HSA Reimbursement: What It Means for Employers

What it means in practice

What counts as an HSA reimbursement. The health savings account (HSA) entry covers eligibility and contributions; this entry covers how money comes out. Under Publication 969, the account holder pays medical bills the HDHP does not cover and asks the HSA trustee for a distribution, or the HSA pays a provider directly. Debit card payments and withdrawals by people the account holder has designated are distributions too (see also Notice 2008-59, Q&A-28). Withdrawals are not required each year, and tax-free distributions remain available after the person can no longer contribute, for example after enrolling in Medicare (Notice 2004-2, Q&A-28).

What counts as a qualified medical expense. Section 223(d)(2) defines qualified medical expenses as amounts paid for "medical care" as defined in section 213(d), to the extent not compensated for by insurance or otherwise. Publication 502 describes medical care as the costs of diagnosis, cure, mitigation, treatment or prevention of disease, or of affecting a part or function of the body, and says it must be primarily to alleviate or prevent a physical or mental disability or illness, not merely beneficial to general health. Items it lists as not qualifying include most cosmetic surgery, health club dues, teeth whitening, funeral expenses, and supplements not recommended for a diagnosed condition. Two HSA differences from the itemized deduction: the draft 2026 Form 8889 instructions note that Public Law 116-136 (2020) removed the prescription requirement for medicines, and section 223(d)(2) treats menstrual care products as medical care.

Whose expenses count. According to Publication 969 and the Form 8889 instructions, an HSA can pay qualified medical expenses for the account holder, the account holder's spouse, and all dependents claimed on the return. It can also pay for some people who could have been claimed but for a joint return or their gross income. A child of parents who are divorced, separated or living apart for the last 6 months of the year is treated as the dependent of both parents. Notice 2004-50 (Q&A-36) says the spouse and dependents do not have to be HSA-eligible or covered by the HDHP. If both spouses have HSAs, either account may pay the other spouse's expenses, but both accounts may not reimburse the same expense (Q&A-38).

The establishment date. Expenses incurred before the HSA is established are not qualified medical expenses, even if the last-month rule treats the person as eligible for the whole year (Publication 969). Notice 2008-59 (Q&A-38 and Q&A-39) explains that state trust law decides when an HSA is established. Most states require funding first, and a trustee may not use an earlier date, such as when HDHP coverage began. An HSA funded by a rollover or transfer from another HSA or an Archer MSA keeps the earlier account's establishment date (Q&A-40). A later HSA is also treated as established on the first account's date if the person had an HSA with a balance above zero at any time in the 18 months before the later account was opened (Q&A-41).

No deadline to reimburse. Notice 2004-50 (Q&A-39) states that there is no time limit on when the distribution must occur. A distribution this year can reimburse an expense from any earlier year, and the account holder can wait until a later year to reimburse a current expense, provided the expense was incurred after the HSA was established. The condition is recordkeeping. Publication 969 says the account holder must keep records sufficient to show that the distributions were exclusively to pay or reimburse qualified medical expenses, that those expenses had not been paid or reimbursed from another source, and that they had not been taken as an itemized deduction in any year. The records are kept with the person's tax records, not sent with the return.

Premiums that qualify. Section 223(d)(2)(B) bars buying insurance with HSA funds, and section 223(d)(2)(C) lists the exceptions: federally required continuation coverage such as COBRA; coverage while receiving unemployment compensation under federal or state law (both also for a spouse or dependent, Notice 2008-59, Q&A-31 and Q&A-32); qualified long-term care insurance; and, once the account holder is 65, health insurance other than Medigap. The age-65 exception includes Medicare Parts A, B and D and the employee share of employer or retiree coverage (Notice 2004-2, Q&A-27; Notice 2008-59, Q&A-29). It turns on the account holder's age, so a 65-year-old spouse's Medicare premiums generally do not qualify if the account holder is under 65 (Notice 2008-59, Q&A-30). Long-term care premiums count only up to the section 213(d)(10) age limits (Notice 2004-50, Q&A-41), which Rev. Proc. 2025-32 sets for 2026 at $500 (age 40 or less), $930 (41 to 50), $1,860 (51 to 60), $4,960 (61 to 70) and $6,200 (over 70).

Direct primary care from 2026. Section 71308 of Public Law 119-21 added direct primary care service arrangements to the section 223(d)(2)(C) exceptions for months beginning after December 31, 2025. IRS Notice 2026-5 describes these as arrangements providing only primary care services from primary care practitioners for a fixed periodic fee, excluding procedures needing general anesthesia, prescription drugs other than vaccines, and lab services not typical of an ambulatory primary care setting. For reimbursement there is no dollar cap on the fee, although fees above $150 a month ($300 if the arrangement covers more than one person) bar contributions while enrolled (A-20). The fee can be treated as incurred monthly, at the start of the coverage period, or when paid (A-19). Fees the employer pays, including through cafeteria plan salary reduction, cannot be reimbursed from the HSA (A-18).

Distributions that are not qualified. Under section 223(f), an amount not used exclusively for qualified medical expenses is included in gross income and generally increases tax by 20% of that amount. The additional tax does not apply after the account holder becomes disabled (section 72(m)(7)), dies, or reaches 65. Publication 969 adds deemed distributions: a prohibited transaction, such as borrowing from the HSA, ends the account's HSA status as of January 1 of that year, and any part pledged as security for a loan is treated as distributed. Trustee administration fees are not distributions (Notice 2004-50, Q&A-69).

Returning a mistaken distribution. Notice 2004-50 (Q&A-37) allows repayment where there is clear and convincing evidence of a mistake of fact due to reasonable cause, such as reasonably but wrongly believing an expense qualified. The 2026 Form 1099-SA instructions require repayment by the return due date (not counting extensions) following the first year the account holder knew or should have known of the mistake. The distribution is then not taxed, no additional tax applies, and the repayment is not a contribution. Trustees may refuse such repayments; if they accept them, they may rely on the account holder's statement (Q&A-76). The Form 8889 instructions call this relief "very limited and unusual."

Reporting: Form 1099-SA and Form 8889. The trustee files Form 1099-SA: box 1 shows the gross distribution, and the trustee "is not required to determine the taxable amount." Box 3 codes include 1 for normal distributions (including direct payments to a provider), 2 for excess contributions, 3 for disability, 4 and 6 after death, and 5 for a prohibited transaction. The account holder completes Form 8889, Part II: total distributions on line 14a, qualified medical expenses paid on line 15, and any taxable amount and 20% additional tax on lines 16 and 17b. Form 8889 must be filed whenever the HSA made a distribution, even with no taxable income.

The employer's limited role. Notice 2004-2 (Q&A-29 and Q&A-30) states that HSA trustees, and employers that contribute, are not required to determine whether distributions are used for qualified medical expenses; individuals make that call and keep the records. That differs from a health reimbursement arrangement (HRA) or health FSA, where Notice 2006-69 sets substantiation methods the employer plan must use; the HSA exclusion comes from section 223, not section 105(b) (Notice 2004-50, Q&A-83). The Department of Labor's EBSA said in Field Assistance Bulletin 2004-01 that HSAs generally are not ERISA plans where employer involvement is limited, including that the employer does not "impose conditions on utilization of HSA funds beyond those permitted under the Code." Notice 2008-59 (Q&A-27) allows a health-care-only debit card only if funds are otherwise readily available, such as by online transfer, ATM or check, and employers must tell employees about that access. In benefits administration materials, that usually means explaining that the employee decides what qualifies and keeps the receipts.

Worked example: delayed reimbursement (illustration). An employee's HDHP coverage starts January 1, 2025, but under state law the HSA is established when first funded, on March 3, 2025. A February 2025 urgent care bill is not a qualified medical expense, because it came before the establishment date. A $1,200 dental bill paid out of pocket in July 2025 can be reimbursed tax-free in 2027, or later, if the employee kept the receipt and the expense was not reimbursed elsewhere or deducted.

Worked example: non-qualified withdrawal (illustration). In 2026, a 50-year-old takes $500 from an HSA for a non-medical purchase. The $500 is included in income and the additional tax is $100 (20% of $500). If the same withdrawal were made at age 66, the $500 would still be included in income, but the 20% additional tax would not apply.

Worked example: long-term care premium (illustration). In 2026, a 45-year-old pays $1,500 in premiums for a qualified long-term care insurance contract. The 2026 limit for ages over 40 through 50 is $930, so the HSA can reimburse up to $930 tax-free. If the HSA also reimburses the other $570, Notice 2004-50 (Q&A-41) treats that amount as not for qualified medical expenses: it is included in income and may be subject to the additional tax.

Where states differ. Federal treatment of HSA distributions does not automatically carry over to state income tax. As one example, the Pennsylvania Department of Revenue's Personal Income Tax Guide states that a distribution from a health or medical savings account that is included in federal taxable income is taxed as interest income for Pennsylvania personal income tax purposes. Other states were not reviewed here (the HSA entry covers California), so check your state tax agency.

Question: Can an HSA pay for a spouse who is not on the HDHP? Yes. Notice 2004-50 (Q&A-36) says distributions for a spouse's or dependent's qualified medical expenses are excluded regardless of their own coverage, unless another plan has already reimbursed the expense.

Question: Can a former employee use the HSA to pay COBRA premiums? Yes. Continuation coverage required under federal law is an exception in section 223(d)(2)(C)(i), and Notice 2008-59 (Q&A-31) extends it to coverage for a spouse or dependent.

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