Publication 969
Medical Savings Accounts (MSAs)

Including: Archer MSAs; Medicare+Choice MSAs

For use in preparing 2002 Returns

Important Change

Medical savings accounts program extended.   The pilot program for MSAs was scheduled to end December 31, 2002, but has been extended until December 31, 2003.

Important Reminder

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Introduction

This publication explains Archer MSAs and introduces Medicare+Choice MSAs. Archer MSAs were created to help self-employed individuals and employees of certain small employers meet the medical care costs of the account holder, the account holder's spouse, or the account holder's dependent(s).

A Medicare+Choice MSA is an Archer MSA designated by Medicare to be used solely to pay the qualified medical expenses of the account holder who is eligible for Medicare. No Medicare+Choice MSAs have been established as of the revision date of this publication.

Archer MSAs and Medicare+Choice MSAs are pilot projects scheduled to end December 31, 2003.

You do not need IRS approval to start your Archer MSA. Complete Form 8853, Archer MSAs and Long-Term Care Insurance Contracts, and attach it to your Form 1040 each year you (or your spouse if you file jointly) have Archer MSA contributions or distributions.

If you have an Archer MSA, you must file Form 1040 to report contributions, your deduction, and distributions. You cannot file Form 1040A or Form 1040EZ.

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Archer MSAs

An Archer MSA is a tax-exempt trust or custodial account that you set up with a U.S. financial institution (like a bank or an insurance company) in which you can save money exclusively for future medical expenses. This account must be used in conjunction with a high deductible health plan (HDHP). See High deductible health plan (HDHP), later.

What are the benefits of an Archer MSA?   You may enjoy several benefits from having an Archer MSA.

• The interest or other earnings on the assets in your Archer MSA are tax free.
• You can claim a tax deduction for contributions you make even if you do not itemize your deductions on Form 1040.
• The contributions remain in your Archer MSA from year to year until you use them.
• An Archer MSA is portable so it stays with you if you change employers or leave the work force.

Qualifying for an Archer MSA

To qualify for an Archer MSA, you must be either of the following.

• An employee (or the spouse of an employee) of a small employer. The employer must maintain an individual or family high deductible health plan (HDHP), defined later, for you (or your spouse).
• A self-employed person (or the spouse of a self-employed person) who maintains an individual or family HDHP.

You can have no other health insurance or Medicare coverage except what is permitted under Other health insurance, later. You must be an eligible individual on the first day of a given month to get an Archer MSA deduction for that month.

If another taxpayer is entitled to claim an exemption for you, you cannot claim a deduction for an Archer MSA contribution. This is true even if the other person does not actually claim your exemption.

Small employer.   A small employer is generally an employer who had an average of 50 or fewer employees during either of the last 2 calendar years. The definition of small employer is modified for new employers and growing employers.

New employer.   A new employer is also considered a small employer for Archer MSAs if he or she reasonably expects to employ 50 or fewer people this year.

Growing employer.   A small employer may begin HDHPs and Archer MSAs for his or her employees and then grow beyond 50 employees. The employer will continue to meet the requirement for small employers if he or she:

• Had 50 or fewer employees when the Archer MSAs began,
• Made a contribution that was excludable or deductible as an Archer MSA for the last year he or she had 50 or fewer employees, and
• Had an average of 200 or fewer employees each year after 1996.

High deductible health plan (HDHP).   To be eligible for an Archer MSA, you must have an HDHP. If you are an employee, the plan must be through your small employer. You generally cannot have another health insurance plan.

Definition.   An HDHP has:

1. A higher annual deductible than typical health plans, and
2. A maximum limit on the annual out-of-pocket medical expenses that you must pay for covered expenses.

Limits.   The following tables show the limits for annual deductibles and the maximum out-of-pocket expenses for high deductible health plans for 2002 and 2003.

Family plans that do not meet the high deductible rules.   There are some family plans that have deductibles for both the family as a whole and for individual family members. Under these plans, if you meet the individual deductible for one family member, you do not have to meet the higher annual deductible amount for the family. If either the deductible for the family as a whole or the deductible for an individual family member is below the minimum annual deductible for that year, the plan does not qualify as an HDHP.

Example.   Mr. Wilber has health insurance with company A in 2002. The annual deductible for the family plan is $4,500. This plan also has an individual deductible of $1,800 for each family member. Mr. Wilber's wife had $2,200 of covered medical expenses. They had no other medical expenses for 2002. The plan paid $400 to Mr. Wilber because Mrs. Wilber met the individual deductible of $1,800, even though the Wilbers did not meet the $4,500 annual deductible for the family plan. The plan does not qualify as an HDHP.

Other health insurance.   You (or your spouse if you file jointly) generally cannot have any other health plan that is not an HDHP. However, this rule does not apply if the other health plan(s) only covers the following items.

1. Accidents.
2. Disability.
3. Dental care.
4. Vision care.
5. Long-term care.
6. Benefits related to workers' compensation laws, tort liabilities, or ownership or use of property.
7. A specific disease or illness.
8. A fixed amount per day (or other period) of hospitalization.

Setting Up an Archer MSA

When you set up an Archer MSA, you will need to work with a trustee and know the rules for contributing and withdrawing money from the account.

Who can be a trustee for an Archer MSA?   The person or business with whom you set up your Archer MSA is called a trustee. A trustee can be a bank, insurance company, or anyone already approved by the IRS to be a trustee of individual retirement arrangements. Your employer may already have some information on Archer MSA trustees in your area.

Who can contribute to my Archer MSA?   Your employer may decide to make contributions to an Archer MSA for you. You do not pay tax on these contributions.

If your employer does not make contributions to your Archer MSA, you can make your own contributions to your Archer MSA and deduct these amounts on your tax return without having to itemize your deductions on Schedule A. Both you and your employer cannot make contributions to your Archer MSA in the same year. You do not have to make contributions to your Archer MSA every year.

There are limits to the amounts that can be contributed to your Archer MSA. See Making Contributions, later.

If your spouse is covered by your HDHP and an excludable amount is contributed by your spouse (or your spouse's employer) to an Archer MSA belonging to your spouse, you cannot make contributions to your own Archer MSA that year.

Changing employers.   If you change employers and still meet the rules for having an Archer MSA, you can continue to use that Archer MSA. However, you may not make additional contributions unless you are otherwise eligible.

When can I make withdrawals from my Archer MSA?   You can make tax-free withdrawals from your Archer MSA to pay for qualified medical expenses (discussed later). If you make withdrawals for other reasons, the amount you withdraw will be subject to income tax and may be subject to an excise tax as well. See Receiving Distributions, later. You do not have to make withdrawals from your Archer MSA each year.

Making Contributions

There are two limits on the amount you or your employer can contribute to your Archer MSA.

1. A limit based on the annual deductible of your HDHP.
2. An income limit based on your:
   1. Wages or compensation if you are an employee, or
   2. Net self-employment income if you are self-employed.

Annual deductible limit.   You can contribute up to 75% of the amount of your annual health plan deductible (65% if you have a self-only plan) to your Archer MSA. You must have the insurance all year to contribute the full amount.

For each full month you did not have an HDHP, you must reduce the amount you can contribute by one-twelfth.

Example 1.   You have an HDHP for your family all year in 2002. The annual deductible is $4,000. You can contribute up to $3,000 ($4,000 × 75%) to your Archer MSA for the year.

Example 2.   You have an HDHP for your family for the entire months of July through December, 2002 (6 months). The annual deductible is $4,000. You can contribute up to $1,500 ($4,000 × 75% ÷ 12 months × 6 months) to your Archer MSA for the year.

If you and your spouse each have a family plan, you are treated as having family coverage with the lower annual deductible of the two health plans. The contribution limit is split equally between you unless you agree on a different division.

Medicare eligible individuals.   Beginning with the first month you are entitled to benefits under Medicare, you cannot contribute to an Archer MSA. However, you may be eligible for a Medicare+Choice MSA, discussed later.

Income limit.   You cannot contribute more than you earned for the year from the employer through whom you have your HDHP.

If you are self-employed, you cannot contribute more than your net self-employment income. This is your income from self-employment minus expenses (including the one-half of self-employment tax deduction).

Example 1.   Bob Smith earned $25,000 from ABC Company in 2002. He had an HDHP for his family at ABC for the entire year. The annual deductible was $4,000. He can contribute up to $3,000 to his Archer MSA (75% × $4,000). He can contribute the full amount because he earned more than $3,000 at ABC.

Example 2.   Joe Craft is self-employed. He had an HDHP for his family for the entire year in 2002. The annual deductible was $3,500. Based on the annual deductible, the maximum contribution to his Archer MSA would have been $2,625 (75% × $3,500). However, after deducting his business expenses, Joe's net self-employment income is $1,950 for the year. Therefore, he is limited to a contribution of $1,950.

When to contribute.   You can make contributions to your Archer MSA until April 15 (or the next business day if April 15 is a Saturday, Sunday, or holiday) of the following year and deduct them on your Form 1040 for the preceding year to the extent your total contributions do not exceed your limitation.

Reporting Contributions on Your Return

Report all contributions to your Archer MSA on Form 8853 and attach it to your Form 1040. Follow the instructions for Form 8853 and complete the Line 5 Limitation Worksheet. Report your Archer MSA deduction on Form 1040, line 27.

You should receive Form 5498-MSA, Archer MSA or Medicare+Choice MSA Information, from the trustee showing the amount you (or your employer) contributed during the year.

Excess contributions.   You must generally pay a 6% excise tax on contributions you or your employer make to your Archer MSA that are greater than the limits discussed earlier. See Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts, to figure the excise tax.

Excess contributions you make.   You may withdraw some or all of your excess contributions and not pay the excise tax on the amount withdrawn if you:

• Withdraw these excess contributions by the due date, including extensions, of your tax return,
• Also withdraw any income earned on the withdrawn contributions and include the earnings in other income on your tax return for the year you withdraw the contributions and earnings, and
• Do not claim a deduction on your Form 1040 for the amount of the withdrawn contributions.

Excess contributions your employer makes.   If your employer makes an excess contribution and the excess was not included in box 1, Form W-2, you must report the excess as other income on your tax return. However, you may withdraw some or all of the excess employer contributions and not pay the excise tax on the amount withdrawn if you:

• Withdraw these excess contributions by the due date, including extensions, of your tax return,
• Also withdraw any income earned on the withdrawn contributions and include the earnings in other income on your tax return for the year you withdraw the contributions and earnings, and
• Do not claim an exclusion from income for the amount of the withdrawn contributions.

Receiving Distributions

You will generally pay medical expenses during the year without being reimbursed by your HDHP until you reach the annual deductible. When you pay medical expenses during the year that are not reimbursed by your HDHP, you can ask the trustee of your Archer MSA to send you a distribution from your Archer MSA.

A distribution is money you get from your Archer MSA. The trustee will report any distribution to you and the IRS on Form 1099-MSA, Distributions From an Archer MSA or Medicare+Choice MSA.

How to report distributions on your tax return.   How you report your distributions depends on whether or not you use the distribution for qualified medical expenses (defined later).

• When you use a distribution from your Archer MSA for qualified medical expenses, you do not pay tax on the distribution but you have to report the distribution on Form 8853. Follow the instructions for the form and attach it to your Form 1040.
• When you do not use a distribution from your Archer MSA for qualified medical expenses, you must pay tax on the distribution. Report the amount on Form 8853 and attach it to your Form 1040. If you have a taxable Archer MSA distribution, include it in the total on Form 1040, line 21, and enter MSA on the dotted line next to line 21. You must also report and pay an additional tax on your Form 1040 unless you meet one of the exceptions listed later under Exceptions to the additional tax.

If an amount (other than a rollover) is contributed to your Archer MSA this year (by you or your employer), you also must report and pay tax on a distribution you receive from your Archer MSA this year that is used to pay for medical expenses of someone who is not covered by an HDHP, or is also covered by another health plan that is not an HDHP, at the time the expenses are incurred. See the instructions for Form 8853 for more information.

Reporting and paying the additional tax.   There is a 15% additional tax on the part of your distributions not used for qualified medical expenses. You report the additional tax on Form 1040, line 61, and enter MSA on the dotted line next to line 61. Attach Form 8853.

Exceptions to the additional tax.   There is no additional tax if you are disabled, are age 65 or older, or die during the year.

Death of the Archer MSA holder.   You should choose a beneficiary when you set up your Archer MSA. What happens to that Archer MSA when you die depends on whom you designate as the beneficiary.

Spouse is the designated beneficiary.   If your spouse is the designated beneficiary of your Archer MSA, it will be treated as your spouse's Archer MSA after your death.

Spouse is not the designated beneficiary.   On the date you die, if someone other than your spouse is the designated beneficiary of your Archer MSA:

1. The account stops being an Archer MSA, and
2. The fair market value of the Archer MSA becomes taxable to the designated beneficiary.

No designated beneficiary.   If you have no beneficiary, the fair market value of the Archer MSA will be included on your final income tax return after your death.

Qualified Medical Expenses

Qualified medical expenses are those that qualify for the medical and dental expenses deduction. These are explained in Publication 502, Medical and Dental Expenses. Examples include amounts paid for doctors' fees, prescription medicines, and necessary hospital services not paid for by insurance.

You cannot deduct qualified medical expenses as an itemized deduction on Schedule A (Form 1040) if you pay for them with a tax-free distribution from your Archer MSA. You also cannot claim a deduction if you use other funds equal to the amount of the distribution.

Also, you cannot claim a health insurance credit for the same expenses that you pay for with a tax-free distribution from your Archer MSA.

Special rules for insurance premiums.   Generally, you cannot treat insurance premiums as qualified medical expenses for Archer MSAs. You can, however, treat premiums for long-term care, health care coverage while you receive unemployment benefits, or health care continuation coverage required under any federal law as qualified medical expenses for Archer MSAs.

Recordkeeping. For each qualified medical expense you deduct as an itemized deduction on Schedule A or pay with a distribution from your Archer MSA, you must keep a record of the name and address of each person you paid and the amount and date of the payment. Do not send these records with your tax return. Keep them with your tax records.

Filing Form 8853

You must file Form 8853 and attach it to Form 1040 if you (or your spouse, if married filing a joint return) had any activity on your Archer MSA during the year. You must file the form even if your employer or your spouse's employer made contributions to the Archer MSA.

Employer Participation

This section contains the rules that employers must follow if they decide to make Archer MSAs available to their employees. Unlike the previous discussions, you refers to the employer and not to the employee.

Health plan.   If you want your employees to be able to have an Archer MSA, you must make an HDHP available to them. You can provide no additional coverage other than those exceptions listed previously under Other health insurance.

Contributions.   You can make contributions to your employees' Archer MSAs. You deduct the contributions on the Employee benefit programs line of your business income tax return for the year you make these contributions. If you are filing Form 1040, Schedule C, this is Part II, line 14.

Comparable contributions.   If you decide to make contributions, you must make comparable contributions to all comparable participating employees' Archer MSAs. Your contributions are comparable if they are either:

• The same amount, or
• The same percentage of the annual deductible limit under the HDHP covering the employees.

Comparable participating employees.   Comparable participating employees:

• Are covered by your HDHP and are eligible to establish an Archer MSA,
• Have the same category of coverage (either self-only or family coverage), and
• Have the same category of employment (either part-time or full-time).

Additional tax.   If you made contributions to your employees' Archer MSAs that were not comparable, you must pay an additional tax of 35% of the amount you contributed. Get Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, to report and pay this tax.

Employment taxes.   Amounts you contribute to your employees' Archer MSAs are generally not subject to employment taxes. You must report the contributions in box 12 of the Form W-2 you file for each employee during the calendar year. Enter Code R in box 12.

Medicare+Choice MSAs

A Medicare+Choice MSA is an Archer MSA designated by Medicare to be used solely to pay the qualified medical expenses of the account holder. To be eligible for a Medicare+Choice MSA, you must be eligible for Medicare and have a high deductible health plan (HDHP) that meets the Medicare guidelines.

A Medicare+Choice MSA is a tax-exempt trust or custodial savings account that you set up with a financial institution (like a bank or an insurance company) in which the Medicare program can deposit money for qualified medical expenses. The money in your account is not taxed if it is used for qualified medical expenses, and it may earn interest or dividends.

An HDHP is a special health insurance policy that has a high deductible. You choose the policy you want to use as part of your Medicare+Choice MSA plan. However, the policy must be approved by the Medicare program.

Note.   At the time this publication went to print, no HDHP had been approved by Medicare. Therefore, no Medicare+Choice MSAs have been established to date.

Medicare+Choice MSAs are administered through the Federal Medicare program. The Health Care Financing Administration (HCFA) has more information about this program. You can get this information by calling 1-800-Medicare (1-800-633-4227). You can also reach HCFA through the Internet at www.medicare.gov.

How To Get Tax Help

You can get help with unresolved tax issues, order free publications and forms, ask tax questions, and get more information from the IRS in several ways. By selecting the method that is best for you, you will have quick and easy access to tax help.

Contacting your Taxpayer Advocate.   If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate.

The Taxpayer Advocate represents your interests and concerns within the IRS by protecting your rights and resolving problems that have not been fixed through normal channels. While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up problems that resulted from previous contacts and ensure that your case is given a complete and impartial review.

To contact your Taxpayer Advocate:

• Call the Taxpayer Advocate at
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• Call, write, or fax the Taxpayer Advocate office in your area.
• Call 1-800-829-4059 if you are a
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For more information, see Publication 1546, The Taxpayer Advocate Service of the IRS.

Free tax services.   To find out what services are available, get Publication 910, Guide to Free Tax Services. It contains a list of free tax publications and an index of tax topics. It also describes other free tax information services, including tax education and assistance programs and a list of TeleTax topics.

Personal computer. With your personal computer and modem, you can access the IRS on the Internet at www.irs.gov. While visiting our web site, you can:

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Phone. Many services are available by phone.
 

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• Solving problems. Take advantage of Everyday Tax Solutions service by calling your local IRS office to set up an in-person appointment at your convenience. Check your local directory assistance or www.irs.gov for the numbers.
• TTY/TDD equipment. If you have access to TTY/TDD equipment, call 1-800-829- 4059 to ask tax questions or to order forms and publications.
• TeleTax topics. Call 1-800-829-4477 to listen to pre-recorded messages covering various tax topics.

Evaluating the quality of our telephone services. To ensure that IRS representatives give accurate, courteous, and professional answers, we use several methods to evaluate the quality of our telephone services. One method is for a second IRS representative to sometimes listen in on or record telephone calls. Another is to ask some callers to complete a short survey at the end of the call.

Walk-in. Many products and services are available on a walk-in basis.
 

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CD-ROM for tax products. You can order IRS Publication 1796, Federal Tax Products on CD-ROM, and obtain:

• Current tax forms, instructions, and publications.
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• Popular tax forms that may be filled in electronically, printed out for submission, and saved for recordkeeping.
• Internal Revenue Bulletins.

The CD-ROM can be purchased from National Technical Information Service (NTIS) by calling 1-877-233-6767 or on the Internet at http://www.irs.gov/cdorders. The first release is available in early January and the final release is available in late February.

CD-ROM for small businesses. IRS Publication 3207, Small Business Resource Guide, is a must for every small business owner or any taxpayer about to start a business. This handy, interactive CD contains all the business tax forms, instructions and publications needed to successfully manage a business. In addition, the CD provides an abundance of other helpful information, such as how to prepare a business plan, finding financing for your business, and much more. The design of the CD makes finding information easy and quick and incorporates file formats and browsers that can be run on virtually any desktop or laptop computer.

It is available in March. You can get a free copy by calling 1-800-829-3676 or by visiting the website at www.irs.gov/smallbiz.

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