by Denise Appleby CISP, CRC, CRPS, CRSP, APA
The use of the term trustee-to-trustee transfer as it relates to qualified HSA funding distributions has created confusion for some owners of health savings account (HSA)s and IRAs, and even some custodians. This uncertainty stems from the fact that the term ‘trustee-to-trustee transfer’ is typically used by financial institutions to refer to a nonreportable movement of assets between retirement accounts of the same type, such as transfers between two traditional IRAs or between two Roth IRAs. And HSAs and IRAs are ( obviously) two different types of accounts.
The Health Opportunity Patient Empowerment Act of 2006 (HOPEA) includes a provision that allows traditional IRA and Roth IRA owners to complete a one-time trustee-to-trustee transfer from their IRAs to their HSAs. These transfers, referred to as qualified HSA funding distributions (QHFD), are limited to the maximum HSA contribution for the year and must be paid directly to the HSA custodian.
Cause of The Confusion
Financial service professionals usually use the term trustee-to-trustee transfer to refer to non-reportable movements of assets between accounts of the same type, where the assets are paid (by the delivering financial institution on behalf of the participant) and delivered directly to the receiving financial institution. Despite the fact that the IRS uses the term trustee-to-trustee transfer to refer to certain reportable transactions, financial service professionals have not followed suit primarily because limiting it to nonreportable transactions helps to prevent confusion when processing movements of assets between accounts. For transactions that are reportable, distribution, rollover and/or direct rollover are the preferred terms for financial institutions.
The IRS’ Meaning
The IRS’ use of the term trustee-to-trustee simply means that the check or other instrument is made payable to the receiving financial institution. Examples include Treasury Regulation 1.408A, as it relates to Roth conversions and recharacterizations , where it is provided that direct conversions and recharacterizations are trustee-to-trustee transfers; and the qualified charitable donations provisions, which provides that the ‘distribution’ must be delivered to the eligible charity as a trustee-to-trustee transfer. As these transactions are reportable, it is evident that the IRS does not limit the term to nonreportable transactions.
So…is a qualified HSA Funding Distribution Reportable?
To determine if a QHFD is reportable, we must look to instructions that the IRS provides to custodians and trustees for filing tax forms.
The instructions for filing Form 1099-R provide that there is no special reporting for qualified HSA funding distributions. Instead, individuals are required to claim any associated tax benefits on their tax returns. Therefore, the issuing custodian is required to report the distribution as they would any regular distribution; that is, the amount should be reported as a taxable distribution in Boxes 1 and 2a of Form 1099-R, and code 2 or code 7 should be inputted in Box 7. Code 2 is used if the distribution occurs before the individual reaches age 59 ½, and code 7 is used if the distribution occurs on, or after, the day the individual reaches age 59 ½.
The instructions for Box 2 of Form 5498-SA, states the issuing custodian must “Enter the total (employer and employee/self-employed) HSA or Archer MSA contributions made in 2007. Include any contribution made in 2007 for 2006. Also include qualified HSA funding distributions (trustee-to-trustee transfers from an IRA to an HSA under section 408(d)(9)) received by you during 2007”
These instructions make it clear that a QHFD is reportable.
What should IRA and HSA owners do with their 1099-R and 5498-SA?
An individual who receives a 1099-R and a 5498-SA should take the following steps:
- Enter the total distribution amount on line 15a of Form 1040.
- If the total distribution was treated as a QHFD and the individual elects to exclude the amount from income, -0- should be entered on line 15b. ( Note, for Form 1040A, the lines are 12a and 12b).
- If only a portion of the distribution represents a QHFD and the individual elects to exclude the QHFD amount from income, only the portion that was not credited to an HSA as a QHFD should be entered on line 15b.
- The individual should input HFD on line 15b, to show that the amount is being excluded from income because it was credited to an HSA as a QHFD. However, HFD should not be inputted, if certain exceptions apply to the amount. These exceptions are noted on page 21 of the Instructions for Filing Form 1040 , under “Exception 2” Note: For tax reporting purposes, the IRS uses the term ‘Qualified health savings account (HSA) funding distribution (HFD)’, instead of QHFD. To ensure acceptability by the IRS, the individual must follow the tax-filing instructions they provide and input HFD.
- If the 1099-R shows withholding taxes, it should be attached to the Form 1040 and a copy maintained with the individual’s tax records.
- Form 5498-SA need not be attached to the Form 1040, but should be filed with the individual’s tax records.
- Read the tax filing instructions carefully and when necessary, work with a competent tax professional to ensure that reporting and elections made are accurate and consistent with the IRS’ instructions and provisions of the tax code.
Unless further guidance is provided to the contrary, IRA custodians must treat these transactions as regular distributions, and HSA custodians must treat them as regular HSA contributions. Additionally, individuals must report the amounts on their tax returns in accordance with the instructions provided by the IRS.