Question

While you are reviewing Patrick's employer's contributions to his Health Savings Account with him, he asks you how the contributions affect his taxes. You should advise him that HSA contributions are

a) Excluded from corporate tax calculations.
b) Not included in the individual taxable income.
c) Taxed at the same rate as the Social Security tax rate.
d) Taxed at the personal income tax rate.

Answer 1

Employer contributions to an individual's Health Savings Account (HSA) are not included in the individual's taxable income and are excluded from payroll taxes. HSAs offer a triple tax advantage, and unlike the regressive Social Security tax, do not tax the contributions, providing significant tax benefits to the individual.

Step-by-step explanation:

When reviewing an employer's contributions to a Health Savings Account (HSA), it's important to understand how these contributions affect an individual's taxes. Employer contributions to an HSA are not included in the individual's taxable income. This means that the money contributed by the employer to the HSA does not count as income to the employee and therefore is not subject to federal income tax. Furthermore, these contributions are also excluded from payroll taxes, which include Social Security and Medicare taxes.

The main benefit of HSA contributions is that they provide a triple tax advantage: contributions are made with pre-tax dollars, the funds grow tax-free, and withdrawals used for qualified medical expenses are not taxed. Unlike contributions to HSAs, self-employed individuals and sole proprietors who do not have HSAs but instead pay taxes on income earned from their business, will face different tax liabilities. They are required to pay individual income taxes on their profits and also cover the entirety of their payroll taxes for Social Security and Medicare, since they do not have an employer to share these costs. The payroll taxes for employees are split between the employer and employee, but for the self-employed, the IRS views them as both employer and employee, necessitating the payment of both halves, known as the self-employment tax.

It is worthwhile noting that the social security tax is considered regressive, as it is imposed only on income below a certain threshold, which for current purposes is $113,000. This means lower income earners pay a greater proportion of their income in social security tax compared to higher income earners. In contrast, an HSA contribution by an employer does not contribute to this regressive nature since it's excluded from taxable income and not considered for Social Security tax calculations.