HSAs in California

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JustinR
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HSAs in California

Post by JustinR »

http://www.bogleheads.org/wiki/Health_Savings_Account
While contributions are deductible on one's federal income tax, this is not always true for state income tax. The following states are not in conformity with federal legislation and do not recognize HSAs, so contributions are not deductible and earnings are taxable[1]:

Alabama
California
New Jersey
I've been looking for more elaboration on this but haven't really been able to find any more information on what this means exactly. Can someone explain like I'm 5 what this means for me if I'm a Californian? I guess that you can deduct for federal tax but I wonder if it's worth the hassle.

So is there any point of using an HSA if you live in California, for either investing purposes or medical purposes?
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Dinero
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Re: HSAs in California

Post by Dinero »

You pay state taxes on dollars contributed to an HSA and pay state taxes on earnings from that HSA (unless the HSA is invested in state-tax deferred investments like CA muni bonds, Treasurys, etc.). You do not pay federal taxes on those dollars.

Even with the CA state tax thing, HSA's still can make sense. You only get so many ways each year to shelter dollars, and deferring into an HSA is available regardless of income. Further, HSAs are really super IRAs, with no taxes due when used for medical expenses. And they can be treated as a regular IRA after age 65, only paying income taxes on withdrawals (but no penalties) for any purpose.
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Re: HSAs in California

Post by Harold »

It means you show the HSA contributions on Schedule CA (540) as an adjustment to your Federal taxable income, thereby increasing your California taxable amount.

HSA contributions still benefit you from the Federal tax perspective -- you just don't get the state tax benefit that residents of most other states get.
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Artsdoctor
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Re: HSAs in California

Post by Artsdoctor »

Justin,

First of all, it's fantastic that you're using the wiki here. The information is invaluable.

I live in California and there really is a lot of confusion on this topic. Essentially, you treat the HSA as it's meant to be treated from a FEDERAL point of view. If you're using it as an investment vehicle (for example, you take your pre-tax dollars, invest it in Vanguard's Total Stock Market Index Admiral shares, and plan on liquidating many years in the future), it can be a very smart tool. But only federally, for now.

From a STATE point of view, you have to treat it the exact same way that you'd treat a taxable account. California doesn't recognize HSAs at all. You can't deduct the annual contribution, and you have to report all dividends and distributions annually on your state income tax form. Furthermore, if you sell a fund in the account at a gain, you'll have to declare that on your California income tax form as well. So from a STATE tax point of view, it's best to keep any investments tax-efficient. (Likewise, if you sell at a loss, you can deduct that loss from any gain in the account as well.)

So for Californians, you would have different income generated between federal and state forms. Additionally, you'd have to keep track of capitals gains and losses using two ledgers: one for federal, and one for state.

This is very unfortunate. For now, the state has decided that it would be too expensive to follow federal rules. And with the state income tax set to go up for high-income earners from 9.3% to as high as 12.3% in 2013, tax-efficiency will play a role in HSAs as well.

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Re: HSAs in California

Post by kaneohe »

Artsdoctor wrote:
So for Californians, you would have different income generated between federal and state forms. Additionally, you'd have to keep track of capitals gains and losses using two ledgers: one for federal, and one for state.
I think you would only need 1 ledger : for CA . Federal withdrawals would either be free or taxed as ordinary income.
Internal transactions wouldn't be taxed by Feds.
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Re: HSAs in California

Post by grabiner »

JustinR wrote:So is there any point of using an HSA if you live in California, for either investing purposes or medical purposes?
You can invest your HSA in Treasury bonds or TIPS, so that gains on the HSA will not be taxable in California either. (And TIPS are a particularly good choice for an HSA, as they reduce the risk that the HSA will grow too large to cover your medical expenses and thus become federally taxable as well.)

Alternatively, you can just invest your HSA in something tax-efficient, and pay the small tax bill. I live in NJ and have all my bonds in my employer plan, so my HSA is invested in a stock ETF. I pay NJ taxes on the dividends, and would pay NJ taxes on any capital gains realized by the ETF (unless I have losses to offset them.)
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Re: HSAs in California

Post by grabiner »

kaneohe wrote:
Artsdoctor wrote:
So for Californians, you would have different income generated between federal and state forms. Additionally, you'd have to keep track of capitals gains and losses using two ledgers: one for federal, and one for state.
I think you would only need 1 ledger : for CA . Federal withdrawals would either be free or taxed as ordinary income.
Internal transactions wouldn't be taxed by Feds.
But you need separate ledgers for capital gains as a whole. If you have a $3500 capital loss carryover and $1000 of capital gains in your HSA, then you deduct $3000 in capital losses from your federal taxes and carry over $500 to next year, while you deduct only $2500 in capital losses from your state taxes and have no carryover to the next year. (And it gets even more complicated if you move to CA; you have to recalculate your capital loss carryover according to CA law, including any gains or losses in the HSA from before you moved there.)

NJ eliminates the issue with separate ledgers because it does not allow capital loss carryovers. If my HSA distributes any capital gains this year, I won't pay taxes because I have losses realized this year; otherwise, the losses will be of no NJ tax benefit, and I will pay NJ tax on any capital gains in either my taxable account or HSA next year unless I have losses next year.
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Re: HSAs in California

Post by kaneohe »

grabiner, thanks...........wasn't thinking about the losses......could be a little messy.
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Re: HSAs in California

Post by jane1 »

Does anyone know how it works if you live in California when you contributed to the HSA (and paid CA state tax on it) but then move to another state after 65. If you withdraw after 65 and treat it like an IRA (for non-medical expenses), do you pay the new state tax on the entire withdrawal? Double state taxation?
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Re: HSAs in California

Post by grabiner »

jane1 wrote:Does anyone know how it works if you live in California when you contributed to the HSA (and paid CA state tax on it) but then move to another state after 65. If you withdraw after 65 and treat it like an IRA (for non-medical expenses), do you pay the new state tax on the entire withdrawal? Double state taxation?
State taxes on intangible investments (such as stocks and bank accounts) are based on the laws of your state of residence at the time you pay the taxes. Thus, if an investment is taxed differently by two states, you can pay double tax or no tax.

Thus, if you contributed to an HSA while a CA resident, and then made a non-qualified withdrawal while not a CA resident, you would pay state tax twice. Conversely, if you contributed to an HSA while a non-CA resident, and then made a non-qualified withdrawal while a CA resident, you would pay no state tax.
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Re: HSAs in California

Post by kaneohe »

grabiner wrote:
jane1 wrote:Does anyone know how it works if you live in California when you contributed to the HSA (and paid CA state tax on it) but then move to another state after 65. If you withdraw after 65 and treat it like an IRA (for non-medical expenses), do you pay the new state tax on the entire withdrawal? Double state taxation?
State taxes on intangible investments (such as stocks and bank accounts) are based on the laws of your state of residence at the time you pay the taxes. Thus, if an investment is taxed differently by two states, you can pay double tax or no tax.

Thus, if you contributed to an HSA while a CA resident, and then made a non-qualified withdrawal while not a CA resident, you would pay state tax twice. Conversely, if you contributed to an HSA while a non-CA resident, and then made a non-qualified withdrawal while a CA resident, you would pay no state tax.
grabiner.....for OP's question could it also depend on the nature of the investment within the HSA? Ex: CDs......tax is paid every yr on the interest in CA; if non-qualified withdrawal is made in another state, the withdrawal is taxed for 2x taxation?
Ex: tax-efficient funds with no distributions: no taxation in CA (at least on distribution component); if non-qualified withdrawal is made in another state, the withdrawal is taxed for 1x taxation? Since no deduction for contribution in CA
and withdrawal for non-qualified expenses in another state would be taxed, this part (contribution)would be 2x taxation
so overall taxation would depend on ratio of gains to contribution? (between 1x and 2x).?
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Re: HSAs in California

Post by grabiner »

kaneohe wrote:
grabiner wrote:Thus, if you contributed to an HSA while a CA resident, and then made a non-qualified withdrawal while not a CA resident, you would pay state tax twice. Conversely, if you contributed to an HSA while a non-CA resident, and then made a non-qualified withdrawal while a CA resident, you would pay no state tax.
grabiner.....for OP's question could it also depend on the nature of the investment within the HSA? Ex: CDs......tax is paid every yr on the interest in CA; if non-qualified withdrawal is made in another state, the withdrawal is taxed for 2x taxation?
Each state imposes taxes according to its own tax laws; whether you paid tax to another state or not is not normally a concern (with the exception that states allow you to take a credit for double taxes on the same income, but I don't think that applies here).
Ex: tax-efficient funds with no distributions: no taxation in CA (at least on distribution component); if non-qualified withdrawal is made in another state, the withdrawal is taxed for 1x taxation? Since no deduction for contribution in CA
and withdrawal for non-qualified expenses in another state would be taxed, this part (contribution)would be 2x taxation
so overall taxation would depend on ratio of gains to contribution? (between 1x and 2x).?
Yes, this is correct. For example, you contribute $5000 in CA and pay CA tax on that $5000. The $5000 then grows to $10,000 with no dividends and then you move to NY, where you take a non-qualified withdrawal. In both CA and NY, your state taxable income is based on your federal taxable income, adjusted for the state's tax laws; thus you owe NY tax on the full $10,000 withdrawal.

Now, consider the situation in the other direction, in which you contribute in NY and move to CA. You paid no tax on the $5000 contributed in NY. If you don't sell the stock, then when you sell the stock in CA, you have a $5000 CA capital gain, which is taxed whether you withdraw the money or not; if you sell the stock while still in NY, you have a $5000 non-taxable gain in NY because NY does not tax gains inside an HSA. And CA imposes no state tax on the non-qualified withdrawal, since under CA law, the HSA is an ordinary taxable account.

This situation also occurs in many other situations with different state tax laws that can carry over to subsequent years. For example, NJ does not allow a deduction for IRA contributions. Therefore, if you contribute $5000 to a federally deductible IRA in NJ, you get no state deduction. Then, if you withdraw the IRA in NY, you pay NY tax on the full amount, including the $5000 that you would have deducted from your NY taxes if you had filed NY taxes in the year you made the contribution.
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Re: HSAs in California

Post by Epsilon Delta »

grabiner wrote:Now, consider the situation in the other direction, in which you contribute in NY and move to CA. You paid no tax on the $5000 contributed in NY. If you don't sell the stock, then when you sell the stock in CA, you have a $5000 CA capital gain, which is taxed whether you withdraw the money or not
Just out of interest where does the $5000 CA basis come from? It can't come from the NY or Federal basis since there isn't one. So CA appears to be taxing an event that is outside of its jurisdiction. Moreover neither NY nor the US requires you to keep records for the non-existent basis. Can CA retroactively penalize you for keeping insufficient records?
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Re: HSAs in California

Post by grabiner »

Epsilon Delta wrote:
grabiner wrote:Now, consider the situation in the other direction, in which you contribute in NY and move to CA. You paid no tax on the $5000 contributed in NY. If you don't sell the stock, then when you sell the stock in CA, you have a $5000 CA capital gain, which is taxed whether you withdraw the money or not
Just out of interest where does the $5000 CA basis come from? It can't come from the NY or Federal basis since there isn't one. So CA appears to be taxing an event that is outside of its jurisdiction. Moreover neither NY nor the US requires you to keep records for the non-existent basis. Can CA retroactively penalize you for keeping insufficient records?
CA imposes taxes according to its own laws, just as the US does; the same situation would apply on your federal tax if you acquired stock in a foreign country which does not tax capital gains, and then moved to the US with no record of your basis.

Again, the same rule applies to other tax situations. NJ does not allow a tax deduction for 403(b) contributions; therefore, if you contributed to a 403(b), you have a basis equal to the amount already taxed by NJ, even if you did not live in NJ when you made the contribution. If you later move to NJ and then withdraw from the 403(b) (or roll the 403(b) over to an IRA and then withdraw from the IRA), you pay tax only on the non-basis portion, provided that you can substantiate your basis.
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Re: HSAs in California

Post by JustinR »

grabiner wrote:
JustinR wrote:So is there any point of using an HSA if you live in California, for either investing purposes or medical purposes?
You can invest your HSA in Treasury bonds or TIPS, so that gains on the HSA will not be taxable in California either. (And TIPS are a particularly good choice for an HSA, as they reduce the risk that the HSA will grow too large to cover your medical expenses and thus become federally taxable as well.)

Alternatively, you can just invest your HSA in something tax-efficient, and pay the small tax bill. I live in NJ and have all my bonds in my employer plan, so my HSA is invested in a stock ETF. I pay NJ taxes on the dividends, and would pay NJ taxes on any capital gains realized by the ETF (unless I have losses to offset them.)
What do you mean by the HSA "growing too large to cover medical expenses, becoming federally taxable"?

Also, I'm getting scared about manually keeping track of cost basis's for the rest of my life just due to this HSA (which I don't have to do for any of my other retirement or taxable accounts). I'm thinking it's not worth the trouble if I'm in CA.
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Re: HSAs in California

Post by grabiner »

JustinR wrote:
grabiner wrote:
JustinR wrote:So is there any point of using an HSA if you live in California, for either investing purposes or medical purposes?
You can invest your HSA in Treasury bonds or TIPS, so that gains on the HSA will not be taxable in California either. (And TIPS are a particularly good choice for an HSA, as they reduce the risk that the HSA will grow too large to cover your medical expenses and thus become federally taxable as well.)
What do you mean by the HSA "growing too large to cover medical expenses, becoming federally taxable"?
If you withdraw from your HSA for purposes other than medical expenses, you will pay federal tax on the withdrawals.

If you hold stocks in your HSA and there is a stock-market boom, your HSA may be more than enough to cover your medical expenses, so you will have to make some taxable withdrawals. If you hold TIPS in an HSA, your HSA is guaranteed to grow at a rate close to inflation, which makes it unlikely that the HSA will exceed your medical expenses.
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Re: HSAs in California

Post by Spirit Rider »

JustinR wrote:
grabiner wrote:
JustinR wrote:So is there any point of using an HSA if you live in California, for either investing purposes or medical purposes?
Also, I'm getting scared about manually keeping track of cost basis's for the rest of my life just due to this HSA (which I don't have to do for any of my other retirement or taxable accounts). I'm thinking it's not worth the trouble if I'm in CA.
Even if you are worried about tracking cost basis's, that is not a reason for not using the HSA.

You still get a federal tax deduction and pay no FICA on payroll contributions. HSA account returns are tax deferred. Distributions for qualified medical expenses are tax-free. If your federal margin tax rate is 28%, this is a 35.65% savings on out of pocket medical expenses.

Just put the money in a interest bearing HSA account and you never have to worry about cost basis's ever.
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Re: HSAs in California

Post by JustinR »

grabiner wrote:
JustinR wrote:
grabiner wrote:
JustinR wrote:So is there any point of using an HSA if you live in California, for either investing purposes or medical purposes?
You can invest your HSA in Treasury bonds or TIPS, so that gains on the HSA will not be taxable in California either. (And TIPS are a particularly good choice for an HSA, as they reduce the risk that the HSA will grow too large to cover your medical expenses and thus become federally taxable as well.)
What do you mean by the HSA "growing too large to cover medical expenses, becoming federally taxable"?
If you withdraw from your HSA for purposes other than medical expenses, you will pay federal tax on the withdrawals.

If you hold stocks in your HSA and there is a stock-market boom, your HSA may be more than enough to cover your medical expenses, so you will have to make some taxable withdrawals. If you hold TIPS in an HSA, your HSA is guaranteed to grow at a rate close to inflation, which makes it unlikely that the HSA will exceed your medical expenses.
Not sure I follow. Isn't having more money always better than having less, even if it'll be taxed?

Spirit Rider wrote:You still get a federal tax deduction and pay no FICA on payroll contributions. HSA account returns are tax deferred. Distributions for qualified medical expenses are tax-free. If your federal margin tax rate is 28%, this is a 35.65% savings on out of pocket medical expenses.
Very good point thank you. Can you explain how you did the math for the 35.68% savings?

Never mind, 28% + FICA 7.65%
Last edited by JustinR on Wed Oct 30, 2013 8:02 am, edited 1 time in total.
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Re: HSAs in California

Post by grabiner »

JustinR wrote:
grabiner wrote:If you withdraw from your HSA for purposes other than medical expenses, you will pay federal tax on the withdrawals.

If you hold stocks in your HSA and there is a stock-market boom, your HSA may be more than enough to cover your medical expenses, so you will have to make some taxable withdrawals. If you hold TIPS in an HSA, your HSA is guaranteed to grow at a rate close to inflation, which makes it unlikely that the HSA will exceed your medical expenses.
Not sure I follow. Isn't having more money always better than having less, even if it'll be taxed?
Yes, but it is better to have more in the account which is taxed at a lower rate. If you have $10,000 in your HSA and $20,000 in your Roth IRA, and you have $10,000 in medical expenses, you can withdraw all $30,000 with no tax cost. If you have $20,000 in your HSA and $10,000 in your Roth IRA, and you have $10,000 in medical expenses, you will owe tax on $10,000 if you withdraw $30,000. A traditional IRA works the same way once you adjust for the fact that the IRS owns 25% of it if your withdrawals are taxed at 25%.

Therefore, it is better to hold less volatile assets in an HSA which might be too large for your medical expenses, and more volatile assets in an IRA or 401(k), so that you get to keep the full benefit of any gains in the more volatile assets.
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Re: HSAs in California

Post by JustinR »

grabiner wrote:
JustinR wrote:
grabiner wrote:If you withdraw from your HSA for purposes other than medical expenses, you will pay federal tax on the withdrawals.

If you hold stocks in your HSA and there is a stock-market boom, your HSA may be more than enough to cover your medical expenses, so you will have to make some taxable withdrawals. If you hold TIPS in an HSA, your HSA is guaranteed to grow at a rate close to inflation, which makes it unlikely that the HSA will exceed your medical expenses.
Not sure I follow. Isn't having more money always better than having less, even if it'll be taxed?
Yes, but it is better to have more in the account which is taxed at a lower rate. If you have $10,000 in your HSA and $20,000 in your Roth IRA, and you have $10,000 in medical expenses, you can withdraw all $30,000 with no tax cost. If you have $20,000 in your HSA and $10,000 in your Roth IRA, and you have $10,000 in medical expenses, you will owe tax on $10,000 if you withdraw $30,000. A traditional IRA works the same way once you adjust for the fact that the IRS owns 25% of it if your withdrawals are taxed at 25%.

Therefore, it is better to hold less volatile assets in an HSA which might be too large for your medical expenses, and more volatile assets in an IRA or 401(k), so that you get to keep the full benefit of any gains in the more volatile assets.
Thanks for all your replies, grabiner. Very helpful for me, a first time HSA investor.

How is having a lot money in your HSA worse than a 401k? Aren't they the same? They're both tax-deferred for non-medical expenses, and you get taxed when you withdraw it.

Also, by saying you should keep less-volatile assets in your HSA, you're just talking about optimal asset allocation, correct? You're not saying that there's anything inherently wrong with investing in equities in your HSA and having it have big gains?
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Re: HSAs in California

Post by grabiner »

JustinR wrote:How is having a lot money in your HSA worse than a 401k? Aren't they the same? They're both tax-deferred for non-medical expenses, and you get taxed when you withdraw it.
It is worse only after tax-adjustment. If you withdraw in a 25% tax bracket, $100 in a 401(k) is equivalent to $75 in a Roth account. $100 in an HSA is worth the full $100 if it is used for medical expenses, but if you are valuing it at $100 post-tax, you only get the benefit of 75% of any gains beyond what you spend on medical expenses.
Also, by saying you should keep less-volatile assets in your HSA, you're just talking about optimal asset allocation, correct? You're not saying that there's anything inherently wrong with investing in equities in your HSA and having it have big gains?
Actually, I am not even talking about asset allocation, just asset location. If you are going to hold stocks and bonds, it is better to have bonds in the HSA and stocks in a 401(k) or IRA.
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Re: HSAs in California

Post by jpd236 »

grabiner wrote:
JustinR wrote:
grabiner wrote:If you withdraw from your HSA for purposes other than medical expenses, you will pay federal tax on the withdrawals.

If you hold stocks in your HSA and there is a stock-market boom, your HSA may be more than enough to cover your medical expenses, so you will have to make some taxable withdrawals. If you hold TIPS in an HSA, your HSA is guaranteed to grow at a rate close to inflation, which makes it unlikely that the HSA will exceed your medical expenses.
Not sure I follow. Isn't having more money always better than having less, even if it'll be taxed?
Yes, but it is better to have more in the account which is taxed at a lower rate. If you have $10,000 in your HSA and $20,000 in your Roth IRA, and you have $10,000 in medical expenses, you can withdraw all $30,000 with no tax cost. If you have $20,000 in your HSA and $10,000 in your Roth IRA, and you have $10,000 in medical expenses, you will owe tax on $10,000 if you withdraw $30,000. A traditional IRA works the same way once you adjust for the fact that the IRS owns 25% of it if your withdrawals are taxed at 25%.

Therefore, it is better to hold less volatile assets in an HSA which might be too large for your medical expenses, and more volatile assets in an IRA or 401(k), so that you get to keep the full benefit of any gains in the more volatile assets.
That still doesn't mean you should change your allocation just to hold less volatile assets like TIPS in the HSA. Holding TIPS in the HSA only makes sense if you have reason to hold TIPS or a similar investment somewhere, in which case the HSA might be an appropriate home for it. But otherwise, not wanting to exceed medical expenses is no reason to be conservative with the HSA.

Holding less volatile assets with a lower expected return is not optimal if those assets lead you to a less risky asset allocation than you would otherwise be happy with.

Also note that simply putting all your bonds in the HSA is likely not optimal as the HSA is a smaller account than other tax-advantaged space, and if stocks tank 50% tomorrow, you won't be able to rebalance from the HSA into your retirement account.
Last edited by jpd236 on Sat Nov 02, 2013 10:14 am, edited 1 time in total.
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Re: HSAs in California

Post by magellan »

grabiner wrote:If you hold stocks in your HSA and there is a stock-market boom, your HSA may be more than enough to cover your medical expenses, so you will have to make some taxable withdrawals. If you hold TIPS in an HSA, your HSA is guaranteed to grow at a rate close to inflation, which makes it unlikely that the HSA will exceed your medical expenses.
This is a good point, but I wonder how much is too much? For someone age 65, what's the expected present value of all future out of pocket medical expenses, including dental, vision, and future medicare premiums (which I think qualify as HSA expenses)?

I'd guess it could easily be $100k or even more.

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Re: HSAs in California

Post by rm »

I am confused about HSA taxation in CA.

I understand I won't get tax deduction so it increases my AGI for CA. I imagine when I get my W2 there will be a seperate code for HSA. When I put in turbo-tax it will automatically deduct from my AGI (For federal) and put as an adjustment for CA. Is that true?

However, how does CA get to know my earnings on the HSA. Say I invest my HSA into a fund. The fund will send a 1099-B. Will it have a seperate code for HSA. Or is it something you just have to fill in your tax forms manually.
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Re: HSAs in California

Post by jpd236 »

rm wrote:I am confused about HSA taxation in CA.

I understand I won't get tax deduction so it increases my AGI for CA. I imagine when I get my W2 there will be a seperate code for HSA. When I put in turbo-tax it will automatically deduct from my AGI (For federal) and put as an adjustment for CA. Is that true?

However, how does CA get to know my earnings on the HSA. Say I invest my HSA into a fund. The fund will send a 1099-B. Will it have a seperate code for HSA. Or is it something you just have to fill in your tax forms manually.
When I did this last year, the contributions were handled correctly. There was a section under CA for manual adjustments which included HSA interest, and I put my interest income there. This year I have dividends as well, so I'm planning on including those. Capital gains would make things more complicated because your ledger could differ from federal to state if you have capital loss to carry over.

I would not expect a 1099-B from the HSA provider for the same reason you don't get them from 401(k)/IRA providers - federally, and in most states, nothing taking place inside the account is taxable, so they have no reason to track it. You'll have to keep track of these things manually and add them together at the end of the year.

(as an aside, note that funds don't send 1099-Bs, brokerages and account custodians do, as far as I know).
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Re: HSAs in California

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rm wrote:I am confused about HSA taxation in CA.

I understand I won't get tax deduction so it increases my AGI for CA. I imagine when I get my W2 there will be a seperate code for HSA. When I put in turbo-tax it will automatically deduct from my AGI (For federal) and put as an adjustment for CA. Is that true?

However, how does CA get to know my earnings on the HSA. Say I invest my HSA into a fund. The fund will send a 1099-B. Will it have a seperate code for HSA. Or is it something you just have to fill in your tax forms manually.
CA doesn't know; you have to make the adjustments manually, as you won't have a 1099 from your HSA as you would from a bank or brokerage account. Similarly, if you sell something in your HSA, you will have a capital gain or loss in CA which is not a federal capital gain or loss.

I needed an override to get TaxAct to handle this in New Jersey last year. TaxAct doesn't support New Jersey interest income which is not reported anywhere on the federal return. The suggested workaround was to create a fake 1099 listing tax-exempt interest, which would then be subject to state tax, but this would have made my federal return incorrect, as tax-exempt interest is reported on the 1040 (and affects some phase-outs even though it is not itself taxable).
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Re: HSAs in California

Post by grabiner »

jpd236 wrote:
grabiner wrote:Therefore, it is better to hold less volatile assets in an HSA which might be too large for your medical expenses, and more volatile assets in an IRA or 401(k), so that you get to keep the full benefit of any gains in the more volatile assets.
That still doesn't mean you should change your allocation just to hold less volatile assets like TIPS in the HSA. Holding TIPS in the HSA only makes sense if you have reason to hold TIPS or a similar investment somewhere, in which case the HSA might be an appropriate home for it. But otherwise, not wanting to exceed medical expenses is no reason to be conservative with the HSA.

Holding less volatile assets with a lower expected return is not optimal if those assets lead you to a less risky asset allocation than you would otherwise be happy with.
I agree with this, which is why I said it as an asset location issue. If you are going to hold TIPS, you should hold them in your HSA, just as if you are going to hold REITs, you should hold them in a tax-deferred account rather than a taxable account.
Also note that simply putting all your bonds in the HSA is likely not optimal as the HSA is a smaller account than other tax-advantaged space, and if stocks tank 50% tomorrow, you won't be able to rebalance from the HSA into your retirement account.
As with other asset location issues, all preferences are relative. If your target TIPS allocation is larger than your HSA, you would hold some TIPS elsewhere; if your TIPS allocation is smaller than your HSA, you would hold something other than TIPS to fill up your HSA. If your target TIPS allocation is equal to your HSA, and then the stock market crashes, you would need to rebalance to a lower dollar allocation to bonds, so you would sell TIPS and buy stock in your HSA. (This can be done at relatively little tax cost, as TIPS don't generate significant capital gains even if your state taxes those gains.)
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Re: HSAs in California

Post by pauperofnorthlake »

I'm relocating from NC to CA in a week. I'm not too happy with my current HSA custodian ($5/mo fee) and am considering a trustee-to-trustee transfer to another HSA custodian. My current HSA balance is all cash (~$2900). If that transaction doesn't take place until after I establish residence in CA, would CA impose any taxes on that transaction?
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Re: HSAs in California

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This thread is now in the Personal Finance (Not Investing) forum.

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Re: HSAs in California

Post by ajcp »

grabiner wrote: Alternatively, you can just invest your HSA in something tax-efficient, and pay the small tax bill. I live in NJ and have all my bonds in my employer plan, so my HSA is invested in a stock ETF. I pay NJ taxes on the dividends, and would pay NJ taxes on any capital gains realized by the ETF (unless I have losses to offset them.)
Why do you do it this way? I've been thinking about this for when I have enough to rollover in January, and it seems like if you don't hold TIPS it's better to hold bonds in the HSA. Dividends are taxed the same for bonds or stocks, so there's no benefit there, and at current rates your dividend income would be about the same for a stock or a bond fund. You'll pay tax on the gains, but can't deduct the losses (unless there's something else to offset obviously). My thought was to put some bonds in the HSA and move the stock to tax differed.
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Re: HSAs in California

Post by BradMajors »

While HSA contributions in California are not tax deductible, HSA WITHDRAWS are tax deductible.
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Re: HSAs in California

Post by Artsdoctor »

^ It's just that when you withdraw from your HSA, you have presumably sold your investment asset for cash. This will more than likely have resulted in a capital gain, and that capital gain is taxable as regular income in CA. Of course, you're always free to move out of state and then when you begin liquidating your investments in your HSA, you'll owe nothing (unless you move to New Jersey!).
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Re: HSAs in California

Post by grabiner »

ajcp wrote:
grabiner wrote: Alternatively, you can just invest your HSA in something tax-efficient, and pay the small tax bill. I live in NJ and have all my bonds in my employer plan, so my HSA is invested in a stock ETF. I pay NJ taxes on the dividends, and would pay NJ taxes on any capital gains realized by the ETF (unless I have losses to offset them.)
Why do you do it this way? I've been thinking about this for when I have enough to rollover in January, and it seems like if you don't hold TIPS it's better to hold bonds in the HSA. Dividends are taxed the same for bonds or stocks, so there's no benefit there, and at current rates your dividend income would be about the same for a stock or a bond fund. You'll pay tax on the gains, but can't deduct the losses (unless there's something else to offset obviously). My thought was to put some bonds in the HSA and move the stock to tax differed.
I no longer live in NJ, so all my unrealized gains are now tax-free. Also, at the time I decided to buy the stocks, bond yields were higher than the yield on the ETF I bought.

And the quality of options in the employer plan is often more important than asset location issues. If the only low-cost option in your 401(k) is an S&P 500 index, then you should hold stocks in your 401(k) even if holding bonds there might be more tax-efficient. If you have an unusually good bond option such as the TSP G fund or TIAA Traditional Annuity, then you should hold bonds in your 401(k).
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Re: HSAs in California

Post by bnes »

For a California resident HSA, if the mutual fund I bought in the HSA has DRIP, do I realize the dividend gain right away, or when the fund is eventually sold?
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Re: HSAs in California

Post by SpaceCowboy »

You'd report the dividend on your CA return in the year that it was received. The gain or loss from the sale of the shares would be reported in the year of the sale.
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Re: HSAs in California

Post by grabiner »

bnes wrote:For a California resident HSA, if the mutual fund I bought in the HSA has DRIP, do I realize the dividend gain right away, or when the fund is eventually sold?
Reinvested dividends (from DRIP for stocks, or just dividends you choose to reinvest in a mutual fund) are treated for tax purposes as if you received the dividend in cash and then immediately used it to buy more shares; the reinvestment is just a convenience. Thus, you pay tax on the dividend in the year paid, but it buys new shares which have their own basis for capital gains.
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Re: HSAs in California

Post by Artsdoctor »

bnes wrote:For a California resident HSA, if the mutual fund I bought in the HSA has DRIP, do I realize the dividend gain right away, or when the fund is eventually sold?
Also, since CA allows carryover losses and taxes capital gains, you'd also have a separate tally going with state versus federal capital gains/losses because your HSA isn't recognized as tax-sheltered by CA.
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Re: HSAs in California

Post by ryman554 »

BradMajors wrote:While HSA contributions in California are not tax deductible, HSA WITHDRAWS are tax deductible.
THIS.

It somewhat takes the sting out of California's rules... especially if you don't pay out of the taxable pocket for medical expenses and use the HSA for what it was (likely) intended for.
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Re: HSAs in California

Post by sunny_socal »

How does one deduct withdrawals?
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Re: HSAs in California

Post by Artsdoctor »

I'm not sure how you'd categorize HSA withdrawals as deductible. CA doesn't recognize HSAs so it's just a taxable account in their eyes. Are you talking about potentially taking medical expenses as a deduction?
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Re: HSAs in California

Post by TimeRunner »

Since I have a CA HSA, and I wanted to move from VEU/VSS into TIP, and do some TLH... there didn't seem to be any way to identify to the broker, TDAmeritrade, specific IDs for ETF lots to capture some losses. I asked their Customer Service and got this reply:

"Since this Self-Directed Brokerage Account (SDBA) is under a tax-exempt status, you are unable to sell specific lots to capture gains or losses. Also, the commission-free ETF program follows the LIFO (Last In First Out) method. "

I thought that was interesting.
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Re: HSAs in California

Post by Artsdoctor »

TimeRunner,

Interesting pick-up. It's possible that you'd still be able to sell specific lots because you'd be able to provide your cost basis register if audited. It sounds as if you won't be getting a 1099 from your HSA (I don't, and I doubt anyone would), so you're on your own regarding keeping track of capital gains and losses. For me, I have tax-loss harvested for state tax reasons in my HSA but I've only sold the entire fund and replaced it with something else, no partial sales.
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Re: HSAs in California

Post by JustinR »

BradMajors wrote:While HSA contributions in California are not tax deductible, HSA WITHDRAWS are tax deductible.
Is this true? How is that done?
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Re: HSAs in California

Post by Artsdoctor »

^ All transactions in an HSA are taxable events. The state doesn't recognize the tax-exempt status so all distributions, capital gains, and capital losses are taxable events. A withdrawal is a non-event because the state didn't recognize the account to begin with.
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Re: HSAs in California

Post by kaneohe »

JustinR wrote:
BradMajors wrote:While HSA contributions in California are not tax deductible, HSA WITHDRAWS are tax deductible.
Is this true? How is that done?
I think the phrase "HSA WITHDRAWS are tax deductible" is misleading. If the withdrawal is for qualified medical expenses, it is not income on the federal return. In this case,since CA uses federal AGI ( which doesn't include the HSA withdrawal) as the starting point, no adjustment is necessary
(so no additional "deduction" or adjustment) on the CA return. As Arts Doctor points out, the HSA is just another taxable account in CA so any sales within the account to provide the withdrawal would be subject to CG taxes in CA (taxed as ordinary income).
Last edited by kaneohe on Fri Dec 11, 2015 12:17 pm, edited 1 time in total.
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Re: HSAs in California

Post by Artsdoctor »

California uses the federal AGI as a starting point. Then, one has to record "adjustments" to the California return. From an HSA perspective, you would add all contributions for the year to your AGI, you would add all distributions to your AGI, and you would add all capital gains to your AGI. Of course, you wouldn't have to add interest from a CA bond or a federal treasury bond, and you can also deduct a capital loss.

A withdrawal from an HSA from a California perspective is a non-event because the state didn't recognize the account as anything but a taxable account to begin with.

The state of California allows carryover losses, so you can TLH in your HSA. If you do so, you'll find that your state carryover loss tally sheet can differ from your federal carryover loss tally sheet.
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Re: HSAs in California

Post by kaneohe »

Artsdoctor wrote:..................................
A withdrawal from an HSA from a California perspective is a non-event because the state didn't recognize the account as anything but a taxable account to begin with.

.............................................
but if the withdrawal from the HSA is not for qualified medical expenses, it is income on the federal return (AGI) and to make it a non-event on the CA return, it must be adjusted (subtracted) out...........
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Re: HSAs in California

Post by Artsdoctor »

If the withdrawal from the HSA is for non-medical expenses, it will affect your FEDERAL return. It will have no bearing on your STATE return. The state doesn't care what you do with the account (the feds do, however).
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Re: HSAs in California

Post by kaneohe »

Artsdoctor wrote:If the withdrawal from the HSA is for non-medical expenses, it will affect your FEDERAL return. It will have no bearing on your STATE return. The state doesn't care what you do with the account (the feds do, however).
but the FED AGI is the starting point for the CA return so if you want the CA return to be correct, you need to remove (adjust)that HSA "income", no?
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Re: HSAs in California

Post by Artsdoctor »

^ Yes. The state form uses the federal AGI as a starting point. However, you make "adjustments" on the state return, both plus and minus.

For example, you have a lot of income from treasuries (remember those days?). You are taxed from a federal income point, but not state. Your federal AGI is used as a starting point for the state income tax form, but you'd enter an adjustment because the treasuries are not taxed by the state.

Your federal and state AGI, then, can vary significantly. Likewise, your running tally of carryover losses from your federal return will start to look very different from your carryover losses on the state return if you've been tax-loss harvesting in your HSA.
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