In Which Year Do You Deduct an Employer Contribution to an Employee’s HSA?

Q:

“I run my own business as a sole proprietorship. I hired my wife as my employee. I want to contribute to her Health Savings Account and take the deduction as a business expense on last year’s return since I think my tax rate will be higher. Can I do that?”

A:

First let me congratulate you for hiring your wife as an employee. In a husband-wife business, having one spouse as an employee is a much more tax efficient arrangement than a partnership. Tax is not always the only consideration of course, but generally you will pay less tax if you can set it up this way.

Now to your question. You (as the employer) are allowed to make a contribution to your employee’s Health Savings Account (HSA) and allocate it either for last year (as long as you make it by the tax filing deadline) or for this year (the calendar year in which you make the contribution). However, regardless of the year to which it is allocated, you (as the employer) are allowed to deduct the payment only in the year you make the actual payment. Here it is straight from the horse’s mouth (IRS Publication 969):

You can make contributions to your employees’ HSAs. You deduct the contributions on the “Employee benefit programs” line of your business income tax return for the year in which you make the contributions. If the contribution is allocated to the prior year, you still deduct it in the year in which you made the contribution.

To sum up, unfortunately you will not be allowed to deduct the contribution as a business expense on last year’s return. If you make the contribution now (in January 2013) you will deduct it on your 2013 return even if it is a 2012 contribution.

There is another option, albeit an imperfect one. You or your wife can make a regular (non-employer) contribution to your wife’s HSA. In other words, you or your wife are allowed to make a contribution to her HSA completely independent of the employer-employee relationship that you have. If you make the contribution in this way, you are allowed to deduct it on last year’s return as long as you: 1) Make the contribution by the April 15 tax filing deadline, and 2) Designate it as a contribution for last year. From IRS Publication 969:

Report all contributions to your HSA on Form 8889 and file it with your Form 1040 or Form 1040NR. You should include all contributions made for 2011, including those made by April 17, 2012, that are designated for 2011.

Note that this quote is about non-employer contributions, so please don’t confuse it with the employer contributions which were discussed above. Also note that the years are off by one because it is the Pub 969 for 2011 returns (the version for 2012 returns is not yet available).

The advantage of making a non-employer contribution to your wife’s HSA is being able to deduct the payment on last year’s return. You mentioned your tax rate will likely be higher so the deduction may be worth more. Plus you accelerate the deduction by a year.

The downside of the non-employer contribution is that the HSA deduction on the front side of Form 1040 is often less valuable than a business deduction. Why? Because a business deduction reduces your income AND employment tax, whereas the HSA deduction on the front side of Form 1040 (e.g. the non-employer contribution) reduces only your income tax. This is less of a concern if your self-employment income is above the FICA wage base (since your marginal rate for self-employment tax is 2.9% above that point rather than the full 13.3% for 2012). You need to weigh the cost of the extra self-employment tax against the savings you expect to realize from the spread between your 2012 and 2013 marginal rates.

Lastly, let me throw in a bonus tip on the reporting. If you make the employer contribution to her HSA, the amount is reported on her W-2 for 2013 (the year the payment is made) rather than 2012 (the year to which it is allocated). From Pub 969 (remember that the years are off by one):

Your employer can make contributions to your HSA between January 1, 2012, and April 17, 2012, that are allocated to 2011. Your employer must notify you and the trustee of your HSA that the contribution is for 2011. The contribution will be reported on your 2012 Form W-2.

It may seem counterintuitive but really it’s not. The W-2 is intended to report compensation to an employee for a given year. Allocating the compensation to a prior year for purposes of the HSA rules doesn’t change the fact that the compensation was received in 2013.

Sources

IRS Publication 969