The HSA Distribution Rules: Part I

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The HSA Distribution Rules: Part I

By Brian Gilmore | Published February 20, 2025

Question: What are the HSA distribution rules?

Short Answer: HSA distributions for unreimbursed qualifying medical expenses are tax-free where incurred after establishing the account by HSA owners or their eligible dependents. Individuals can also roll over or transfer HSA balances to another custodian without tax consequences. Non-medical distributions are subject to ordinary income tax and (if under age 65) a 20% additional tax.

Starting Point: Only HSA-Eligible Individuals Can Establish and Contribute to an HSA

Health Savings Account (HSA) eligibility is required for any individual to establish an account and make or receive HSA contributions. Individuals must satisfy the following four requirements to be HSA-eligible:

Be covered by a qualified high deductible health plan (HDHP);
Have no other disqualifying health coverage;
Not be enrolled in any part of Medicare; and
Not be able to be claimed as a dependent on someone else’s current-year tax return.

Section 223 of the Internal Revenue Code imposes annual HSA contribution limits that adjust each year for inflation. Each individual’s limit is based primarily on whether the individual is enrolled in employee-only vs. family HDHP coverage, whether the individual is age 55+, and the number of months HSA eligibility in the year.

For more details:

HSA Distributions for Qualified Medical Expenses are Tax-Free

Employees can take a tax-free distribution from their HSA to pay or be reimbursed for IRC §213(d) qualified medical expenses that are incurred after establishing the account and are not reimbursed by another plan or arrangement. Section 213(d) defines qualifying medical expenses as the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and for the purpose of affecting any part or function of the body. These expenses include medical services rendered by medical practitioners, medicines and drugs, as well as the cost of equipment, supplies, and diagnostic devices for medical purposes. The best general IRS overview of what constitutes a §213(d) medical expense is IRS Publication 502.

Although in almost all circumstances the Publication 502 list of §213(d) medical expenses mirrors those expenses eligible for tax-free HSA distributions, there are a few differences. The slight modifications to the list of reimbursable expenses for account-based plans are set forth in IRS Publication 969.

The three areas of difference between standard §213(d) expenses and HSA qualified medical expenses are:

Over-the-Counter Medicines and Drugs (HSA-Eligible)
Menstrual Care Products (HSA-Eligible)
Premiums (Generally Not HSA-Eligible, Exceptions Apply)

HSA Qualified Medical Expenses Difference #1: Over-the-Counter Medicines and Drugs HSA-Eligible

With the exception of insulin, over-the-counter (OTC) medicines and drugs are deductible §213(d) qualified medical expenses only if prescribed. However, the CARES Act removed this ACA-era restriction for HSA (and FSA/HRA) OTC expenses as of 2020. As a result, employees may take tax-free HSA distributions for any OTC medicines and drugs without the need for a prescription.

HSA Qualified Medical Expense Difference #2: Menstrual Care Products HSA-Eligible

Deductible §213(d) qualified medical expenses do not include menstrual care products. However, the CARES Act expanded eligible HSA (and FSA/HRA) expenses as of 2020 to include menstrual care products, including tampons, pads, liners, cups, sponges, or similar products. As a result, employees may take a tax-free HSA distribution for such menstrual care products.

HSA Qualified Medical Expense Difference #3: Premiums Generally Not an HSA-Eligible Expense

The most significant discrepancy from the standard list of deductible §213 qualified medical expenses is the general exclusion of premium expenses from the list of HSA qualified medical expenses. Except in the four limited situations described below, use of an HSA to pay for premium expenses would be a non-medical distribution subject to income taxes and (if under age 65) a 20% additional tax.

HSA-Eligible Premium Expense: Long-Term Care Insurance Premiums

Individuals can take tax-free HSA distributions to pay for long-term care policy premiums, but only up to a limit that is based on age that adjusts annually. The annual cap on tax-free HSA distributions for long-term care insurance premiums is as follows in 2025:

Age 40 or under: $480
Age 41 to 50: $900
Age 51 to 60: $1,800
Age 61 to 70: $4,810
Age 71 and over: $6,020

HSA-Eligible Premium Expense: COBRA Premiums

Individuals can take tax-free HSA distributions for COBRA premiums or any other continuation coverage premiums required by federal law (e.g., USERRA).

HSA-Eligible Premium Expense: Premiums While Individual is Receiving Federal or State Unemployment

Individuals who are receiving unemployment under federal or state law can take tax-free HSA distributions to pay for any health plan premium, including individual coverage purchased on the Exchange.

HSA-Eligible Premium Expense #4: Medicare Premiums

Individuals who have reached age 65 can take tax-free HSA distributions for Medicare, an employer-sponsored retiree plan, or any other health coverage. However, Medicare supplemental policy premiums (such as Medigap) do not qualify for tax-free HSA distributions.

For more details: HSA Distributions for Premium Expenses

Tax-Free Medical Distributions Also Available for Expenses Incurred by Eligible Dependents

An employee can take tax-free medical distributions for expenses incurred by the employee HSA holder and:

The employee’s spouse;
The employee’s children under age 19;
The employee’s children under age 24 if a full-time student; and
The employee’s tax dependents.

For more details: HSAs and Family Members

HSA Distributions for Spouse

HSA owners can take a tax-free medical distribution for qualified medical expenses incurred by a spouse (same-sex or opposite-sex) regardless of whether the spouse is enrolled in the HDHP or is otherwise HSA-eligible.

Example 1:

Maximus Meridus is enrolled in employee-only HDHP coverage through his employer Legionnaires, Inc.
His spouse Giannina is enrolled in non-HDHP HMO coverage through her employer.

Result 1:

Maximus can use his HSA to pay for his spouse Giannina’s qualifying medical expenses even though she is not enrolled in the HDHP and is not HSA-eligible.

HSA Distributions for Children

The HSA rules do not incorporate the ACA Age 26 Rule providing that medical plans (including HDHPs) generally must cover children to age 26, and that coverage is non-taxable through the end of the year in which the child reaches age 26. This means that although an employee may cover a child under the HDHP to age 26, the child must qualify as the employee’s tax dependent under IRC §152 (as modified by §223(d)(2)(A)) to take tax-free HSA distributions from the employee’s HSA for the child’s medical expenses. The child’s HSA eligibility status is irrelevant for these purposes.

To meet the “qualifying child” tax dependent test, the child relationship must generally meet the following five requirements:

Child Relationship: The individual’s biological child, adopted child (including legally placed for adoption), stepchild, or foster child (or a sibling, half sibling, stepsibling, or descendant of any of those individuals);
Child Residence: The child must live with the individual for more than half the year (exceptions apply for temporary absences, children who were born or died during the year, kidnapped children, and children of divorced or separated parents);
Child Age: The child must be under age 19 at the end of the year. If the child is a full-time student for at least five calendar months of the year, the child must be under age 24 at the end of the year. No age limit applies if the child is permanently and totally disabled;
Child Support: The child cannot have provided more than half of his or her own support for the year; and
Child Taxes: The child cannot file a joint return for the year.

The age limitation (under age 19, or under age 24 if a full-time student) is a significant and unfortunate restriction for HSAs, especially because the standard ACA age 26 rule applies for virtually all other forms of health coverage and accounts (HDHP, health FSA, HRA, etc.). Multiple legislative proposals have sought to remedy this inequity, so there is at least some hope that Congress will eventually address the apparent oversight.

Important Notes:

This is just a general overview of tax dependent status.
For more details on the test to be a qualifying child, see IRS Publication 501.
Employers should not provide personal income tax advice, and any questions about tax dependent status should be referred to the employee’s personal tax advisor.
The HDHP definition of an eligible child will permit coverage to age 26 per the ACA requirements regardless of whether the child is a tax dependent.

Example 2:

Lucilla Aurelius is enrolled in employee + child HDHP coverage through her employer Curia Julia, Inc.
Her child Lucius Verus is 21 years old and attending Sapienza University as a full-time student.
Lucilla claims Lucius as a qualifying child tax dependent on her individual tax return.

Result 2:

Lucilla can use her HSA to pay for her child Lucius’s qualifying medical expenses even though he is not under age 19 because he is a full-time student and qualifies for tax dependent status under IRC §152, as modified by §223(d)(2)(A).
For these purposes, it is irrelevant whether Lucius is enrolled in the HDHP or is otherwise HSA-eligible.

HSA Distributions for Domestic Partners

A domestic partner’s medical expenses will qualify for a tax-free distribution from the employee’s HSA only if the domestic partner qualifies as the employee’s tax dependent under IRC §152, as modified by §223(d)(2)(A). The domestic partner’s HSA eligibility is irrelevant for these purposes.

To meet the modified “qualifying relative” tax dependent test, the relationship generally must meet the following requirements:

Not a Qualifying Child: The relative cannot be a qualifying child of any taxpayer;
Member of Household: The relative must live with the individual all year as a member of the individual’s household (the “same principal place of abode”), except for certain relatives not subject to this residency requirement;
Support Test: The individual must provide more than half of the relative’s total support for the year; and
Citizen/Resident Test: The relative must be a U.S. citizen, U.S. resident alien, U.S. national, or resident of Canada or Mexico.

Important Notes:

This is just a general overview of tax dependent status.
For more details on the test to be a qualifying relative, see IRS Publication 501.
The §223(d)(2)(A) modification removes certain requirements from the general qualifying relative definition, including the gross income limitation (which otherwise would require the dependent’s gross income to be less than $5,200 (2025 limit, indexed)).
The HDHP may provide for domestic partner eligibility regardless of whether the domestic partner qualifies as the employee’s tax dependent.
Employers should not provide personal income tax advice, and any questions about tax dependent status should be referred to the employee’s personal tax advisor.

Example 3:

Commodus is enrolled in employee + domestic partner HDHP coverage through his employer Colosseum Entertainment, Inc.
His domestic partner Marcia Aurelia does not qualify as Commodus’s tax dependent.

Result 3:

Commodus cannot use his HSA to pay for his domestic partner Marcia’s expenses on a tax-free basis because she does not qualify as his tax dependent.

For more details: HSAs and Domestic Partners

Other Tax Dependents

Employees may also take a tax-free distribution from their HSA for the medical expenses of any other individuals who qualify as the employee’s tax dependent under IRC §152, as modified by §223(d)(2)(A). For more details on the individuals who may qualify as a tax dependent for these purposes, see IRS Publication 501 and IRS Publication 969.

Non-Medical Distributions: Subject to Income Taxes and a 20% Additional Tax

Unlike a health FSA or HRA, the HSA can be used for both medical and non-medical expenses. The HSA is an individual account owned by the employee with no administrative gatekeeper to restrict HSA distributions.

The general rule is that there are two adverse individual income tax consequences of taking a non-medical HSA distribution:

The distribution is includible in gross income; and
The distribution is subject to a 20% additional tax.

The HSA owner must report non-medical distributions on the Form 8889 (Lines 14a, 16, and 17b), which is included with the individual income tax return (Form 1040). Failure to properly report non-medical distributions is subject to IRS audit.

Example 4:

Cicero is age 31 (and not disabled) with a large HSA balance.
He uses his HSA to purchase a $2,500 Ultra HD 8K TV.

Result 4:

Cicero must report the non-medical distribution on his Form 8889 and include the $2,500 distribution in his gross income when filing his individual income tax return.
Cicero must also pay a 20% additional tax on the $2,500 distribution ($500 additional tax).

For more details: Using an HSA for Non-Medical Expenses

Avoiding the 20% Additional Tax

The 20% additional tax does not apply to a non-medical distribution for an individual who:

Dies;
Becomes Disabled; or
Turns age 65.

An individual is considered disabled if he or she is unable to engage in any substantial gainful activity due to a physical or mental impairment which can be expected to result in death or continue indefinitely.

Although the 20% additional tax does not apply to a non-medical distribution for any individual who meets one of these exceptions, the distribution must still be included in the individual’s gross income. In other words, only standard ordinary income taxes apply (in the same manner as a traditional 401(k) or IRA distribution).

Example 5:

Marcus Aurelius is over age 65 and has a large HSA balance.
He uses his HSA to purchase a $2,500 Ultra HD 8K TV.

Result 5:

Marcus must report the non-medical distribution on his Form 8889 and include the $2,500 distribution in his gross income when filing his individual income tax return.
However, Marcus is not subject to the 20% additional tax because he is over age 65.

For more details: HSAs and Medicare

Avoiding Taxation for a Mistaken HSA Distribution: Return Funds by April 15

Mistaken non-medical HSA distributions may occur in situations such as a misunderstanding as to whether a particular item or service qualified as a medical expense, whether an individual’s expenses qualified for tax-free distributions, or the amount of cost-sharing the HDHP would cover. Absent an exception in these situations, the standard taxation and 20% additional tax would apply for any such distribution.

Fortunately, the IRS permits individuals to avoid taxation where there is clear and convincing evidence that the amounts were distributed from an HSA because of a mistake of fact due to reasonable cause. To qualify, the individual must repay the mistaken distribution to the HSA no later than April 15 following the first year the employee knew or should have known the distribution was a mistake. The HSA custodian may rely on the employee’s representation that the distribution was, in fact, a mistake when processing the repayment.

Example 6:

Quintus Laetus is enrolled in the Praetorian Corp. HDHP and contributes to an HSA.
He uses his HSA to pay $150 for the cost-sharing expenses incurred from physical therapy services.
The HDHP later reprocesses Quintus’s claim and determines that he overpaid because the appropriate cost-sharing was $100. Quintus receives a $50 refund from the provider.

Result 6:

There is clear and convincing evidence that Quintus’s $50 excess HSA distribution was a mistake of fact due to reasonable cause.
He has until April 15 of the year following discovery of the overpayment to repay the $50 excess distribution to his HSA.
If Quintus fails to return the $50 mistaken distribution by April 15 it will be subject to income taxes and the 20% additional tax for the non-medical distribution.
Alternatively, if Quintus has incurred other qualifying medical expenses that year of at least $50 for which he has not taken a distribution, Quintus can substitute with other qualifying amounts by forgoing a distribution for at least $50 to offset the mistaken amounts.

IRS Reporting of Mistaken Distribution Repayments

The IRS Form 1099-SA and 5498-SA Instructions (addressing HSA distributions and contributions respectively) direct the HSA custodian accepting the return of a mistaken distribution not to report the mistaken distribution on Form 1099-SA. If the Form 1099-SA has already been filed with the IRS including the distribution, the custodian is to correct the Form 1099-SA filing (and the version provided to the HSA holder) as soon as the custodian becomes aware of the error.

Example 7:

Same situation as Example 6.
The HSA custodian Mensarii Bank agrees to accept repayment of Quintus’s mistaken distribution.
Quintus makes the repayment of the mistaken distribution to the HSA by the following April 15.

Result 7:

Mensarii Bank will adjust the Form 1099-SA to remove the mistaken distribution.
Quintus will not be subject to taxation for the $50 amount returned to the HSA, and therefore he will not report them as taxable distributions (Lines 14a, 16, and 17b) on his Form 8889.

For more details: Correcting Mistaken HSA Distributions

Stay tuned for The HSA Distribution Rules: Part II addressing the other distribution rules!

Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship. Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).

Brian Gilmore

Lead Benefits Counsel, VP, Newfront

Brian Gilmore is the Lead Benefits Counsel at Newfront. He assists clients on a wide variety of employee benefits compliance issues. The primary areas of his practice include ERISA, ACA, COBRA, HIPAA, Section 125 Cafeteria Plans, and 401(k) plans. Brian also presents regularly at trade events and in webinars on current hot topics in employee benefits law.