Income and Assets · Adjustments to Income

Health savings accounts

The limit is not an annual allowance. It is the sum of monthly limitations for the months in which the individual was eligible, and eligibility is tested on the first day of each month. Two consequences follow that catch people out: entitlement to Medicare drops the limitation to zero from that month onward, and a taxpayer who becomes eligible mid-year gets only the months they had — unless they use the last-month rule, which comes with a testing period and a second penalty of its own.

The rule

The deduction. An individual who is an eligible individual for any month during the year is allowed a deduction equal to the aggregate amount paid in cash during the year to a health savings account of that individual (IRC § 223(a)).

Who is eligible. An individual covered under a high deductible health plan as of the first day of the month, and not also covered, while so covered, under any health plan which is not a high deductible health plan and which provides coverage for any benefit covered under the high deductible plan (IRC § 223(c)(1)(A)(i), (ii)). Any other health coverage that overlaps disqualifies.

The limit is monthly. The deduction may not exceed the sum of the monthly limitations for the months the individual was eligible, each being one twelfth of the applicable annual figure (IRC § 223(b)(1), (2)). An individual aged 55 or over before the close of the year adds the catch-up amount (§ 223(b)(3)).

Married couples share one family limit. Where either spouse has family coverage, both are treated as having only that family coverage — the one with the lowest annual deductible where they have different plans — and the limit is divided equally between them unless they agree otherwise, with each spouse’s catch-up amount left outside the division (IRC § 223(b)(5)).

Medicare entitlement zeroes it. The monthly limitation is zero for the first month the individual is entitled to benefits under title XVIII of the Social Security Act and for each month thereafter (IRC § 223(b)(7)). Entitlement, not merely reaching the age.

Dependents cannot deduct. No deduction is allowed to an individual for whom another taxpayer is allowed a § 151 deduction for a taxable year beginning in the same calendar year (IRC § 223(b)(6)).

The last-month rule, and its cost. An individual who is an eligible individual during the last month of the year is treated as eligible for every month of it (IRC § 223(b)(8)(A)). But if at any time during the testing period they are not an eligible individual, the contributions that could not have been made but for that rule are included in gross income, and the tax is increased by 10 percent of that amount (§ 223(b)(8)(B)(i)) — unless the failure is by death or disability (§ 223(b)(8)(B)(ii)).

Distributions. Amounts used exclusively to pay qualified medical expenses of any account beneficiary are not includible in gross income (IRC § 223(f)(1)); anything else is included in the beneficiary’s gross income (§ 223(f)(2)), and the tax is increased by 20 percent of the amount included (§ 223(f)(4)(A)).

Three exceptions to the additional tax. It does not apply where the distribution is made after the beneficiary becomes disabled within § 72(m)(7), or dies (IRC § 223(f)(4)(B)), or after attaining the age specified in section 1811 of the Social Security Act (§ 223(f)(4)(C)) — the statute points at the Medicare age rather than naming a number.

Qualified medical expenses, and one exclusion. Amounts paid for medical care within § 213(d) for the beneficiary, spouse and dependents, only to the extent not compensated by insurance or otherwise — including menstrual care products — but not any payment for insurance (IRC § 223(d)(2)(A), (B)).

Excess contributions can be undone. An excess contribution withdrawn, with the net income attributable to it, on or before the due date of the return including extensions escapes the inclusion rule (IRC § 223(f)(3)(A)).

Current figures

How it works in practice

Count the eligible months before doing anything else. Eligibility is tested on the first day of each month, so coverage beginning on 2 March produces no March month. Multiply the eligible months by one twelfth of the annual figure, add the catch-up for a taxpayer 55 or over, and compare that to what was actually contributed — including employer contributions, which count against the same limit.

The Medicare interaction is the most common real-world failure. Enrolment is often backdated by up to six months when Social Security benefits are claimed after full retirement age, and § 223(b)(7) zeroes the limitation from the first month of entitlement. Contributions made in those backdated months are excess contributions discovered after the fact, and the fix is the § 223(f)(3) withdrawal by the extended due date.

Treat the last-month rule as a financing decision with a condition attached, not a free allowance. It converts a partial year into a full one, and the testing period runs to the end of the following calendar year. A taxpayer who changes jobs, marries onto a spouse’s non-qualifying plan, or reaches Medicare during that period picks up both the inclusion and the 10 percent tax.

Distinguish the two additional taxes carefully: 10 percent for failing the last-month testing period under § 223(b)(8)(B)(i)(II), and 20 percent for a non-medical distribution under § 223(f)(4)(A). They arise from different provisions and have different exceptions.

How this has changed

Pub. L. 119-21 widened the regime in three places in 2025. Section 71307(a) added § 223(c)(2)(H), which treats a bronze or catastrophic plan available as individual coverage through an Exchange as a high deductible health plan — so a large group of Exchange enrollees became able to hold an account without changing plans. Section 71308(a) added § 223(c)(1)(E), providing that a direct primary care service arrangement is not a health plan that disqualifies the individual, and § 71308(b) added a corresponding clause to the qualified medical expense definition. Section 71306(a) rewrote the telehealth safe harbour in § 223(c)(2)(E), removing the time limitation that had previously confined it.

The telehealth safe harbour is now permanent, after several temporary versions. It began as pandemic relief, was extended more than once, lapsed, and was restored. The current text is unqualified: a plan does not fail to be a high deductible health plan by reason of failing to have a deductible for telehealth and other remote care services. Material written between 2022 and 2025 describes windows that no longer apply.

Two other safe harbours sit alongside it and are easy to miss: surprise billing under § 223(c)(2)(F) and certain insulin products under § 223(c)(2)(G). Neither disqualifies a plan for providing benefits before the deductible is met.

The additional tax on non-medical distributions rose from 10 to 20 percent in 2010 and the exceptions did not change with it. Note that § 223(f)(4)(C) never names an age: it points at section 1811 of the Social Security Act, so the exception tracks Medicare eligibility rather than a fixed number in the Code.

Exam focus

Expect a partial year of eligibility, testing whether you prorate by month or allow the annual figure.

Expect Medicare, and read for entitlement rather than age — backdated enrolment is the usual trap.

Expect a married couple with two plans, where the answer is one shared family limit and two separate catch-ups.

Expect the two rates — 10 percent and 20 percent — offered against each other.

Check yourself

1. A taxpayer is covered by a qualifying plan from 1 July. What is the contribution limit for the year?

Answer: Six twelfths of the applicable annual amount, plus six twelfths of the catch-up if aged 55 or over, under IRC § 223(b)(1) and (2) — unless the last-month rule in § 223(b)(8)(A) is used.

2. What happens if the last-month rule is used and eligibility is lost the following June?

Answer: The contributions that could not have been made but for the rule are included in gross income for the year of the failure and the tax is increased by 10 percent of that amount, under IRC § 223(b)(8)(B)(i), unless the failure was by death or disability.

3. A 62-year-old withdraws 5,000 dollars from an account and uses it to pay a credit card bill. What is the consequence?

Answer: The 5,000 dollars is included in gross income under IRC § 223(f)(2) and the tax is increased by 20 percent of it under § 223(f)(4)(A). None of the § 223(f)(4)(B) or (C) exceptions applies at 62 absent disability.

4. A married couple each hold their own account and one spouse has family coverage. May each contribute the family maximum?

Answer: No. IRC § 223(b)(5)(A) treats both as having only the family coverage, giving one family limit divided equally unless they agree otherwise — though each may add their own catch-up amount.

5. May an account pay health insurance premiums?

Answer: Not generally. IRC § 223(d)(2)(B) provides that the definition of qualified medical expenses does not apply to any payment for insurance, subject only to the narrow categories listed elsewhere in that paragraph.