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Two Ways Employers Contribute to Employee HSA Savings and Nondiscrimination Testing

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HSA Tax Benefits

All employer contributions to employee HSAs are made on a “pre-tax” basis. Employers may make pre-tax contributions to their employees’ HSAs either through a Section 125 plan or through a direct contribution. Contributions can be made in one lump sum or in payments throughout the year. Deposited funds belong to the employee. The combination of employer and employee contributions cannot exceed the IRS annual maximums.

Direct Employer Contributions (outside a Section 125 Plan)

  • Employer contributions can generally be excluded from federal income tax, Social Security tax, Medicare tax, federal unemployment taxes (FUTA) and state unemployment taxes.*
  • Employers must make “comparable” contributions to their employees’ HSAs, on behalf of all of their eligible employees, in order to be tax-deductible as an employee benefit. In order to be considered “comparable,” the IRS requires that the amount be either an equal dollar amount or percentage of the deductible for the high deductible health plan. Employers are allowed to treat different categories of employees differently for the purposes of contributions. Those categories include:
    • Full-time versus part-time
    • Self only, self plus one, self plus two, or self plus three or more
    • HSA-eligible versus non-eligible

An exception to the comparability rules allows employers to contribute more to the HSAs of non-highly compensated individuals. For this purpose, the definition of “highly compensated employee” is based on the same definition used for qualified retirement plans.

Failure to comply with these rules may result in a 35 percent penalty, so employers are encouraged to consult their tax adviser or legal counsel to make sure they comply with these rules.

  • Employers are not allowed to take an additional deduction for the payroll taxes (Social Security tax, Medicare tax and FUTA) associated with employee “post-tax” contributions.

 

Employer Contributions through a Section 125 Plan

Employers may choose to make contributions to their employees’ HSAs as part of a Section 125 plan (also known as a “cafeteria plan” or a “salary reduction plan”). Employers gain greater savings by allowing their employees to contribute on a “pre-tax” basis to their own HSA via payroll deduction. Employer and employee contributions may be combined and forwarded directly to the savings institution.

  • Employer contributions can generally be excluded from federal income tax, Social Security tax, Medicare tax FUTA and state unemployment taxes.*
  • Employers also derive HSA tax benefits by not paying Social Security tax, Medicare tax and FUTA on their employees’ contributions. These tax savings are only achievable through the Section 125 plan.
  • Employers contributing through a Section 125 plan are not subject to the comparability rules described above, but are subject to a different set of rules that require the employer to ensure the contributions do not favor highly compensated employees. If an employer chooses to offer “Matching Contributions,” it must be done through a Section 125 plan.

Employer and Employee HSA Savings and Nondiscrimination Testing Issues Under Section 125

26 CFR 54.4980G-5 – HSA comparability rules and cafeteria plans and waiver of excise tax.

From: http://www.law.cornell.edu/cfr/text/26/54.4980G-5

§ 54.4980G-5 HSA comparability rules and cafeteria plans and waiver of excise tax.

Q-1: If an employer makes contributions through a section 125 cafeteria plan to the HSA of each employee who is an eligible individual, are the contributions subject to the comparability rules?
A-1: (a) In general. No. The comparability rules do not apply to HSA contributions that an employer makes through a section 125 cafeteria plan. However, contributions to an HSA made through a cafeteria plan are subject to the section 125 nondiscrimination rules (eligibility rules, contributions and benefits tests and key employee concentration tests). See section 125(b), (c) and (g) and the regulations thereunder.
(b) Contributions made through a section 125 cafeteria plan. Employer contributions to employees’ HSAs are made through a section 125 cafeteria plan and are subject to the section 125 cafeteria plan nondiscrimination rules and not the comparability rules if under the written cafeteria plan, the employees have the right to elect to receive cash or other taxable benefits in lieu of all or a portion of an HSA contribution (meaning that all or a portion of the HSA contributions are available as pre-tax salary reduction amounts), regardless of whether an employee actually elects to contribute any amount to the HSA by salary reduction.
Q-2: If an employer makes contributions through a cafeteria plan to the HSA of each employee who is an eligible individual in an amount equal to the amount of the employee’s HSA contribution or a percentage of the amount of the employee’s HSA contribution (matching contributions), are the contributions subject to the section 4980G comparability rules?
A-2: No. The comparability rules do not apply to HSA contributions that an employer makes through a section 125 cafeteria plan. Thus, where matching contributions are made by an employer through a cafeteria plan, the contributions are not subject to the comparability rules of section 4980G. However, contributions, including matching contributions, to an HSA made under a cafeteria plan are subject to the section 125 nondiscrimination rules (eligibility rules, contributions and benefits tests and key employee concentration tests). See Q & A-1 of this section.
Q-3: If under the employer’s cafeteria plan, employees who are eligible individuals and who participate in health assessments, disease management programs or wellness programs receive an employer contribution to an HSA and the employees have the right to elect to make pre-tax salary reduction contributions to their HSAs, are the contributions subject to the comparability rules?
A-3: (a) In general. No. The comparability rules do not apply to employer contributions to an HSA made through a cafeteria plan. See Q & A-1 of this section.
(b) Examples. The following examples illustrate the rules in this § 54.4980G-5. The examples read as follows:
Example 1.
Employer A’s written cafeteria plan permits employees to elect to make pre-tax salary reduction contributions to their HSAs. Employees making this election have the right to receive cash or other taxable benefits in lieu of their HSA pre-tax contribution. The section 125 cafeteria plan nondiscrimination rules and not the comparability rules apply because the HSA contributions are made through the cafeteria plan.
Example 2.
Employer B’s written cafeteria plan permits employees to elect to make pre-tax salary reduction contributions to their HSAs. Employees making this election have the right to receive cash or other taxable benefits in lieu of their HSA pre-tax contribution. Employer B automatically contributes a non-elective matching contribution or seed money to the HSA of each employee who makes a pre-tax HSA contribution. The section 125 cafeteria plan nondiscrimination rules and not the comparability rules apply to Employer B’s HSA contributions because the HSA contributions are made through the cafeteria plan.
Example 3.
Employer C’s written cafeteria plan permits employees to elect to make pre-tax salary reduction contributions to their HSAs. Employees making this election have the right to receive cash or other taxable benefits in lieu of their HSA pre-tax contribution. Employer C makes a non-elective contribution to the HSAs of all employees who complete a health risk assessment and participate in Employer C’s wellness program. Employees do not have the right to receive cash or other taxable benefits in lieu of Employer C’s non-elective contribution. The section 125 cafeteria plan nondiscrimination rules and not the comparability rules apply to Employer C’s HSA contributions because the HSA contributions are made through the cafeteria plan.
Example 4.
Employer D’s written cafeteria plan permits employees to elect to make pre-tax salary reduction contributions to their HSAs. Employees making this election have the right to receive cash or other taxable benefits in lieu of their HSA pre-tax contribution. Employees participating in the plan who are eligible individuals receive automatic employer contributions to their HSAs. Employees make no election with respect to Employer D’s contribution and do not have the right to receive cash or other taxable benefits in lieu of Employer D’s contribution but are permitted to make their own pre-tax salary reduction contributions to fund their HSAs. The section 125 cafeteria plan nondiscrimination rules and not the comparability rules apply to Employer D’s HSA contributions because the HSA contributions are made through the cafeteria plan.
Q-4: May all or part of the excise tax imposed under section 4980G be waived?
A-4: In the case of a failure which is due to reasonable cause and not to willful neglect, all or a portion of the excise tax imposed under section 4980G may be waived to the extent that the payment of the tax would be excessive relative to the failure involved. See sections 4980G(b) and 4980E(c).
[T.D. 9277, 71 FR 43058, July 31, 2006]