November 18, 2022

S Corp HSA Contributions: Guide for Owners (2023)

Contents

If you’re HSA-eligible and your business is an S corporation, HSA contributions made through your business are an easy way to pay less tax. In this guide, I’ll explain why you’d contribute to an HSA from your business, as opposed to contributing outside your business, and provide a step-by-step guide.

What is an HSA?

A Health Savings Account is exactly what it sounds like: a savings account for medical expenses. But don’t let the name fool you, HSAs are vastly different from the regular savings account you might have at your bank. 

HSAs have unique and generous tax-advantages that make them an attractive choice for S corporation owners who want to simultaneously pay less tax and save for medical expenses.

HSA contributions are tax-deductible. This means that each dollar you contribute to an HSA will reduce the amount of tax you’ll pay for the current tax year. You can even make contributions to decrease last year’s taxes until April 15th of the current year.

Contributions can be invested in stocks, bonds, ETFs, or simply left in an interest-bearing account. Earnings on your HSA investments grow tax-free. You don’t need to report income earned in your HSA on your tax return. 

When you need to take money out of your HSA, distributions are also tax-free to the extent they cover qualified medical expenses such as deductibles, copays, coinsurance, prescriptions, and others.

Let’s walk through an example.

Suppose you contributed $1,000 to an HSA last year and invested the contribution in a stock. Your investment appreciated by $100 between last year and this year and paid you $10 in dividends. This year, you took out the full $1,110 and used it to pay for qualified medical expenses.

In this example, you’d deduct the $1,000 contribution on last year’s tax return, which reduces your taxable income and overall tax liability. You’d get a 1099-SA for this year’s distribution, but the distribution wouldn’t be taxable since you used the entire distribution to pay for qualified medical expenses. The result is $110 in tax-free income for paying medical expenses.

Who can contribute to an HSA?

To be eligible to contribute to an HSA, you must:

  • Be covered under a high deductible health plan (“HDHP”);
  • Have no other health coverage, with a few exceptions permitted by the IRS;
  • Not be enrolled in Medicare; and
  • Not be claimed as a dependent on someone else’s tax return.

An HDHP is a health insurance plan that generally has a deductible of at least $1,400 for self-only coverage or $2,800 for family coverage in 2022 ($1,500 and $3,000 in 2023). 

If you’re married, you and your spouse can each have self-only health insurance coverage and still be eligible to contribute to an HSA separately if your respective health insurance qualifies as an HDHP.  

Health Savings Accounts can only be established by individuals, not by businesses. However, an employer can contribute to an employee’s HSA and receive a tax deduction for the contribution.

How much can your S corp contribute to your HSA?

The annual HSA contribution limits are: 

  • Self-only coverage: $3,650 in 2022 ($3,850 in 2023); or
  • Family coverage: $7,300 in 2022 ($7,750 in 2023).

If you’re 55 years old or older, you can make an additional "catch-up" contribution of $1,000 to either your self-only HSA or family HSA.

Your S corporation can contribute to your HSA up to the applicable annual maximum contribution. You must reduce your personal contributions or your spouse’s contributions by the amount that was contributed by your S corporation.

Be aware that contributions to your HSA beyond the annual limits will be subject to a 6% excise tax per year.

The benefits of contributing to an HSA from a S corp

The primary benefit of making HSA contributions from your S corporation is that the contributions are deductible expenses for the S corporation. This deduction passes through to your personal tax return as a reduction in income on Schedule E.

On your personal tax return, you’d include the HSA contributions as salary income on Line 1 and deduct the contributions as a negative adjustment to total income on Line 10. The salary income and corresponding HSA adjustment offset each other for a net zero effect. 

In effect, the HSA contributions are deducted twice (once by your S corporation and once by you) but only taxed once (through your W-2). This yields a net deduction and therefore reduces the amount of tax you’ll pay.

Of course, the process for deducting HSA contributions is more straightforward if you don’t run the contributions through your S corporation. You’d still get the deduction but would only need to report the contribution in one place: on your personal tax return.

HSA contributions are included in your compensation

So, if the net impact to your tax return is the same, what is the benefit of making HSA contributions from your S corporation?

The answer is related to the “reasonable compensation” standard set by the IRS.

As an S corporation owner, you’re probably aware that you must be paid a “reasonable” salary for services you render to your S corporation. Your salary for these services is subject to income taxes, Social Security taxes, and Medicare taxes. 

By contributing to an HSA through your S corporation, you’re shifting taxable income from passthrough income on Schedule E to salary income on Line 1 of your personal tax return. The HSA contribution results in no change to your total income. You’re simply recharacterizing the income.

On the S corporation tax return, your business reports the HSA contributions as deductible officer compensation and includes the contributions on your W-2 as gross salary. The HSA contributions increase your total compensation figure and, therefore, increase the likelihood that you comply with the “reasonable compensation” standard.

HSA contributions aren’t subject to FICA taxes

What about social security and Medicare taxes? By increasing gross salary, won’t you pay additional taxes?

It’s true that your compensation as a shareholder-employee is generally subject to income taxes, Social Security taxes, and Medicare taxes. HSA contributions, however, are unique in that they aren’t subject to Social Security and Medicare taxes. So you’d only pay income taxes on the HSA contributions which are offset by an adjustment on your personal tax return.

This means that, in addition to the deduction for HSA contributions you’ll take on your personal tax return, HSA contributions made from your S corporation increase your compensation for purposes of complying with reasonable salary requirements and result in no additional Social Security and Medicare taxes.

This strategy decreases the total amount of tax you’ll pay. It’s an effective tax avoidance strategy for taxpayers who own an S corporation and are eligible to make contributions to an HSA.

How to make contributions to an HSA from an S corp?

Opening an HSA at your bank or other financial institution is the first step to making HSA contributions from your S corporation. HSAs can only be opened by individuals, so you’ll need to set up your HSA independently from your business.

The next step is to fund your HSA in one of two ways:

  1. Transfer funds from your personal bank account into the HSA; or
  2. Transfer funds from a business bank account into the HSA.

The next steps you’ll take depend on which of these ways you funded your HSA.

If you contributed to your HSA from your personal account, your S corporation will need to reimburse you for the HSA contributions. Reimbursements should be made through an IRS compliant “accountable plan.” 

This is important: to get the tax benefits of making HSA contributions through your S corporation, your business must actually reimburse you for the HSA contributions you made outside your business.

Be aware of HSA tax reporting requirements

HSA contributions that your S corporation made either directly to your HSA or indirectly through a reimbursement to you must be reported on your Form W-2. Form W-2 is the tax form that reports your compensation as an employee of the S corporation. You’ll get Form W-2 at year-end through your payroll software.

You’d then report the amount in Box 1 of your W-2 on Line 1 of your annual tax return (known as Form 1040). To get the offsetting deduction on your tax return, you’d then report the HSA contribution amount on Form 8889, which is a form specifically for HSAs.

Your S corporation will also get a deduction for the HSA contributions it made directly to your HSA or indirectly through an accountable plan reimbursement. The deduction is taken on Line 7 “Compensation of Officers” of the S corporation’s annual tax return (known as Form 1120-S).

Your S corporation can make contributions to your HSA through April 15th of the following year for a particular tax year. You’ll need to inform the HSA administrator that these contributions should be allocated to the previous tax year. The S corporation will report the contribution on your Form W-2 for the year in which the contribution was actually made (i.e. the following year).

Conclusion

I hope this guide has helped you understand the benefits of contributing to an HSA from your S corporation. If anything wasn’t clear, or you’d like to learn more about HSAs and S corporations, please get in touch.

This content is for informational purposes only and does not constitute legal, business, or tax advice. You should consult your own attorney, business advisor, or tax advisor regarding matters mentioned in this post. We take no responsibility for actions taken based on the information provided.

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