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Tax-Free Bill of Health

Health-care accounts with tax benefits

This story appears in the January 2005 issue of Entrepreneur. Subscribe »

Tax-advantaged health-care spending accounts are proliferating--and that means more opportunities to save on taxes as well as more ways to help pay for health costs. Here's a look at how each one stacks up.

  • Health Savings Accounts (HSAs): With an HSA, an employer or employee--or both--can make tax-free contributions to the account if the employee is covered by a qualified high-deductible health plan. Employer contributions are tax deductible, excludable from gross income, and are not subject to employment taxes. Employees can use tax-free withdrawals to pay for most medical expenses not covered by the high-deductible plan. It's possible for employees to make after-tax contributions and take a deduction on their tax returns, or pretax contributions if the employer has a Section 125 plan. In the latter case, employees reduce their salary by the amount of the contribution, and the employer makes the contribution on their behalf. HSA amounts are fully vested and can be retained when an employee leaves employment.
  • Health Reimbursement Arrangements (HRAs): HRAs are more beneficial for employers than are HSAs. They can be used to pay any qualified medical expenses, including health-care premiums. HRAs are typically not funded--they are bookkeeping accounts that are credited with amounts by the employer. No employer assets are actually set aside. Reimbursements to employees come from employer assets--it's at that point that the employer pays for the expense and is entitled to a deduction.

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