On July 31, 2006, the Internal Revenue Service issued final regulations concerning the rules that must be met for employer contributions to eligible employees’ Health Savings Accounts (HSAs) to be treated as comparable. According to Treas. Reg. 54.4980G, employer contributions to HSAs that are not comparable subject the employer to excise taxes.
For contributions made January 1, 2007 and after, employers that elect to make contributions to their employees’ HSAs are required to make comparable contributions for all employees who:
Are eligible individuals enrolled in a high deductible health plan (HDHP);
Are in the same category of employment; and
Have the same category of coverage.
Note that the comparability rules apply separately to each of the following four categories of employment:
current full-time employees,
current part-time employees (i.e., working less than 30 hours per week),
former employees other than individuals on COBRA coverage, and
collectively bargained employees.
Categories of HDHP coverage:
self-only coverage, and
family coverage to include the following tiers:
self plus one,
self plus two,
self plus three or more.
An employer can make different contributions (i.e. a different dollar amount or a different percentage of the HDHP deductible) for each of these three categories, so long as the contribution for the self-plus-three-or-more category is not less than the contribution for self-plus-two, which is not less than the contribution for self-plus-one.
In order to be considered comparable, an employer’s contributions to an HSA must be the same dollar amount or the same percentage of the HDHP deductible for every eligible employee in the same category of employment and category of coverage.
Employers can choose the employment and coverage categories for which they will make HSA contributions. For example, an employer could contribute to the HSAs of full-time employees, but not part-time or former employees. Also an employer could choose to contribute to the HSAs of employees with family coverage, but not to the HSAs of employees with single-only coverage (or vice versa).
Employers also can choose to vary the level of contributions by employment or coverage category. For example, an employer may contribute higher amounts (or percentage) to full-time employees with family coverage than to full-time employees with single-only coverage. Similarly, an employer could contribute a higher amount to full-time employees with single-only coverage than to part-time employees with single-only coverage. Combining the employment and coverage categories allows an employer to have a maximum of six different contribution levels. The proposed rules, however, do clearly provide that these are the exclusive categories for comparability testing.
For contributions beginning January 1, 2007 and forward, the rule allows greater contributions for non-highly compensated (lower paid) employees without violating the HSA comparability rule for employer contributions made outside of a Section 125 cafeteria plan. Highly compensated employees typically have more than five percent company ownership during the current or previous plan year or have annual compensation of more than $95,000 (indexed for 2006) in the previous plan year.
This ruling only applies to employer contributions made to the employee's HSA outside a cafeteria plan.
This will allow employers to contribute more to the HSAs of non-highly compensated employees without violating the comparability rule.
Employers are already allowed to make greater contributions to non-highly compensated employees' HSAs within the cafeteria plan (see below "Key Exception to Comparability Rules - Section 125" for more information).
This rule now allows greater employer contributions to non-highly compensated employees outside the cafeteria plan.
The employer contributes $200 to Sam's HSA. Sam is a full time employee with single coverage. Sam is also a highly compensated employee. The employer also contributes $400 to Joe's HSA. Joe is also a full time employee with single coverage. However, Joe is a non-highly compensated employee. These conditions are permissible under the new rule for employers subject to comparability rules.
An employer that contributes to HSAs in any of the following ways will fail the comparability requirements:
Varying contributions levels within an employment or coverage category by the amount of the employee’s HSA contribution;
Making matching contributions that are a percentage of the employee’s contribution or the employee’s salary;
Making additional or greater contributions to employees who have attained a specified age or have a specified number of years of service; or
Conditioning employer HSA contributions on the employee’s participation in health assessments, disease management, or wellness programs (because not all comparable participating employees may participate in the programs).
The final regulations allow employers to limit HSA contributions to just employees who have coverage under the HDHP offered by the employer, and not another HDHP (e.g., an HDHP of a spouse’s employer). However, if an employer contributes for any employee in a category who has coverage under an HDHP not maintained by the employer, the employer must make comparable contributions to all such employees. A potential trap of the unwary exists in situations where spouses both work for the same employer, but only have family HDHP coverage through one of the employees. If the employer contributes to HSAs for employees who have outside HDHP coverage, the employer must contribute to the HSAs of both spouses. On the other hand, if the employer limits its HSA contributions to those employees with employer-provided HDHP coverage, then the employer only needs to contribute to the HSA of the employee who has elected the employer-provided HDHP coverage.
The final regulations also provide that the comparability rules apply on a controlled group basis and if the employer maintains multiple HDHPs. So, if an employer maintains more than one HDHP (even if they are maintained by different members of the same controlled group), it must make comparable contributions on behalf of all comparable participating employees, regardless of the HDHP in which they are enrolled.
Comment: As outlined in the final regulations, the exclusive categories used for comparability testing will prevent employers from contributing different amounts (or percentages) to various other common classifications, such as management and non-management groups, different collective bargaining groups, or different geographic locations.
Comment: Thus, an employer still may be able to restrict its HSA contributions to a limited group of employees (e.g., management-only) if it maintains a HDHP only for those employees and makes HSA contributions only to eligible individuals covered under that plan. Such an arrangement, however, would need to comply with other nondiscrimination rules that might be applicable, such as the rules under Code Sections 105(h) and 125.
A key exception to the comparability rules is for employer-funded HSA contributions made “through a cafeteria plan.” Such contributions are not subject to the HSA comparability rules, but are subject to the Code Section 125 nondiscrimination rules. The final regulations clarify that contributions are made "through a cafeteria plan" if 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 employees actually elect to contribute any amount to the HSA by salary reduction. Nonelective employer contributions made to all HSA-eligible participants (who make no election with respect to the employer contribution and have no right to receive cash or other taxable benefits in lieu of the contribution) are also determined to be made through a cafeteria plan because the participants are also permitted to make their own pre-tax salary reduction contributions to fund their HSAs.
Thus, for example, the final regulations state that matching contributions made by an employer through a cafeteria plan are not subject to the comparability rules. Similarly, the final regulations specifically provide that the comparability rules do not apply if, under the employer’s cafeteria plan, eligible employees who participate in health assessments, disease management, or wellness programs receive an employer HSA contribution (unless they elect to receive cash).
Although compliance with the comparability rules is tested on a calendar year basis, an individual’s eligibility to make or receive HSA contributions is determined as of the first day of each month. To coordinate these rules, the IRS set forth three methods for the timing of contributions that will satisfy the comparability requirements.
Under the pay-as-you-go approach, contributions can be made one or more times per year based on the employee’s eligibility for each month of the year. Contributions must be made at the same time for all employees in the relevant categories. Any differences in the employer’s usual payroll periods for different groups of employees can be ignored (e.g., contributions made each pay period for salaried and hourly employees are considered to be made at the same time even if salaried employees are paid monthly and hourly employees are paid bi-weekly). Under the pay-as-you-go approach, an employer has the flexibility to change the level or amount of contributions or discontinue them mid-year.
Under the look-back approach, contributions are made once a year at the end of the year for each employee who was eligible for any month of the year, but only for the number of months the employee was eligible. Note that this approach may result in cash flow issues for employees who have to wait until their HSA is funded before getting eligible medical expenses reimbursed.
Finally, pre-funded contributions are made at the beginning of the year for all employees who are eligible at that time. For employees hired during the year, the employer may pre-fund them (based on the number of months remaining in the year) or may elect to use one of the other permissible funding methods. Since HSA contributions are non-forfeitable, an employer cannot recover any pre-funded contributions if an employee terminates employment during the year. As with the other comparability rules, the proposed regulations provide that an employer may utilize different contribution methods for different categories of employees and employees who have different categories of coverage. However, there is a consistency rule with respect to employees within each relevant category.
An employer is obligated to contribute for an employee who has not yet established an HSA when the employer funds the accounts. If an employee has not established an HSA at the time the employer funds its employees' HSAs, the employer complies with the comparability rules by contributing comparable amounts plus reasonable interest to the employee's HSA when the employee establishes the HSA, taking into account each month that the employee was a comparable participating employee.
Comment: Using a cafeteria plan will be a popular funding technique for many employers, especially in cases where an employer wants to provide an economic incentive to participate a comprehensive consumer-driven health program that includes health assessments, disease management, or wellness programs.
If an employer fails to make comparable contributions for a calendar year, it has until April 15th of the following year to make additional HSA contributions to satisfy the comparability rules. Any such corrective HSA contributions must also include reasonable interest, but the employer does not have to contribute amounts in excess of the annual HSA contribution limit in effect for the calendar year with respect to which such corrective contributions were made. As noted above, HSA contributions are non-forfeitable. So, an employer cannot reduce HSA contributions already made to satisfy the comparability rules.
If employer contributions do not satisfy the comparability rules for a calendar year, the employer is subject to an excise tax equal to 25% of the total amount contributed by the employer to all employees’ HSAs for that period. However, in the case of a failure due to reasonable cause and not willful neglect, the IRS may waive all or a portion of the excise tax to the extent that the payment of the tax would be excessive relative to the failure involved.
This Special Advisory is for informational purposes only. It is not intended to constitute legal advice or purport to treat all the issues surrounding any one topic.