1. © 2011 Proskauer. All Rights Reserved. Legal Aspects of Health Savings Accounts (HSAs) August 2011 Stacy H. Barrow sbarrow@proskauer.com 617.526.9648 1

2. © 2011 Proskauer. All Rights Reserved. Today’s Agenda Update on National Health Care Reform HSA Background HSA Eligibility Rules HSA Enhancements ­ Rollovers ­ Contributions Employer Contributions to HSAs ­ Comparable Contributions ­ Contributions through a Cafeteria Plan Examples of HSA Coordination with FSAs & HRAs 2

3. © 2011 Proskauer. All Rights Reserved. Legislative/Judicial Update  Is it going away?  HR 2: “An Act to repeal the job-killing health care law”  HR 9: “Instructing certain committees to report legislation replacing the job-killing health care law”  Enacted Legislation  Repeal of Vouchers  1099 Correction  Other Areas Being Considered  Elimination of OTC Prescription Drug Requirement  Elimination of CLASS Act  Medical Loss Ratio Changes © 2011 Proskauer. All Rights Reserved.

4. Legislative/Judicial Update  Is it legal? Many constitutional challenges  Suits filed in most states; five federal court decisions:  Thomas More Law Center v. Barack Obama, et al. (MI)  Liberty University v. Timothy Geithner (VA)  Mead v. Holder (DC)  Commonwealth of Virginia v. Sebelius (VA)  Florida v. Dept. of Health and Human Services (FL)  22 Attorneys General  4 Governors © 2011 Proskauer. All Rights Reserved.

5. Legislative/Judicial Update  On June 29, 2011, the 6th Circuit Court of Appeals affirmed the district court’s decision in Thomas More Law Center v. Obama, finding that the individual mandate is a valid exercise of congressional authority under the Commerce Clause  The court found that the individual mandate is within Congress’ power to regulate economic activity that has a substantial effect on interstate commerce, even if such activity is wholly intrastate  The court also recognized that the Commerce Clause permits Congress to regulate non-economic intrastate activity (e.g., individuals who, through “inaction,” fail to comply with the individual mandate) if doing so is essential to a larger scheme that regulates economic activity (e.g., health care reform) © 2011 Proskauer. All Rights Reserved.

6. Legislative/Judicial Update The 6th Circuit decision is noteworthy for several reasons: ­ It is the first decision on the merits of PPACA at the appellate level ­ It is binding on other 6th Circuit cases, and has already resulted in the dismissal of one count of a complaint challenging the individual mandate’s constitutionality under the Commerce Clause ­ It was the first case not decided along party lines ­ Of the five lawsuits to have been decided at the district court level, the three decided by Democratic appointees have upheld PPACA, whereas the two decided by Republican appointees have deemed PPACA unconstitutional, either in whole or in part © 2011 Proskauer. All Rights Reserved.

7. Legislative/Judicial Update  On August 12, the 11th Circuit Court of Appeals in Florida v. Dept. of Health and Human Services ruled that the individual mandate exceeds Congress’ power under the Commerce Clause (however, it did not declare the entire law unconstitutional)  The Court found that:  The Act’s Medicaid expansion provisions are not unconstitutionally coercive, and thus are valid spending conditions  The individual mandate exceeds Congress's authority to regulate interstate commerce  The individual mandate is not a valid exercise of the tax power  The individual mandate can be severed from the rest of the Act, so only the individual mandate itself (and nothing else) is invalidated © 2011 Proskauer. All Rights Reserved.

8. Definitions FSA – Health Care Flexible Spending Account HDHP – Qualified High Deductible Health Plan HRA – Health Reimbursement Arrangement HSA – Health Savings Account IRA – Individual Retirement Account 8

9. © 2011 Proskauer. All Rights Reserved. Background HSAs first became available to taxpayers in 2004 as part of Congress’ attempt to expand health care coverage and control costs through consumer-directed programs. HSAs are tax-favored investment accounts that may be used to pay for an individual's current or future health, vision and dental expenses To set up an HSA, an individual must be covered by an HDHP and satisfy certain other eligibility rules. Within the statutory limits, employer contributions to an HSA are not taxable, and the individual may make tax-deductible contributions to the HSA 9

10. © 2011 Proskauer. All Rights Reserved. HSA Eligibility There are four basic HSA eligibility rules: 1.Covered by a qualified High Deductible Health Plan; 2.Not covered by any non-HDHP plan; 3.Not entitled to Medicare; and 4.Not eligible to be claimed as a dependent on another individual’s federal tax return 10

11. © 2011 Proskauer. All Rights Reserved. HSA Eligibility 1.In order to qualify, the HDHP must have an annual deductible at or above the statutory minimum, and contributions and out-of- pocket limits at or below the statutory maximum 11 2012 Minimum Annual Deductible for HDHP 2012 Maximum Annual HSA Contribution 2012 Maximum Annual Out-of- Pocket Individual$1,200$3,100$6,050 Family$2,400$6,250$12,100

12. © 2011 Proskauer. All Rights Reserved. HSA Eligibility 2.In order to be eligible to contribute to an HSA, an individual must not be covered under any non-qualified health care plan, with two exceptions: permitted insurance and permitted coverage a)Permitted insurance: Worker’s compensation, tort liability, ownership liability, specified disease coverage, per-diem indemnity insurance b)Permitted coverage: Accident coverage, disability, dental, vision, long-term care 12

13. © 2011 Proskauer. All Rights Reserved. HSA Eligibility 3.Individuals who are entitled to Medicare are not eligible to establish or contribute towards an HSA ­ Entitled means actually covered under any part of Medicare: Part A, Part B, a Medicare Advantage Plan, or Part D ­ Individuals who are eligible for Medicare, but have not enrolled, may establish and contribute to an HSA 13

14. © 2011 Proskauer. All Rights Reserved. HSA Eligibility 4.Any individual who is eligible to be claimed as a dependent on another person’s federal tax return is not eligible to establish or contribute to an HSA ­ Example: A student who is eligible for an HDHP, but whose parents claim her as a dependent because she meets the IRS definition of “qualifying relative” is not HSA eligible 14

15. © 2011 Proskauer. All Rights Reserved. HSA Enhancements Rollover from an FSA or HRA ­ Employers may permit participants to transfer, tax-free, their balances in FSAs and/or HRAs into an HSA ­ The transfer is limited to the lesser of the balance in the FSA or HRA as of September 21, 2006, or the balance as of the date of distribution ­ Employers must not discriminate under this provision—if the employer allows any employee to transfer balances, then all employees covered under a high deductible plan of the employer must be allowed to do so ­ Rollover must be completed before January 1, 2012 15

16. © 2011 Proskauer. All Rights Reserved. HSA Enhancements Rollover from an IRA ­ This provision permits a one-time trustee-to-trustee transfer of funds from an IRA to an HSA. The transfer is tax-free and not subject to the 10 percent additional tax on early distributions ­ If an individual makes a transfer from an IRA to an HSA, the annual amount he or she can contribute to the HSA is reduced by the amount transferred from the IRA ­ Only one transfer per individual is permitted, unless the transfer is made during a month when an individual has self- only coverage, in which case an additional transfer may be made during a subsequent month within the taxable year in which the individual has family coverage 16

17. © 2011 Proskauer. All Rights Reserved. HSA Enhancements FSA grace period may not prevent HSA eligibility ­ Generally, an individual may not participate in both an HSA and an FSA because FSA coverage is not an HDHP ­ According to the IRS, this restriction included any FSA “grace period,” even if there was no money left in the FSA ­ However, individuals with a zero balance in their FSA at year end may contribute to an HSA at the start of the new year 17

18. © 2011 Proskauer. All Rights Reserved. HSA Enhancements Full-year contribution allowed for mid-year enrollees ­ This provision allows individuals who first enroll in a high deductible plan after the start of the year to make a full HSA contribution for the year ­ However, if the individual does not remain eligible for the HDHP during the testing period, then an amount equal to the HSA deduction during the period that the individual was treated as eligible is included in income, and an additional 10% tax applies to the amount includable ­ The testing period begins with the last month of the taxable year and ending on the last day of the twelfth month following such month 18

19. © 2011 Proskauer. All Rights Reserved. Employer Contributions to HSAs Employers can, but are not required to, contribute to their employees’ HSAs If an employer contributes to an employee’s HSA, the contributions are excludable from federal taxable income and are not taxable to the individual Employers can structure their contributions under one of two rule sets: ­ Comparable Contributions ­ Contributions through a Cafeteria Plan 19

20. © 2011 Proskauer. All Rights Reserved. Comparable Employer Contributions Comparable employees are employees in the same category (full-time, part-time, former) who have the same tier of coverage ­ Employers may use up to 4 tiers: ­ Single (self only) ­ Employee & 1 Dependent ­ Employee & 2 Dependents ­ Employee & 3 or more Dependents ­ Restriction: contributions to each family tier must be equal to or greater than the tier below 20

21. © 2011 Proskauer. All Rights Reserved. Comparable Employer Contributions Employees may be placed in the following categories only: ­ Full-time (30 hours) ­ Part-time (<30 hours) ­ Former Employees (does not include COBRA) ­ Union (collectively bargained health benefits) Note: the 30-hour threshold must be used ­ Differences not permitted for: Management, Salaried, Specific locations or subgroups (e.g., division or subsidiary) 21

22. © 2011 Proskauer. All Rights Reserved. Comparable Employer Contributions Contributions will be comparable only if they are calculated using one of two methods: ­ Same dollar amount by tier (single or family); or ­ Same percentage of the HDHP deductible (single or family level) When HSA contributions are not comparable, the penalty is a 35% excise tax 22

23. © 2011 Proskauer. All Rights Reserved. Employer Contributions Through Cafeteria Plan Employer contributions toward an employee’s HSA offered under a cafeteria plan will generally be in one of 3 forms: 1.Salary reductions; 2.Employer credits (cashable or non-cashable); and/or 3.Employer non-credit contributions such as: ­ Flat dollar amount ­ Specified percentage of deductible(s) ­ Matching contributions 23

24. © 2011 Proskauer. All Rights Reserved. Employer Contributions Through Cafeteria Plan An employer’s HSA contribution may not be considered to be “through” a cafeteria plan if the contribution is non-elective and non-cashable ­ Example of a contribution not “through” a cafeteria plan: ­ Employees contribute to HDHP via salary reduction, ­ Employer contributes to HSA for all enrollees, and ­ Employer contribution is only for the HSA: ­ It can’t be taken as cash, ­ It can’t be used for other benefits, and ­ Employees cannot contribute pre-tax to HSAs ­ Employer’s HSA contribution is not through a cafeteria plan! 24

25. © 2011 Proskauer. All Rights Reserved. Coordination of HSAs with FSAs and HRAs Employers implementing qualified high deductible health plans to facilitate the use of HSAs should consider the following five plan design examples and their effect on an employee’s eligibility to contribute to an HSA 25

26. © 2011 Proskauer. All Rights Reserved. Hypothetical HDHP For the purpose of the following five examples, the HDHP has the following features: ­ 80%/20% coinsurance ­ $1,200 deductible for individual, $2,400 for family ­ Maximum out-of-pocket cost of $6,050 for individual, $12,100 for family ­ HDHP covers standard medical and Rx expenses, and does not cover dental or vision expenses 26

27. © 2011 Proskauer. All Rights Reserved. 1. HSA with “Traditional” HRA or FSA Both the FSA and the HRA cover all qualified medical expenses not covered by the HDHP (co-payments, co-insurance, expenses not covered due to the deductible, any other medical expenses not covered by the HDHP) This individual is not eligible to contribute to an HSA ­ The FSA and HRA pay or reimburse medical expenses incurred before the annual deductible has been satisfied ­ The FSA and HRA are not limited to the exceptions for permitted insurance, permitted coverage, or preventive care ­ Note: In this example, both the FSA and HRA are considered health plans that are NOT qualified HDHPs 27

28. © 2011 Proskauer. All Rights Reserved. 2. HSA with “Limited Purpose” HRA or FSA Both the FSA and the HRA are “limited purpose” arrangements that cover only vision or dental expenses, as well as preventive care (without regard as to whether the HDHP deductible has been satisfied) This individual is eligible to contribute to an HSA ­ The FSA and HRA pay or reimburse medical expenses incurred before the annual deductible has been satisfied ­ However, the medical expenses paid by the FSA or HRA include only vision and dental benefits (which are permitted or disregarded coverage) and preventive care 28

29. © 2011 Proskauer. All Rights Reserved. 3. HSA with “Suspended” HRA The individual elects, before the beginning of the HRA coverage period, to suspend the payment of medical expenses during the upcoming HRA coverage period (permitted or disregarded coverage and preventive care is allowed) This individual is eligible to contribute to an HSA ­ The individual is eligible to contribute to an HSA until the individual is again entitled to receive, from the HRA, payments for medical expenses incurred after the suspension ­ Note: This allows an HRA and HSA to co-exist by permitting an individual to maintain an HRA (and to continue receiving accruals) and still be eligible to contribute to an HSA 29

30. © 2011 Proskauer. All Rights Reserved. 4. HSA with “Post Deductible” HRA or FSA Both the FSA and the HRA are “post deductible” arrangements that only pay or reimburse medical expenses after the HDHP deductible has been satisfied (permitted or disregarded coverage and preventive care is allowed) This individual is eligible to contribute to an HSA ­ The FSA and HRA do not reimburse medical expenses incurred before the annual deductible has been satisfied ­ Note: The Post Deductible HRA or FSA will not qualify as a HDHP; the individual will need to be covered by a qualified HDHP in order to contribute to an HSA 30

31. © 2011 Proskauer. All Rights Reserved. 5. HSA with “Retirement” HRA The HRA is a “retirement” HRA and only reimburses expenses incurred after the individual retires This individual is eligible to contribute to an HSA ­ The individual is eligible to contribute to an HSA before retirement because the HRA will only pay or reimburse medical expenses incurred after retirement ­ Note: This individual will not be eligible to make contributions to an HSA after retirement 31

32. © 2011 Proskauer. All Rights Reserved. 32 Questions? August 2011 Stacy H. Barrow sbarrow@proskauer.com 617.526.9648