Are These Expenses Qualified for Tax-Free Distributions? It Depends . . .

Some health-related expenses fall into a (single shade of) gray area when determining whether they're qualified for tax-free withdrawals from a Health Savings Account.

When it comes to Health Savings Accounts, you - the account owner - are master of your domain. You categorize each expense as qualified or non-qualified. But that doesn't mean that you have free rein. At some point, the Internal Revenue Service may have an opportunity to weigh in. And you don't want to have stretched the definition of qualified expenses beyond what the IRS considers valid.

Who Decides?

When you participate in a Health FSA program, the plan administrator determines whether an expense is qualified. That's because withdrawals are permitted only for qualified expenses. The plan itself - and the pre-tax status of every participant's election - could be at risk if the administrator doesn't carefully examine all requests for reimbursement.

But Health Savings Accounts are different. They're not a plan in the sense of falling under the definition of employer-sponsored medical coverage. The law forbids account providers from substantiating withdrawals and doesn't permit employers to require documentation , either. You, the account owner, make the call and report your activity on your personal income tax return. You decide how conservative or aggressive you want to be in reimbursing expenses that fall into the gray area. The Internal Revenue Service reviews your judgments only if it audits your tax return and focuses on your account activity.

Rule of Thumb on Qualified Expenses

In my industry, we refer to Section 213(d) expenses as being qualified. That passage in the federal tax code doesn't provide a list, but it does offer guidance. Let's look at the relevant wording:

213 (d) Definitions

For purposes of this section—

(1) The term “medical care” means amounts paid—

(A) for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body. . .

That's a broad definition. From it, I glean that any service covered by your medical plan is qualified for reimbursement. And I interpret it to mean that cosmetic services - like a tummy tuck, removal of crow's feet, or breast augmentation for vanity's sake fall outside that definition.

But there are some services that legitimately fall into a gray area - they may or may not be qualified, depending on circumstances. Let's examine some.

Vitamins

Products and services that maintain general health aren't qualified. Your multivitamin doesn't qualify. Nor does your calcium supplement if you're asymptomatic and boosting your calcium intake to prevent the natural loss of bone density with age.

But some vitamins meet the definition of qualified expenses. One example is pre-natal vitamins. Another is vitamin B-12 for a patient who has undergone a gastric bypass or gastric sleeve procedure. In these procedures, most of the stomach (and in the case of bypass, part of the small intestine) are removed, which limits the organ surface to absorb vitamins and minerals from small quantities of food consumed. Calcium supplements may be qualified if you're diagnosed with osteoporosis (as opposed to trying to forestall onset).

Massage

Another interesting topic. First, to burst your bubble, a weekend trip to the spa for a mud bath and relaxing massage administered by the hunky pool boy is not a qualified expense. Sorry.

But massage may be qualified if prescribed by a doctor as, say, an alternative to traditional physical therapy for recovery from an injury or condition. That massage would be medical - stimulating blood flow to certain issue to promote healing - and wouldn't involve cucumber slices over your eyes.

Weight Loss

Last week, a Health Savings Account owner asked me whether a weight-loss program can be reimbursed tax-free from her account. She's been thinking about this topic for some time, and the other day she passed a new place on her way to work.

This one's tricky. If your goal is to lose 20 pounds before attending a class reunion or family wedding, you can't reimburse the cost of a formal weight-loss program. That's purely cosmetic.

On the other hand, if your doctor diagnoses an illness or condition (morbid obesity, diabetes), certain aspects of the treatment plan may be a qualified expense. Foods are never a qualified expense, but certain medical and nutritional counseling may qualify.

Gym

Membership dues to a gym may or may not be qualified. Generally, they're not. And you can see a common theme here: The federal tax code doesn't give preferential treatment for activity that maintains good health (think back to our vitamin discussion above), but once you become sick (often because you didn't engage in the activities that maintain good health), services to restore your health are often qualified.

If you go to the gym to build strength, engage in cardio activity, and improve your flexibility, you can't reimburse your membership dues tax-free. On the other hand, if your doctor prescribes a physical regimen in which you must engage to treat a specific condition, and she monitors your activity and measures your progress, that plan might pass muster and the membership dues may be qualified. But that's true only if you were not attending a health club prior to the diagnosis and treatment. If you were already a member of that (or any) fitness facility, you incur no additional cost to engage in the prescribed program.

The typical diagnosis would be morbid obesity, with a prescribed cardio routine. But that may not be the only diagnosis. Years ago, I also saw a Health FSA participant successfully document a regimen of weightlifting to strengthen bones after a diagnosis of osteoporosis. His doctor practiced Eastern medicine and believed in strength training rather than calcium supplements and prescription drugs to increase bone density.

Personal Trainer

The rule of thumb is that a personal trainer's fee isn't a qualified expense. I'm going to defy convention and believe that mine is. After my spinal-fusion surgery, my doctor told me that I needed to strengthen my core to reduce pressure on my lower back. He suggested either physical therapy or a personal trainer. He mentioned that many of his patients have done well with personal trainers.

So, I headed to my health club and engaged the services of a trainer. The monthly membership dues weren't a qualified expense because I was already a member. But the trainer is working with me specifically to strengthen my core - not to turn my triceps into guns or help me prepare for a 10K road race. Because the training is focused on (per above) "treatment . . . for the purpose of affecting any structure or function of the body.," I believe that this service is qualified and that the $193 monthly fee for three months is eligible for tax-free distribution from my Health Savings Account. So, I'll retain the doctor's written order to strengthen my core and the trainer's contract in my tax files.

I won't know whether my judgment is right for years - if ever. I'm a Health Savings Account saver. I retain receipts for qualified expenses, but I don't reimburse these expenses now. Instead, I keep the paperwork in case I want to make a withdrawal later in life for a non-qualified expense. Then, I can match documentation for qualified expenses that weren't reimbursed with the non-qualified expense so that I can report on that year's tax return that the withdrawal was for qualified expenses.

The Bottom Line

Health FSA participants don't live with the uncertainty of whether their judgments are correct. The plan administrator determines whether an expense is qualified or not during the plan year. But Health Savings Accounts don't have a requirement for immediate substantiation. You, the account owner, must determine whether an expense is qualified.

I counsel people to be conservative. You don't want to face taxes, interest, and fines if the IRS reviews our activity during an audit and determines that some expenses weren't qualified. So, err on the side of caution. You'll probably never accumulate sufficient balances in your account to reimburse tax-free all the obviously qualified expenses that you incur on or after the date that you establish your Health Savings Account. Better to reimburse certain qualified expenses than risk having the IRS disagree with your view.

I'm director of strategy and compliance at Benefit Strategies, LLC, an administrator of Health Savings Accounts and reimbursement accounts. You can read and subscribe to my Health Savings Account GPS blog here and read my weekly HSA Monday Mythbuster and HSA Wednesday Wisdom columns and occasional Healthcare Update column published on LinkedIn. My book, HSAs: The Tax-Perfect Retirement Account, is the definitive guide to navigating the intersection of Health Savings Accounts, retirement planning, and Medicare. It's available in paperback and e-book at Amazon.

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