The Pennsylvania Legislature enacted the Health Savings Account Act (the "HSA Act") 72 P.S. §§3402b.1-3402b.6, on July 14, 2005, to be effective sixty days thereafter. As enacted, Section 4 of the HSA Act did not provide an exclusion from Pennsylvania tax for contributions by employers and employees to health savings account plans. Accordingly, there were not deductions allowed from taxable income for contributions to health savings accounts for Pennsylvania purposes under the HSA Act. Under Section 4 of the HSA Act, the following items were excluded from Pennsylvania tax:
(1) any income of a health savings account;
(2) any amount paid or distributed out of a health savings account that is used exclusively to pay the qualified medical expenses of the account beneficiary; and
(3) any amount paid or distributed out of a health savings account that is used exclusively to reimburse an account beneficiary for qualified medical expenses.
72 P.S. §3402b.4(a)
The following items were included in the income of the account beneficiary and subject to Pennsylvania tax:
(1) any amount paid or distributed out of a health savings account that is used for any purpose other than to pay the qualified medical expenses of the account beneficiary;
(2) any excess contribution distribution that has not previously been included in the account beneficiary’s income; and
(3) any amount of the account beneficiary’s income attributable to an excess contribution distribution
72 P.S. §3402b.4(b)
On February 14, 2005, an amendment to the HSA Act was proposed in House Bill 2125, so that the Pennsylvania Act could follow the health savings account provisions set forth in Section 223 of the Internal Revenue Code. In addition, although the HSA Act contained no tax exclusion or deduction for contributions made to a health savings account, the Pennsylvania Department of Revenue issued a tax bulletin (PIT-06-005) on April 12, 2006, in which it indicated that: (1) payments made by an employer for a nondiscriminatory health plan are excluded from compensation and accordingly, not subject to withholding tax and (2) payments directed by an employee to a health savings account under the employer’s federally qualified cafeteria plan and maintained as a qualified benefit of that plan are excluded from compensation and therefore not subject to withholding tax.
By amendment dated June 21, 2006, for tax years beginning after December 31, 2005 and effective immediately, the entirety of Section 4 of the HSA Act has been repealed, and Pennsylvania has adopted law that conforms to the federal tax treatment of health savings accounts so that the definition of income now includes the following language of Section 303(a)(6) of the Pennsylvania Tax Reform Code of 1971 (72 P.S. §7303(a)(6)), as amended:
Interest derived from obligations which are not statutorily free from state or local taxation under any other act of the General Assembly of the Commonwealth of Pennsylvania or under the laws of the United States and any amount paid under contract of life insurance of endowment or annuity contract, which is includible in gross income for federal income tax purposes and any amount paid out of the Archer Medical Savings Account or Health Savings Account that is includible in the gross income of an account beneficiary for federal income tax purposes.
Accordingly, effective immediately an applying to tax years beginning after December 31, 2005, where contributions to and income and distributions from qualified health savings accounts are deductible for purposes of Section 223 of the Internal Revenue Code, they shall, under 72 P.S. §303(a)(6), above, not be included in taxable income for Pennsylvania purposes. Under both federal and Pennsylvania law, distributions that are not used for qualified medical expenses will be taxable as interest income.
For more information , contact Jamie Aul at 412.594.3923.