Can You Reimburse a Non-Dependent Adult Child's Expenses Tax-Free?

Can You Reimburse a Non-Dependent Adult Child's Expenses Tax-Free?

Your adult child remains covered on your medical plan but no longer qualifies as your tax dependent. Can you reimburse the child's qualified expenses tax-free from your Health Savings Account?

Under federal law, children can remain covered on a parent's medical plan until the child turns age 26. This law applies even if the child is no longer the parent's tax dependent, is no longer a full-time student, or is married. This provision of federal law has helped many young adults remain covered while they pursue their first jobs at companies or causes that don't offer a medical plan, continue their educations, or simply seek to avoid payroll deductions to maximize their discretionary income.

The law creates a certain level of confusion, however, when the parent owns a Health Savings Account and needs to know whether he or she can reimburse the child's qualified expenses tax-free from that account. Let's review the law and the family's options.

Qualified Distributions

Distributions from a Health Savings Account aren't included in the owner's taxable income if the withdraw meets three requirements:

  1. The expense is qualified under the federal tax code.
  2. The expense has a date of service or treatment after the owner established the account.
  3. The patient or purchaser is a qualified family member.

We assume that Requirements 1 and 2 have been met. Let's focus on No. 3.

A Health Savings Account owner can reimburse her own, her spouse's, and her tax dependents' qualified expenses tax-free. That's it. No other family members' expenses are qualified, even if the items or services meet the first two requirements.

In our scenario, the adult child no longer qualifies as a tax dependent. Therefore, the parent can't reimburse tax-free any qualified expenses that the child incurs with dates of service or purchase after the child lost her status of a parent's tax dependent. This rule holds true even if the child still lives with the parent and remains covered on the parent's medical plan to age 26.

Coverage and Distributions

This fact reinforces one of the most important concepts to understand when it comes to Health Savings Accounts: In some families,

  • whom you can cover on your medical plan and
  • whose expenses you can reimburse tax-free from your Health Savings Account

. . . are different.

That's because family members eligible to enroll on a medical plan is determined by federal law, state law, insurer rules, and employer decisions. On the other hand, the tax status of distributions from a Health Savings Account is determined by the federal Internal Revenue Code.

So, in this case, what are the family options if the parent wants to help a child with a qualified medical, dental, or vision expense?

Option 1: Another Health Savings Account

Is the adult non-dependent child eligible to open and fund her own Health Savings Account? She must be covered on an HSA-qualified plan, can't be enrolled in any disqualifying coverage, and can't be claimed as another taxpayer's tax dependent. Assuming that this child meets all three requirements, she can open an account in her name and reimburse her qualified expenses tax-free.

Note that she doesn't have to be the medical-plan subscriber. Health Savings Account eligibility is determined covered-person-by-covered-person. It's not unusual for other family members - often a spouse - besides the subscriber (the employee on a group plan or policy owner of nongroup coverage) to be HSA-eligible.

How much can the adult child contribute to her Health Savings Account? Federal tax law doesn't address this issue. But a dozen years ago, in a meeting of a professional organization, an Internal Revenue Service employee, expressing his personal views rather than stating IRS policy, acknowledged that the child may be entitled to contribute up to the statutory limit of a family contract - irrespective of the contributions that other family members make. The statue clearly limits married couples to the statutory annual limit for a family contract ($7,300 in 2022 and $7,750 in 2023). But it's silent on maximum contributions for other HSA-eligible family members (like a domestic partner, an ex-spouse, or a non-dependent child) covered on a family contract.

What is the child, despite not qualifying as the parent's tax dependent, doesn't have the financial resources to pay a high bill for a qualified expense? The law allows anyone to contribute to an HSA-eligible Health Savings Account owner's account. Thus, the child can open an account and the parent can contribute to fund the account. In this case, the account owner rather than the parent receives the tax deduction.

Option 2: A Health FSA

A second option is to reimburse the qualified expense from a Health FSA if either the parent or the child participates in one through her employer. A Health FSA reimburses the same qualified medical, dental, and vision expenses tax-free as a Health Savings Account.

You probably know that a person can't be covered by a Health FSA (her own, a spouse's, or a parent's) and fund a Health Savings Account. Option 2 can take one of two forms:

  1. If the parent isn't funding a Health Savings Account, the parent can enroll in a general Health FSA. Ditto for the child.
  2. If the parent or child is maintaining eligibility to fund a Health Savings Account, she can participate in an employer's Limited-Purpose Health FSA, which reimburses dental and vision expenses only. Coverage on this Health FSA plan design doesn't disqualify a person from opening or funding a Health Savings Account.

Option 2 limits reimbursement to the adult child's dental or vision expenses. That's somewhat limiting, but it's a nice back-up plan, with the added features that (1) the parent receives the tax deduction in what's usually a higher marginal federal (and perhaps state) marginal tax bracket and (2) the full election can be spent on the first day of the plan year (adding a cash-blow advantage to the tax benefits).

The Bottom Line

Health Savings Account rules often create opportunities for multiple family members to open and fund a Health Savings Account. The requirements to open an account are identified in the law and present no risk to the taxpayer. The funding limits when multiple family members who aren't married to each other are covered on the plan and HSA-eligible is not written in statute and thus subject to some element of risk. But a reasonable interpretation of the existing rules, plus the personal opinion of an IRS official with deep knowledge of the law, may lead people in this situation to fund multiple family members' Health Savings Accounts up to the statutory family limit for a family contract.

#HSAMondayMythbuster #HSAWednesdayWisdom #HSA #HealthSavingsAccount #TaxPerfect

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