to their HSA with after tax dollars and take the above the line deduction outlined above.

As a sole proprietor, can I make allow my employees to make pre-tax contributions to their HSAs?
Yes. A sole proprietor with a number of employees may find it beneficial to institute a section 125 plan (or cafeteria plan) to allow employees to make pre- tax, salary deferrals into their HSAs. However, the sole proprietor would not be eligible to participate in such a plan.   (Top of Page)

Partnerships, LLCs, and 2% Owners of S-Corps

How are partners and 2% S-Corp owners treated for HSA Contributions? Partnerships, LLC’są and S-corporations are generally treated as flow through entities for purpose of HSA contributions made on behalf of the owners. That is, HSA contributions and health insurance payments benefiting the owners are not deductible by the business but flow through to the owner.

Partnerships and multiple member LLCs. Contributions on behalf of partners by the partnership are treated as distributions to the partners (under §731), they are not deductible by the partnership and do not affect the distributive shares of partnership income and deductions. The contributions are reported as distributions of money on Schedule K-1 and the partner can then take a deduction for the HSA contribution on their personal income tax return. Contributions made pursuant to a Section 125 plan will be added back to the owners as a taxable fringe benefit negating any tax benefit they might have otherwise received from a Section 125 plans.

Note – an exception exists for Guaranteed Payments to partners, if the partner is entitled to a guaranteed payment from the partnership, then a special rule applies. The HSA contributions are still not treated the same as contributions to other employees. These contributions are deductible by the partnership (under IRC § 162) and are includable in the partner’s gross income. The contribution is also reported as a guaranteed payment on the K-1. The partner can then deduct the HSA contribution on his or her personal income tax return.

2% shareholders of S-corporations. Anyone that owns more than 2% of an S-corporation is regarded as an owner of the corporation with regards to HSA contributions. As a result they can not make pre-tax contributions to their HSA via a salary reduction. Any contributions made on their behalf by the corporation are taxable and they may be deducted on their personal income tax.

Can Partners make pre-tax contributions via a salary reduction to their HSAs
No. Partners are not eligible to make pre-tax contributions to their HSAs via a salary reduction. Instead they may make personal contributions using after-tax dollars and take the above the line deduction outlined above.

Can a partnership provide for its employees to make pre-tax contributions to their HSAs? Yes. By establishing a 125 plan or a cafeteria plan a partnership can provide for its employees to make pre-tax contributions to their HSAs.  

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