Health Savings Accounts (HSA)

How it works

A Health Savings Account is a tax-exempt trust or custodial account a person can fund only while covered by a High Deductible Health Plan, under IRC section 223. It does something no other account in the Code does: it skips tax at every stage. The contribution is deductible above the line going in, the account's earnings are exempt from tax while they grow, and a distribution for a qualified medical expense comes out excluded from gross income.

A traditional 401(k) or IRA is deductible going in and taxed coming out; a Roth is taxed going in and tax-free coming out. Either way, one end of the transaction is taxed. An HSA taxes neither end, as long as the money is used for medical care, which is what makes it the most tax-advantaged account available rather than merely a good one.

The FICA lever, and why ownership changes it

For a W-2 employee, including staff at a business the owner runs, the cleanest way to fund an HSA is a salary-reduction contribution through a Section 125 cafeteria plan. That routes the money around income tax and around FICA and FUTA both, under IRC sections 3121(a)(5)(G) and 3306(b)(5)(G), so the full 7.65% employee and 7.65% employer Social Security and Medicare tax is escaped on the dollars contributed, not just the income tax. It is not the only route to that result. A direct employer contribution made outside a cafeteria plan is also generally excluded from wages. What the cafeteria plan uniquely does is let the employee's own salary reduction reach the same place.

A shareholder who owns more than 2% of an S corporation cannot use that route. IRC section 1372 treats a more-than-2% shareholder as self-employed for fringe-benefit purposes, so that person is not a Section 125 employee at all. Under IRS Notice 2005-8, the workaround runs the other direction: the corporation includes the HSA contribution in Box 1 wages, taxable for income tax, but leaves it out of Boxes 3 and 5, so it never becomes Social Security or Medicare wages. The shareholder then claims the above-the-line deduction on Form 8889, offsetting the Box 1 income tax. The Box 3 and 5 exclusion is conditional rather than automatic: Notice 2005-8 applies it only where the requirements of Section 3121(a)(2)(B) are met, which asks that the payment be made under a plan or system for employees generally. Where that holds, the result matches a rank-and-file employee's, income-tax neutral and free of FICA, reached through a W-2 add-back and a deduction rather than salary reduction. The compensation still has to survive reasonable-compensation scrutiny on its own, independent of the HSA add-back.

The stealth-retirement mechanism

Nothing in the statute puts a deadline on reimbursing yourself for a qualified medical expense. As long as the expense was incurred after the HSA existed, qualifies as medical care under IRC section 213(d), and was never reimbursed by insurance, it can sit unclaimed for years. That supports a second use beyond current bills: pay smaller expenses out of pocket, keep the receipt, and leave the HSA invested to grow tax-free rather than draining it immediately. The receipts become a standing claim on tax-free money, exercisable whenever it is useful, functioning like a Roth bucket funded with money that was deductible going in. After age 65, a non-medical distribution loses its tax-free treatment but keeps its shelter from the 20% tax described later on this page, so the account degrades at worst into something that behaves like a traditional IRA, never into something that costs more.

Florida has no individual income tax, so the deduction above is already the whole income-tax story; there is no separate state HSA deduction on top of it. What Florida ownership changes is which lever matters: a W-2 employee already gets the FICA exemption through the Section 125 route, while a more-than-2% shareholder has no such route, which is why the routing question above is the one piece worth getting right.

Who this applies to

Eligibility turns entirely on health coverage status, not on job title, entity type, or how someone is paid. For any month a contribution is made, IRC section 223(c)(1) requires all of the following to be true.

• HDHP coverage on the first day of the month. The plan has to be a qualifying High Deductible Health Plan, tested against the deductible and out-of-pocket bands described below, not just a plan someone describes as high-deductible.
• No other disqualifying coverage. Permitted coverage, such as dental, vision, disability, or accident coverage, does not count against eligibility. A general-purpose health FSA does; only a limited-purpose FSA restricted to dental and vision expenses is compatible with an HSA.
• No Medicare enrollment. Enrolling in any part of Medicare, including the Part A that starts automatically when Social Security is claimed at 65, ends eligibility. It does not always end it only going forward. Where enrollment is delayed and later filed, Part A entitlement can be backdated up to six months, though never before the month of turning 65, and contributions made during that retroactive stretch become excess contributions after the fact.
• Not claimable as a dependent on someone else's return, under IRC section 223(b)(6).

Where ownership changes the mechanics, not the eligibility

A more-than-2% S corporation shareholder who is HDHP-covered is an eligible individual on exactly the same terms as anyone else. Nothing about owning the company changes the four tests above. What changes, as covered above, is only how a contribution reaches the account tax-effectively, since the cafeteria-plan route is closed to that shareholder specifically.

The age-55 catch-up belongs to the individual, not the household: a spouse who is also 55 or older needs their own $1,000 added to their own HSA, since it cannot be combined into one account.

None of this depends on business structure otherwise. A sole proprietor, a partner, a W-2 employee, and a shareholder-employee can all be eligible individuals on the same coverage terms; only the contribution mechanics for a more-than-2% shareholder, covered above, work differently.

What it requires

Two structural tests run every year: whether the plan clears the HDHP bands, and how much can go in under the contribution ceiling. Both move with inflation under IRC sections 223(c)(2) and 223(b)(2), so the dollar amounts shift annually. The 2025 and 2026 figures below show the current shape of both.

The out-of-pocket maximum caps deductibles, copays, and coinsurance together; it does not include premiums. A plan that fits inside both bands for a given year qualifies as an HDHP for that year regardless of what the insurer calls it, and a plan that misses either band does not, no matter how large its deductible looks.

Contribution timing has its own trap built in. Eligibility is tested month by month, and the limit is generally one-twelfth of the annual amount for each eligible month. IRC section 223(b)(8), the last-month rule, is the exception: someone who is HDHP-eligible on December 1 can contribute the full annual amount for the year even though they were not eligible every month. The tradeoff is a 13-month testing period running through the following December 31, and staying HDHP-eligible for that entire stretch is what the full contribution is conditioned on.

The deduction has to be claimed on time and reported correctly. A contribution counts for a given tax year if it reaches the custodian, designated for that year, by the unextended return due date under IRC section 223(d)(4)(B), roughly April 15 of the following year. Any year with contribution or distribution activity requires Form 8889 attached to Form 1040, with the deduction itself flowing through Schedule 1.

What changed under the 2025 tax law known as OBBBA

OBBBA widened what counts as HDHP-compatible coverage without touching the figures above. Telehealth and other remote care can now be covered before the deductible is met, permanently, for plan years beginning on or after January 1, 2025. Bronze and Catastrophic exchange plans count as HDHPs starting January 1, 2026, regardless of purchase channel. And a Direct Primary Care arrangement no longer disqualifies HDHP coverage, for months after December 31, 2025, as long as the aggregate monthly fee stays at or under $150 for one person or $300 for more than one, a cap indexed after 2026 under the amended IRC section 223(c)(1) and IRS Notice 2026-5. I cover that cap, and what happens once a fee crosses it, in my direct primary care and HSA eligibility piece.

What you need to document

Proof the plan actually qualifies

The plan's Summary of Benefits and Coverage, showing the deductible and out-of-pocket maximum fall inside the bands for that specific coverage year, not just a general description of the plan as high-deductible.

Coverage status for every month a contribution was made

Records ruling out disqualifying coverage, Medicare enrollment, and dependent status for each month, since the eligibility test runs monthly rather than once a year.

Contribution records tied to the correct tax year

Custodian confirmation of the year a contribution is designated for, particularly for anything made between January 1 and the filing deadline that is meant to count against the prior year.

A receipt for every expense held for later reimbursement

Documentation that the expense is medical care under IRC section 213(d), that it was incurred after the HSA existed, and that no insurer reimbursed it. This is the entire defense behind the reimburse-later position, and it has to be assembled as expenses happen rather than reconstructed at reimbursement time.

Payroll records for a more-than-2% shareholder's contribution

W-2 documentation showing the amount included in Box 1 but excluded from Boxes 3 and 5, together with the Form 8889 claiming the offsetting deduction, so the position matches IRS Notice 2005-8 rather than looking like an ordinary cafeteria-plan exclusion.

Where it goes wrong

Most of what turns an HSA position into an exam problem is a coverage or documentation failure rather than anything aggressive about the account itself.

• Coverage that was never actually HDHP. Either the plan fails the deductible and out-of-pocket test, or the person had disqualifying coverage they did not think of as coverage: a spouse's non-HDHP family plan, a general-purpose FSA, or Medicare enrollment, including the Part A that starts automatically when Social Security is claimed at 65.
• Excess contributions. Anything over the indexed limit, or over the prorated amount for a partial year of eligibility, draws a 6% excise tax under IRC section 4973 for every year it stays in the account. Withdrawing the excess and its earnings before the return due date is what stops the tax from repeating.
• A last-month-rule contribution followed by lost coverage. Using the December 1 rule to fund the full year, then dropping HDHP coverage before the 13-month testing period ends, pulls the excess back into income and adds a 10% tax under IRC section 223(b)(8)(B).
• Distributions that were not for medical care. Anything outside IRC section 213(d) is ordinary income plus an additional 20% tax under IRC section 223(f)(4), unless the owner is 65 or older, disabled, or deceased. That 20% rate is double what an early IRA withdrawal costs, which is what makes casual non-medical debit-card use expensive rather than merely taxable.
• No receipts behind a reimburse-later claim. The entire position depends on proving the expense happened after the account existed, qualified as medical care, and was not otherwise reimbursed. Without that proof on exam, there is no position left to defend.
• A more-than-2% shareholder's contribution run through a cafeteria plan. That routing is invalid under IRC section 1372 regardless of intent. Where a preparer has treated it as a Box 3 and Box 5 salary-reduction exclusion instead of a Notice 2005-8 add-back, the FICA exclusion is exposed to being unwound on exam.

A situation where this comes up

The pattern I see most often is an S corporation owner who was a rank-and-file employee somewhere else before starting the business, remembers HSA contributions running through a cafeteria plan on that old paycheck, and sets payroll up the same way now that they own more than 2% of the company. It is the natural assumption, and it is the wrong one. The fix is not complicated once it is caught: stop the salary-reduction treatment, include the contribution in Box 1 wages, keep it out of Boxes 3 and 5, and let the deduction claimed on Form 8889 do the work the cafeteria plan used to do.

The version that worries me more is quieter. Someone turns 65, claims Social Security, and does not realize that Medicare Part A starts automatically and ends HSA eligibility that same month, sometimes years before the person considers themselves retired. The version of this that catches careful people is the delayed filer: Part A can be backdated up to six months when enrollment is finally made, so contributions that looked fine when they went in become excess retroactively, and stopping on the enrollment date is not enough. Contributions keep going in on autopilot because nothing about the paycheck or the account looks different, and the excess sits there drawing the excise tax under section 4973 until an unrelated review of the account turns it up.