State Has No Tax Break for Health Accounts

Thousands of Californians who signed up for health savings accounts in the last year could get an unpleasant surprise when they prepare their income taxes.

The accounts allow Americans to set aside as much as $5,450 a year before federal taxes to cover out-of-pocket healthcare costs, and what they don’t spend can accumulate as savings. The health accounts are also shielded from state income taxes in most of the country, but California is one of seven states that have declined to provide an exemption.

The discrepancy has existed since HSAs were established in 2004, but most of the accounts weren’t opened until last year. That means many Californians won’t realize that they don’t get a state exemption until they view their W-2 statements and see that their state taxable income is thousands of dollars higher than their federal income.

“It’s going to hit people between the eyes,” said Assemblyman George A. Plescia (R-San Diego).

Plescia and state Sen. Abel Maldonado (R-Santa Cruz) are sponsoring bills that would exempt HSAs from California income taxes, but similar efforts have died in committee for the last two years. Maldonado believes that as more Californians open these accounts, pressure will build on the Legislature to allow a state income tax deduction.

“Other states get the benefit,” he said. “But our Legislature is saying no.”

Last year, Maldonado’s bill to provide a state tax exemption died in the Senate Revenue and Tax Committee.

The panel’s chairman, Sen. Michael Machado (D-Linden) believes that the accounts provide a tax break for people who don’t really need it, said Colin Grinnell, a consultant for Machado.

Health savings accounts, created as part of the Medicare Modernization Act, can be opened only by someone with a so-called high-deductible health insurance policy -- defined as any policy that has a deductible of at least $1,050 for an individual or at least $2,100 for a family in 2006.

Opponents of health savings accounts, including labor unions and advocates for the poor, say high-deductible insurance isn’t a good product for people of modest means because they can’t afford to pay $1,000 to $2,000 a year in out-of-pocket costs, and they would also struggle to set aside that much money out of their paychecks to build their accounts.

Grinnell also contended that the accounts disproportionately benefit people who are healthy because the savings accrue only for people who don’t have to spend the money on healthcare costs.

Supporters counter that many middle-class workers have insurance policies that meet the deductible requirements, and that the accounts also benefit many small-business owners who can’t afford the high premium cost for low-deductible insurance. The high-deductible policies offered through health savings account packages are 60% to 70% cheaper to buy than policies with smaller deductibles, said Chini Krisnan, chief executive of Healthia Inc., an online health insurance shopping site.

More than 3 million individuals now have health savings accounts, with 2 million of the accounts opened last year, according to America’s Health Insurance Plans, an industry trade group.

They are not to be confused with so-called flexible spending accounts, which companies set up for their workers to set aside tax-free dollars to pay uninsured medical bills and health plan deductibles.

Unspent money in a flexible spending account at year-end is lost, whereas money is allowed to accumulate year after year in a health savings account.

There is no break-out on how many HSAs have been opened in California. But if the plans were distributed evenly throughout the country, hundreds of thousands of Californians could be expected to have these plans based on the state’s population.

The account holder can tap it to pay medical bills subject to the deductible, as well as other uncovered medical expenses.

However, if the savings isn’t needed for immediate spending, it can remain in the account, accumulating interest.

Because contributions can be made every year, the savings portion of the HSA can be used to accumulate large amounts of cash over time. Account holders don’t have to pay federal taxes on the savings until they withdraw the money. If the money is used for medical expenses, it will not be taxable.

Employees can create the plans in several ways. If they have a qualifying corporate health insurance plan -- one with the necessary deductible -- they can opt into that. Generally, employers would offer a health savings account in tandem with that coverage.

If their employer doesn’t offer a qualifying plan, workers can forgo the company insurance and buy qualifying coverage and open a health savings account on their own.

Both insurers and banks are heavily promoting the plans, which are proving to be the fastest-growing type of health insurance in history, according to America’s Health Insurance Plans.

Yet few people appear aware of the lack of state tax benefits, experts add. Malcolm Orland, a Beverly Hills tax accountant, said he had received several pitches for HSAs touting the federal tax benefits without mentioning the lack of state advantages.

Krisnan acknowledged that his health shopping website did not warn buyers in states without an income tax exemption -- California, Wisconsin, Alabama, Pennsylvania, New Jersey, Massachusetts and Maine -- that they would not receive a tax break.

After being interviewed by The Times, he said he would add a warning.

The IRS offers an 18-page booklet, Publication 969, on various health savings options. It can be downloaded from the IRS website at www.irs.gov or requested by calling (800) TAX-FORM.