Unequal tax treatment of HSAs and 529s

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nps
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Unequal tax treatment of HSAs and 529s

Post by nps » Sun Aug 19, 2018 10:27 am

As far as I can tell, while IRS does not appear to directly address the tax exclusion of distributions from either 529 plans or HSAs for qualified prior year expenses, most web articles and posts here seem to indicate that taxpayers are ok to exclude this type of income for HSAs but not 529 plans. Is there any rationale for this difference in assumption?

Also welcome any correction to my view that this is not definitively addressed, or that the prevailing wisdom differs between the two types of plans.

runner3081
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Re: Unequal tax treatment of HSAs and 529s

Post by runner3081 » Sun Aug 19, 2018 10:47 am

Not sure if there have been changes since 2016, but this article is a good one.

""If I use money from other sources to pay for my student's college costs incurred this year, but save the receipts and reimburse myself many years later by taking a 529 withdrawal, would that withdrawal still be tax-free?"

The answer is, it's not entirely clear. Surprisingly, the actual tax rules contained in section 529 and IRS Publication 970 don't spell out that the timing of expenses and distributions must match up in the same tax year. The IRS hasn't specifically said yes or no to that issue. But it approached the topic when it published Announcement 2008-17 in January 2008, which stated in part:

"Section 529 is silent regarding whether distributions must be made from a section 529 account in the same tax year as QHEEs (qualified higher education expenses) were paid or incurred. Concerns have been raised that individuals could allow the account to grow indefinitely on a tax-deferred basis before requesting reimbursement or use distributions in earlier years to pay QHEEs in later years."

The IRS and Treasury Department are now proposing to develop a new rule permitting recipients of 529 plan distributions to count only those qualifying expenses paid during the same calendar year as the distribution, plus expenses paid within the first three months of the following year. But that rule has yet to be implemented."

https://www.cbsnews.com/news/the-tricky ... thdrawals/

letsgobobby
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Re: Unequal tax treatment of HSAs and 529s

Post by letsgobobby » Sun Aug 19, 2018 10:52 am

Fascinating question. Has it never really been addressed definitively?

Dottie57
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Re: Unequal tax treatment of HSAs and 529s

Post by Dottie57 » Sun Aug 19, 2018 11:03 am

nps wrote:
Sun Aug 19, 2018 10:27 am
As far as I can tell, while IRS does not appear to directly address the tax exclusion of distributions from either 529 plans or HSAs for qualified prior year expenses, most web articles and posts here seem to indicate that taxpayers are ok to exclude this type of income for HSAs but not 529 plans. Is there any rationale for this difference in assumption?

Also welcome any correction to my view that this is not definitively addressed, or that the prevailing wisdom differs between the two types of plans.
I have always been told from first day available to me that receipts need to be kept and matched against distributions from an HSA. The year of the distribution did not matter.

For 529s - no knowledge. I thought the rules were baked into the law that created the type of fund.

47Percent
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Re: Unequal tax treatment of HSAs and 529s

Post by 47Percent » Sun Aug 19, 2018 11:53 am

On a related topic, does anyone know how many years can they go back in an audit looking into the HSA expenses?

about 8 years ago I matched up the withdrawal against accumulated prior years expenses. It was all clear to me then. But now I can't find the documentation or the receipts. May be I can reconstruct the receipts for 90% of those because most of it was related to one incident.

After that, I have only withdrawn a couple of times, all for then current year's expenses,and kept the documentation/receipts.

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camillus
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Re: Unequal tax treatment of HSAs and 529s

Post by camillus » Sun Aug 19, 2018 12:01 pm

Conversely, wouldn't it be interesting if at some future date the IRS moved the rules of HSA distributions closer to that of 529s, that is, mandating that qualified withdrawals happen in the same year as the expense. You have to admit, allowing people to hoard receipts for years and years for a later qualified withdrawal to buy a boat doesn't make a great deal of sense!

(Just commenting on the different tax treatment. No excess speculation intended.)

nps
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Re: Unequal tax treatment of HSAs and 529s

Post by nps » Sun Aug 19, 2018 6:02 pm

runner3081 wrote:
Sun Aug 19, 2018 10:47 am
Not sure if there have been changes since 2016, but this article is a good one.

""If I use money from other sources to pay for my student's college costs incurred this year, but save the receipts and reimburse myself many years later by taking a 529 withdrawal, would that withdrawal still be tax-free?"

The answer is, it's not entirely clear. Surprisingly, the actual tax rules contained in section 529 and IRS Publication 970 don't spell out that the timing of expenses and distributions must match up in the same tax year. The IRS hasn't specifically said yes or no to that issue. But it approached the topic when it published Announcement 2008-17 in January 2008, which stated in part:

"Section 529 is silent regarding whether distributions must be made from a section 529 account in the same tax year as QHEEs (qualified higher education expenses) were paid or incurred. Concerns have been raised that individuals could allow the account to grow indefinitely on a tax-deferred basis before requesting reimbursement or use distributions in earlier years to pay QHEEs in later years."

The IRS and Treasury Department are now proposing to develop a new rule permitting recipients of 529 plan distributions to count only those qualifying expenses paid during the same calendar year as the distribution, plus expenses paid within the first three months of the following year. But that rule has yet to be implemented."

https://www.cbsnews.com/news/the-tricky ... thdrawals/
Thanks, maybe that's a source of the belief that this is potentially not ok for 529 distributions. Interesting though that the rule was proposed ten years ago and still does not exist.

runner3081
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Re: Unequal tax treatment of HSAs and 529s

Post by runner3081 » Sun Aug 19, 2018 8:37 pm

camillus wrote:
Sun Aug 19, 2018 12:01 pm
Conversely, wouldn't it be interesting if at some future date the IRS moved the rules of HSA distributions closer to that of 529s, that is, mandating that qualified withdrawals happen in the same year as the expense.
But that doesn't even appear to be the case for a 529.

nps
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Re: Unequal tax treatment of HSAs and 529s

Post by nps » Mon Aug 20, 2018 6:44 pm

runner3081 wrote:
Sun Aug 19, 2018 8:37 pm
camillus wrote:
Sun Aug 19, 2018 12:01 pm
Conversely, wouldn't it be interesting if at some future date the IRS moved the rules of HSA distributions closer to that of 529s, that is, mandating that qualified withdrawals happen in the same year as the expense.
But that doesn't even appear to be the case for a 529.
The argument I have most commonly seen is that this is assumed for 529s due to cash basis accounting. Again even if true, not sure how HSAs would be different.

Spirit Rider
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Re: Unequal tax treatment of HSAs and 529s

Post by Spirit Rider » Mon Aug 20, 2018 11:57 pm

nps wrote:
Sun Aug 19, 2018 10:27 am
As far as I can tell, while IRS does not appear to directly address the tax exclusion of distributions from either 529 plans or HSAs for qualified prior year expenses, most web articles and posts here seem to indicate that taxpayers are ok to exclude this type of income for HSAs but not 529 plans. Is there any rationale for this difference in assumption?

Also welcome any correction to my view that this is not definitively addressed, or that the prevailing wisdom differs between the two types of plans.
From IRS Notice 2004-50 Q&A 39. Deferred distributions for expenses incurred in prior years. This IRS notice from the very first year of HSA accounts is very definitive.

Q-39. When must a distribution from an HSA be taken to pay or reimburse, on a tax free basis, qualified medical expenses incurred in the current year?
A-39. An account beneficiary may defer to later taxable years distributions from HSAs to pay or reimburse qualified medical expenses incurred in the current year as long as the expenses were incurred after the HSA was established. Similarly, a distribution from an HSA in the current year can be used to pay or reimburse expenses incurred in any prior year as long as the expenses were incurred after the HSA was established. Thus, there is no time limit on when the distribution must occur. However, to be excludable from the account beneficiary’s gross income, he or she must keep records sufficient to later show that the distributions were exclusively to pay or reimburse qualified medical expenses, that the qualified medical expenses have not been previously paid or reimbursed from another source and that the medical expenses have not been taken as an itemized deduction in any prior taxable year.


From IRS Publication 970, Figuring the Taxable Portion of a Distribution. While this statement is less definitive, the examples show distributions and expenses only in the same year.

To determine if total distributions for the year are more or less than the amount of qualified education expenses, you must compare the total of all QTP distributions for the tax year to the adjusted qualified education expenses.

nps
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Re: Unequal tax treatment of HSAs and 529s

Post by nps » Tue Aug 21, 2018 5:49 am

Spirit Rider wrote:
Mon Aug 20, 2018 11:57 pm
nps wrote:
Sun Aug 19, 2018 10:27 am
As far as I can tell, while IRS does not appear to directly address the tax exclusion of distributions from either 529 plans or HSAs for qualified prior year expenses, most web articles and posts here seem to indicate that taxpayers are ok to exclude this type of income for HSAs but not 529 plans. Is there any rationale for this difference in assumption?

Also welcome any correction to my view that this is not definitively addressed, or that the prevailing wisdom differs between the two types of plans.
From IRS Notice 2004-50 Q&A 39. Deferred distributions for expenses incurred in prior years. This IRS notice from the very first year of HSA accounts is very definitive.

Q-39. When must a distribution from an HSA be taken to pay or reimburse, on a tax free basis, qualified medical expenses incurred in the current year?
A-39. An account beneficiary may defer to later taxable years distributions from HSAs to pay or reimburse qualified medical expenses incurred in the current year as long as the expenses were incurred after the HSA was established. Similarly, a distribution from an HSA in the current year can be used to pay or reimburse expenses incurred in any prior year as long as the expenses were incurred after the HSA was established. Thus, there is no time limit on when the distribution must occur. However, to be excludable from the account beneficiary’s gross income, he or she must keep records sufficient to later show that the distributions were exclusively to pay or reimburse qualified medical expenses, that the qualified medical expenses have not been previously paid or reimbursed from another source and that the medical expenses have not been taken as an itemized deduction in any prior taxable year.


From IRS Publication 970, Figuring the Taxable Portion of a Distribution. While this statement is less definitive, the examples show distributions and expenses only in the same year.

To determine if total distributions for the year are more or less than the amount of qualified education expenses, you must compare the total of all QTP distributions for the tax year to the adjusted qualified education expenses.
Thanks! I've referred to that Q&A before and must have missed or forgotten that portion. You're correct, that's very specific. Other areas of the tax code dealing with various deductions are very specific about current year expenses being deductible only in that year. All l I have found for 529s is the same publication language you have.

Spirit Rider
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Re: Unequal tax treatment of HSAs and 529s

Post by Spirit Rider » Tue Aug 21, 2018 8:35 am

nps wrote:
Tue Aug 21, 2018 5:49 am
Thanks! I've referred to that Q&A before and must have missed or forgotten that portion. You're correct, that's very specific. Other areas of the tax code dealing with various deductions are very specific about current year expenses being deductible only in that year. All l I have found for 529s is the same publication language you have.
Then there is the practical reality. From personal experience and anecdotal reports on BH. If your 1099-Q is significantly higher than the beneficiary's 1098-T. You will receive a CP-2000 letter from the IRS assessing income tax and penalties on the difference.

The IRS then requires you to prove that all the 1099-Q distributions were for qualified educational expenses of that year. I have been through this twice. First, because of a refund from the school. Second, because the COA allowance for off-campus housing, computer, internet and books were > $10K.

I think it is highly likely that a 1099-Q with no corresponding 1098-T will automatically generate an IRS CP-2000 letter.

lstone19
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Re: Unequal tax treatment of HSAs and 529s

Post by lstone19 » Tue Aug 21, 2018 11:03 am

Spirit Rider wrote:
Tue Aug 21, 2018 8:35 am
Then there is the practical reality. From personal experience and anecdotal reports on BH. If your 1099-Q is significantly higher than the beneficiary's 1098-T. You will receive a CP-2000 letter from the IRS assessing income tax and penalties on the difference.

The IRS then requires you to prove that all the 1099-Q distributions were for qualified educational expenses of that year. I have been through this twice. First, because of a refund from the school. Second, because the COA allowance for off-campus housing, computer, internet and books were > $10K.

I think it is highly likely that a 1099-Q with no corresponding 1098-T will automatically generate an IRS CP-2000 letter.
Our experience has been the exact opposite. Never a CP-2000 despite 1099-Q distributions larger than 1098-T or in one year, no 1098-T (a weird interaction between 1098-T reporting tuition billed in one year vs. that tuition being paid by a university provided scholarship the next year and his Fall tuition (paid with 529 funds) being less than the scholarship amount used for Spring). But a difference for us with income too high for any credits, all 529 distributions were made to our son rather than us so he received the 1099-Q, not us.

nps
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Re: Unequal tax treatment of HSAs and 529s

Post by nps » Tue Aug 21, 2018 11:32 am

Spirit Rider wrote:
Tue Aug 21, 2018 8:35 am
The IRS then requires you to prove that all the 1099-Q distributions were for qualified educational expenses of that year.
That would be very strong evidence indeed. So you're saying their letter requested proof not only that you had sufficient QEEs, but that they were incurred in the year of QTP distribution? Or did they only ask for the dates associated with the expenses?

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