Tax-Advantaged Accounts for Health Care
Expenses: Side-by-Side Comparison
Carol Rapaport
Analyst in Health Care Financing
June 18, 2010
Congressional Research Service
7-5700
www.crs.gov
RS21573
CRS Report for Congress
P
repared for Members and Committees of Congress
Tax-Advantaged Accounts for Health Care Expenses: Side-by-Side Comparison
Summary
Four types of tax-advantaged accounts can be used to pay for unreimbursed medical expenses:
health care Flexible Spending Accounts (FSAs), Health Reimbursement Accounts (HRAs),
Health Savings Accounts (HSAs), and Medical Savings Accounts (MSAs). Unreimbursed
medical expenses typically include deductibles, copayments, and goods and/or services not
covered by insurance. Although these accounts share some common features, they also differ in
important respects.
This report provides brief summaries of the four accounts and compares them with respect to
eligibility, contribution limits, use of funds, and other characteristics for tax year 2010. The report
then discusses changes to the accounts resulting from the enactment of the Patient Protection and
Affordable Care Act (P.L. 111-148 as amended). The final section of the report covers
participation levels in these accounts. The report will be updated when relevant statutory or
regulatory changes occur, when new data become available, and as Congress considers issues
associated with these accounts.
Congressional Research Service
Tax-Advantaged Accounts for Health Care Expenses: Side-by-Side Comparison
Contents
Introduction ................................................................................................................................ 1
Current Law................................................................................................................................ 1
Flexible Spending Accounts .................................................................................................. 1
Health Reimbursement Accounts........................................................................................... 2
Health Savings Accounts....................................................................................................... 2
Medical Savings Accounts .................................................................................................... 3
Patient Protection and Affordable Care Act (PPACA) Changes to Tax-Advantaged
Accounts.................................................................................................................................. 6
Participation in the Tax-Advantaged Accounts............................................................................. 6
Figures
Figure 1. Number of IRS Returns Claiming the HSA Deduction and the MSA Deduction,
2004-2008................................................................................................................................ 7
Tables
Table 1. Summary of the Rules for FSAs, HRAs, HSAs, and MSAs, 2010................................... 4
Contacts
Author Contact Information ........................................................................................................ 8
Congressional Research Service
Tax-Advantaged Accounts for Health Care Expenses: Side-by-Side Comparison
Introduction
Four types of tax-advantaged accounts can be used to pay for unreimbursed medical expenses:
health care Flexible Spending Accounts (FSAs), Health Reimbursement Accounts (HRAs),
Health Savings Accounts (HSAs), and Medical Savings Accounts (MSAs).1 Unreimbursed
medical expenses typically include deductibles, copayments, and goods and/or services not
covered by insurance.2 The first part of this report describes the current law surrounding these
accounts and provides a side-by-side comparison of their key features. The second section details
changes to the accounts effective over the next two years that were enacted by the Patient
Protection and Affordable Care Act (P.L. 111-148 as amended). The third section investigates the
participation rates in each account type. The report will be updated when relevant statutory or
regulatory changes occur, when new data become available, and as Congress considers issues
associated with these accounts.
Current Law
The text in this section provides summaries of each account as of June 2010. Although the
accounts differ in many ways, they each provide tax savings to the account holders. Table 1
provides a more detailed side-by-side comparison of the laws and regulations governing each
account.
Flexible Spending Accounts
FSAs are employer-established arrangements that reimburse employees for medical and dental
expenses not covered by insurance or otherwise reimbursable.3 They are usually funded through
salary reduction agreements under which employees receive lower monetary wages in exchange
for equivalent contributions to their flexible spending accounts. For example, employees may
forgo $100 a month in their 2010 paychecks in exchange for a $1,200 annual contribution to their
FSA. Employees choose how much to put into their accounts, and this amount can vary from year
to year. Employees forfeit unused balances at the end of the year unless the employer offers a
grace period for additional claims of up to 2½ months after the end of the year (e.g., so medical
expenses incurred by March 15, 2011, could be reimbursed from the FSA for 2010). The entire
annual amount of an FSA must be made available to employees at the beginning of the year.
While compensation received as wages is subject to income taxes, as well as Social Security and
Medicare taxes, compensation received as FSA contributions is not subject to these taxes. (Social
Security and Medicare together are known as employment taxes.) For this reason, employees who
anticipate having health expenses not covered by insurance may prefer FSAs over monetary
wages.
1 For additional general information, see Internal Revenue Service publication 969, Health Savings Accounts and Other
Tax-Favored Health Plans, available at http://www.irs.gov/pub/irs-pdf/p969.pdf.
2 These accounts may not be used to pay for health insurance premiums.
3 For additional information on FSAs, see CRS Report RL32656, Health Care Flexible Spending Accounts, by
Janemarie Mulvey.
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Tax-Advantaged Accounts for Health Care Expenses: Side-by-Side Comparison
FSAs funded by salary reductions are governed by Section 125 of the Internal Revenue Code,
which exempts contributions from taxes despite the fact that employees have the choice to receive
taxable wages.4 Most rules regarding FSAs are not spelled out in the Code; they were initially
included in proposed regulations issued by the Internal Revenue Service (IRS) in 1984 and 1989,
and have been subsequently modified.5
Health Reimbursement Accounts
HRAs are employer-established arrangements to reimburse employees for medical and dental
expenses not covered by insurance or otherwise reimbursable. As is the case with FSAs,
contributions are subject to neither income nor employment taxes. However, contributions cannot
be made through the employees’ salary reduction agreements; only employers may contribute. In
addition, funds must be used for qualified medical expenses as defined by the IRC. Employers
may restrict the types of medical and health services that are eligible for reimbursement. For
example, an employer may choose not to reimburse expenses associated with acupuncture
treatments. Unlike FSAs, employers need not actually fund HRAs until employees draw upon
them. Also unlike FSAs, reimbursements can be limited to amounts previously contributed.
Unused balances may be carried over indefinitely, though employers may limit the aggregate
carryovers.
HRAs are governed by Section 105 of the Internal Revenue Code, which allows health plan
benefits used for medical care to be exempt from taxes, and Section 106 of the Code, which
allows employer contributions to those plans to be tax-exempt. Rules regarding HRAs are spelled
out in IRS revenue rulings and notices issued in 2002.6
Health Savings Accounts
HSAs are tax-exempt accounts that are used to pay for medical and dental expenses not covered
by insurance or otherwise reimbursable. Unlike the FSAs and MSAs (discussed below), they are
established by individuals with an insurance plan meeting certain criteria. An individual may
purchase an HSA-qualified insurance plan through the individual insurance market. For those
individuals with employer-sponsored insurance, the employer must offer a HSA-qualified plan in
the small group or large group insurance market.
To be HSA-qualified, the insurance plan must be a high-deductible health plan (HDHP). The
required level of deductible varies over time with the cost of living. In 2010, a HDHP is defined
as one with a deductible of at least $1,200 for self-only coverage and $2,400 for family coverage.
There are other criteria, including that the plan holder have no other health insurance policy, with
some exceptions.
4 Section 125 governs cafeteria plans; it provides an express exception to the constructive receipt rule, which requires
taxation of what is normally nontaxable income when taxpayers have the choice of receiving taxable income or
nontaxable income.
5 See Mulvey, Op. Cit., and Internal Revenue Service, “Employee Benefits—Cafeteria Plans,” 72 Federal Register
43938 - 43989, August 6, 2007.
6 IRS Revenue Ruling 2002-41 and Notice 2002-45.
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Tax-Advantaged Accounts for Health Care Expenses: Side-by-Side Comparison
In 2010, HSA contributions are limited to $3,050 for self-only coverage and $6,150 for family
coverage. An additional contribution of $1,000 is allowed people aged 55 and older. HSA holders
cannot contribute to their account in any year where they do not have qualifying HDHPs. On the
other hand, HSA holders can draw funds for their accounts even if they are not permitted to
contribute.
HSAs carry significant tax advantages. Contributions made by employers are exempt from
income and employment taxes. Account owners may deduct contributions they make from
adjusted gross income.7 Owners do not have to itemize deductions to take advantage of this tax
credit. Withdrawals for medical expenses are not taxed; those used for any non-medical purpose
are taxable and subject to a 10% penalty except in cases of disability, death, or attaining age 65.
Unused balances may be carried over from year to year without limit.
HSAs were first authorized by the Medicare Prescription Drug, Improvement, and Modernization
Act of 2003 (MMA, P.L. 108-173). Most statutory rules are in Section 223 of the Internal
Revenue Code. The Treasury Department provides revenue guidance as well.8
Medical Savings Accounts
MSAs, also known as Archer MSAs,9 are a precursor to HSAs.10 Like HSAs, MSAs can be
established and contributions made only when insurance plan holders have a HDHP and no other
coverage, with some exceptions. Contributions made by employers are exempt from income and
employment taxes. Contributions made by account owners (allowed only if the employer does not
contribute) are deductible for income-tax purposes even if the account owner does not itemize
medical deductions. Withdrawals are not taxed if used for medical expenses; those used for non-
medical purposes are taxable and generally subject to an additional 15% penalty. Unused balances
may be carried over from year to year without limit.
The principal difference between HSAs and MSAs is that MSA eligibility is limited to people
who are self-employed or employed by a small employer (50 or fewer employees, on average). In
addition, the minimum deductible levels are higher and the contribution limits are lower.
MSAs were first authorized by the Health Insurance Portability and Accountability Act of 1996
(P.L. 104-191). The legislation limited the total number of accounts to 750,000, with a few MSAs
excluded from that total. Most statutory rules governing MSAs are in Section 220 of the Internal
Revenue Code.
7 Adjusted gross income is total income less income that is not subject to tax less certain business deductions.
Contributions to HSAs are considered income that is not subject to tax.
8 For additional information, see CRS Report RL33257, Health Savings Accounts: Overview of Rules for 2010, by
Janemarie Mulvey.
9 Representative Bill Archer sponsored the authorizing legislation.
10 This discussion excludes Medicare MSAs.
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Table 1. Summary of the Rules for FSAs, HRAs, HSAs, and MSAs, 2010
Health Care Flexible
Spending
Health Reimbursement
Health Savings Accounts
Medical Savings Accounts
Accounts (FSAs)
Accounts (HRAs)
(HSAs)
(Archer MSAs)
Eligibility Employees
whose
Employees whose employers
Individuals with qualifying high-deductible
Individuals with qualifying high-deductible
employers offer this benefit. offer this benefit. Former
health insurance. Ineligible individuals may health insurance who are employees of a
Former employees may be
employees may be included. The
keep previously established accounts but
small employer (average of 50 or fewer
included. Employers not
self-employed are not eligible.
cannot make contributions.
workers). Ineligible individuals may keep
restricted by size.
Employers not restricted by size.
previously established accounts but cannot
make contributions.
Definition of
No health insurance
No health insurance
Self-only deductible must be at least
Self-only deductible must be at least $2,000
qualifying health requirements.
requirements, although HRAs are $1,200; the family deductible must be at
but not over $3,000; the family deductible
insurance
usually combined with high
least $2,400. Annual out-of-pocket
must be at least $4,050 but not over $6,050.
deductible health plans.
expenses for covered benefits cannot
Annual out-of-pocket expenses for covered
exceed $5,950 for self-only coverage and
benefits cannot exceed $4,000 and $7,400
$11,900 for family coverage. Deductible
respectively.
need not apply to preventive care.
Contributions
By employer, employee, or
Only by employer.
By any person on behalf of an eligible
By employer or account owner, but not
both. Usual y funded by
individual.
both in the same year.
employee through salary
reduction agreement.
Annual
None required, although
None required. Employers
$3,050 for self-only coverage and $6,150
65% of the deductible for self-only coverage
contribution
employers usual y impose a
usual y set their contributions
for family coverage. Account owners 55
and 75% of the deductible for family
limits
limit.
below the annual deductible of
years old or older and not in Medicare
coverage.
the accompanying health
can contribute an additional $1,000 in
insurance.
2010.
Qualifying
Most unreimbursed medical
Most unreimbursed medical
Most unreimbursed medical expenses.
Most unreimbursed medical expenses. May
expenses
expenses, although
expenses, although employers
May be used for premiums for long-term
be used for premiums for long-term care
employers may impose
may impose additional limitations. care insurance, COBRA, health insurance insurance, COBRA, and health insurance for
additional limitations. May
May be used for long-term care
for those receiving unemployment
those receiving unemployment
not be used for long-term
and health insurance premiums, if compensation under federal or state law, compensation under federal or state law.
care or health insurance
the employer allows.
and health insurance (other than Medigap
premiums.
policies) for individuals who are 65 years
of age and older.
CRS-4
Health Care Flexible
Spending
Health Reimbursement
Health Savings Accounts
Medical Savings Accounts
Accounts (FSAs)
Accounts (HRAs)
(HSAs)
(Archer MSAs)
Al owable non-
None.
None.
Permitted, subject to income tax. A 10%
Permitted, subject to income tax. A 15%
medical
penalty except in cases of disability,
penalty except in cases of disability, death,
withdrawals
death, or attaining age 65.a
or attaining age 65.a
Carryover of
Balances remaining at year’s
Permitted, although some
Full amount may be carried over
Full amount may be carried over indefinitely.
unused funds
end (or up to 2½ months
employers limit amount that can
indefinitely.
A limited, one-time rollover to a HSA is
after year’s end, if employer be carried over. A limited, one-
allowed.
permits) are forfeited to
time rollover to a HSA is
employer. A limited, one-
allowed.
time rollover to a HSA is
allowed.
Portability Balances
generally
forfeited
At discretion of employer,
Portable. Portable.
at termination, although
though subject to COBRA
COBRA extensions
provisions.
sometimes apply.
Note: Rules are expressed in general terms. The employer may have no incentive to provide HRA benefits to terminated employees.
a. PPACA will increase this penalty in 2011.
CRS-5
Tax-Advantaged Accounts for Health Care Expenses: Side-by-Side Comparison
Patient Protection and Affordable Care Act (PPACA)
Changes to Tax-Advantaged Accounts
The Patient Protection and Affordable Care Act (PPACA, P.L. 111-148), as amended by the
Health Care and Education Reconciliation Act of 2010 (P.L. 111-152), imposes various
restrictions on the accounts.11 One set of changes makes three of the savings accounts more
compatible with the existing Internal Revenue Code (IRC) requirements covering what can be
itemized for those who do take deductions for medical expenses.12 Under current law, over-the-
counter (OTC) medications (except insulin) cannot be included in itemized deductions unless
they are prescribed by a physician. However, under current law, OTC medications can by funded
through FSA, HSA, or MSA accounts. Starting in 2011, PPACA will prohibit using funds from
FSA, HSA, and MSA accounts for OTC medications (except insulin) unless they are prescribed
by a physician.13
The second change concerns limits on the FSA contribution. No statutory limits on the amount an
employee can contribute to a FSA existed prior to PPACA. Instead, individual employers often
imposed their own limits. Beginning in 2013, PPACA will limit the annual amount an employee
can contribute to $2,500.
The final change is that PPACA, effective in 2011, increases the penalties imposed for account
withdrawals for nonmedical purposes for those under age 65 in two accounts The penalty for
nonmedical withdrawals from HSAs will increase to 20% from 10%. The penalty for nonmedical
withdrawals from MSAs will increase to 20% from 15%.
Participation in the Tax-Advantaged Accounts
Measuring total participation in the four tax-advantaged accounts is difficult because of a lack of
reliable and timely data. The Department of Labor (Bureau of Labor Statistics) and the Treasury
Department (IRS), a few research organizations, and several human resources private-sector
consulting firms measure various concepts of account participation. To use HSAs as an example,
measures of total HSA participation include
• the number of individuals (adults and children) whose medical expenses can be
funded through an HSA because they are covered by a HSA-eligible HDHP;
• the number of employees who chose a HSA-eligible, employer-provided
insurance plan and go on to actually open an HAS;
• the number of tax-filing household units who take the HSA deduction; and
11 For more information on this issue, see CRS Report R41128, Health-Related Revenue Provisions in the Patient
Protection and Affordable Care Act (PPACA) , by Janemarie Mulvey.
12 This is the deduction currently taken when qualified medical expenses exceed 7.5% of adjusted gross income.
13 In the past, the IRS has defined a drug as prescribed if its purchase requires a prescription. For example, aspirin
would not be eligible for reimbursement even when recommended by a physician because its purchase does not require
a prescription. For more information, see Internal Revenue Service, Medical and Dental Expenses, November 10, 2009.
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Tax-Advantaged Accounts for Health Care Expenses: Side-by-Side Comparison
• the number of individuals or households in a sample who report having an HSA
when asked by an interviewer, with those numbers statistically adjusted to
represent the number in the population as a whole.
These concepts are neither the “correct” nor “incorrect” measures of HSA participation. Rather,
they are simply measures of different ideas. The various concepts have different strengths and
weaknesses as measures. Nevertheless, a primary criteria for reporting data on the four savings
accounts is to use ideas that are comparable across all accounts.
Unfortunately, there does not appear to be a participation measure available for all four accounts.
Instead, CRS reports one accurate measure for two accounts. Because all individuals with a HSA
or a MSA can claim deductions on their tax returns, the IRS maintains data on the number of tax
returns with these deductions. Figure 1 presents the number of returns that filed for a HSA
deduction and that filed for a MSA deduction.
Using tax returns as the unit of HSA and MSA measurement has at least three disadvantages.
First, each return could represent an individual, a married couple, or a family. Second, the number
of adults and children eligible to use funds in each HSA is unknown. Third, the most recent
available data cover 2008, while other data sources have 2009 data available. Nevertheless, there
is no other source with which CRS is familiar that allows for a comparison of these two accounts.
Figure 1. Number of IRS Returns Claiming the HSA Deduction and the MSA
Deduction, 2004-2008
900,000
810,279
800,000
700,000
581,438
600,000
s
rn
tu 500,000
e
f R
r o
e
b 400,000
m
351,170
Nu
300,000
211,766
200,000
88,110
100,000
30,883
18,391
17,011
8,584
0
2004
2005
2006
2007
2008
Year
Number of Returns with HSA Deduction
Number of Returns with MSA Deduction
Source: Internal Revenue Service, Individual Income Tax Returns, Preliminary Data, various years,
http://www.irs.gov/taxstats/indtaxstats/article/0,,id=133414,00.html#_prelim.
Notes: Almost no return should claim both deductions. Data for the number of returns with a MSA in 2008
were not reported by the IRS.
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Tax-Advantaged Accounts for Health Care Expenses: Side-by-Side Comparison
In every year since 2004, the number of returns with an HSA deduction far exceeded the number
of returns with an MSA deduction. Moreover, the number of HSA returns increase rapidly since
their inception in 2004, while the number of MSA returns declined rapidly.
Similar IRS participation data do not exist for FSAs and HRAs, which are available only through
employer-sponsored health insurance coverage and are not enumerated on an individual’s income
tax return. One survey of employers found that between 2% and 3% of the workers covered by
health insurance enrolled in an HRA between 2006 and 2009.14 CRS has not found a comparable
percentage of workers covered by health insurance who were enrolled in a FSA.
Author Contact Information
Carol Rapaport
Analyst in Health Care Financing
crapaport@crs.loc.gov, 7-7329
14 The Kaiser Family Foundation and Health Research & Educational Trust, Employer Health Benefits 2009 Annual
Survey, 2009, p. 130.
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