Archer MSAs

To qualify for an Archer MSA, you must be:

• An employee (or the spouse of an employee) of a small employer. The employer must maintain an individual or family high deductible health plan (HDHP), defined later, for you (or your spouse), or
• A self-employed person (or the spouse of a self-employed person) who maintains an individual or family HDHP.

You can have no other health insurance or Medicare coverage except what is permitted under Other health insurance, later. You must be an eligible individual on the first day of a given month to get an Archer MSA deduction for that month.

If another taxpayer is entitled to claim an exemption for you, you cannot claim a deduction for an Archer MSA contribution. This is true even if the other person does not actually claim your exemption.

Understanding Archer MSAs

To understand Archer MSAs, you will want to know what an Archer MSA is and what the benefits are of having one. You will also need to know whether you meet the rules for starting an Archer MSA. If you meet the rules, then you will want to read the section titled Setting Up an Archer MSA, later.

What is an Archer MSA? An Archer MSA is a tax-exempt trust or custodial account with a financial institution (like a bank or an insurance company) in which you can save money for future medical expenses. This account must be used in conjunction with an HDHP. See What is a high deductible health plan (HDHP), later.

What are the benefits of an Archer MSA? You may enjoy several benefits from having an Archer MSA.

• The interest or other earnings on the assets in your Archer MSA are tax-free.
• You can claim a tax deduction for contributions you make even if you do not itemize your deductions on Form 1040.
• The contributions remain in your Archer MSA from year to year until you use them.

Rules for Starting an Archer MSA

You need to meet the following rules before you can start an Archer MSA.

1. You must work for a small employer or be self-employed.
2. You must have an HDHP.

Who is a small employer? A small employer is generally an employer who had an average of 50 or fewer employees during either of the last 2 calendar years. The definition of small employer is modified for new employers and growing employers.

New employer. A new employer is also considered a small employer for Archer MSAs if he or she reasonably expects to employ 50 or fewer people this year.

Growing employer. A small employer may begin HDHPs and Archer MSAs for his or her employees and then grow beyond 50 employees. The employer will continue to meet the requirement for small employers if he or she:

• Had 50 or fewer employees when the Archer MSAs began,
• Made a contribution for the last year he or she had 50 or fewer employees, and
• Had an average of 200 or fewer employees each year after 1996.

What is a high deductible health plan (HDHP)? To be eligible for an Archer MSA, you must have an HDHP. If you are an employee, the plan must be through your small employer. You generally cannot have another health insurance plan.

Definition. An HDHP has:

1. A higher annual deductible than typical health plans, and
2. A maximum limit on the annual out-of-pocket medical expenses that you must pay for covered expenses.

Limits. The following tables show the limits for annual deductibles and the maximum out-of-pocket expenses for high deductible health plans for 2000 and 2001. Limits may be changed in future years because of inflation adjustments.

Family plans that do not currently meet the high deductible rules. There are some family plans that have deductibles for individual family members. These deductibles are less than the annual deductible for the family plan. Under these plans, if you meet the individual deductible for one family member, you do not have to meet the annual deductible amount for the family plan. These plans do not qualify as HDHPs.

Example. Mr. Wilber has health insurance with company A in 2000. The annual deductible for the family plan is $4,500. This plan also has an individual deductible of $1,800 for each family member. Mr. Wilber's wife had $2,200 of covered medical expenses. They had no other medical expenses for 2000. The plan paid $400 to Mr. Wilber because Mrs. Wilber met the individual deductible of $1,800, even though the Wilbers did not meet the $4,500 annual deductible for the family plan. The plan does not qualify as an HDHP.

Insurance companies that have family plans with individual deductibles may change these health plans to meet the high deductible rules. Check with your insurance company if you have such a plan to see if it is going to change the plan to meet the rules.

Other health insurance. You (or your spouse if you file jointly) generally cannot have any other health plan that is not an HDHP. However, this rule does not apply if the other health plan(s) only covers the following items.

1. Accidents.
2. Disability.
3. Dental care.
4. Vision care.
5. Long-term care.
6. Benefits related to workers' compensation laws, tort liabilities, or ownership or use of property.
7. A specific disease or illness.
8. A fixed amount per day (or other period) of hospitalization.

Setting Up an Archer MSA

When you set up an Archer MSA, you will need to work with a trustee and know the rules for contributing and withdrawing money from the account.

Archer MSA trustee. The person or business with whom you set up your Archer MSA is called a trustee. A trustee can be a bank, insurance company, or anyone already approved by the IRS to be a trustee of individual retirement arrangements. Your employer may already have some information on Archer MSA trustees in your area.

Who can contribute to my Archer MSA? Your employer may decide to make contributions to an Archer MSA for you. You do not pay tax on these contributions. If your employer does not make contributions to your Archer MSA, you can make your own contributions to your Archer MSA and deduct these amounts on your tax return without itemizing deductions. Both you and your employer cannot make contributions to your Archer MSA in the same year. There are limits to the amounts that can be contributed to your Archer MSA. See Making Contributions, later. You do not have to make contributions to your Archer MSA every year.

If your spouse is covered by your HDHP and an amount is contributed by your spouse (or your spouse's employer) to an Archer MSA belonging to your spouse, you cannot make contributions to your own Archer MSA that year.

When can I make withdrawals from my Archer MSA? You can make tax-free withdrawals from your Archer MSA to pay for qualified medical expenses (discussed later). If you make withdrawals for other reasons, the amount you withdraw will be subject to income tax and may be subject to an excise tax as well. See Receiving Distributions, later. You do not have to make withdrawals from your Archer MSA each year.

Changing employers. If you change employers and still meet the rules for having an Archer MSA, you can continue to use that Archer MSA. However, you may not make additional contributions unless you are otherwise eligible.

Making Contributions

There are two limits on the amount you or your employer can contribute to your Archer MSA. One is based on the annual deductible of your HDHP. The other is based on your wages or compensation if you are an employee, or your net self-employment income if you are self-employed.

Annual deductible. You can contribute up to 75% of the amount of your annual health plan deductible (65% if you have a self-only plan) to your Archer MSA. You must have the insurance all year to contribute the full amount.

For each full month you did not have an HDHP, you must reduce the amount you can contribute by one-twelfth.

Example 1. You have an HDHP for your family all year in 2000. The annual deductible is $4,000. You can contribute $3,000 ($4,000 × 75%) to your Archer MSA for the year.

Example 2. You have an HDHP for your family for the entire months of July through December, 2000 (6 months). The annual deductible is $4,000. You can contribute $1,500 ($4,000 × 75% × 12 months × 6 months) to your Archer MSA for the year.

If you and your spouse each have a family plan, you are treated as having family coverage with the lower annual deductible of the two health plans. The contribution limit is split equally between you unless you agree on a different division.

Wages or compensation. You cannot contribute more than you earned for the year from the employer through whom you have your HDHP. If you are self-employed, you cannot contribute more than your net self-employment income. This is your income from self-employment minus expenses (including the one-half of self-employment tax deduction).

Example 1. Bob Smith earned $25,000 from ABC Company in 2000. He had an HDHP for his family at ABC for the entire year. The annual deductible was $4,000. He can contribute $3,000 to his Archer MSA (75% × $4,000). He can contribute the full amount because he earned more than $3,000 at ABC.

Example 2. Joe Craft is self-employed. He had an HDHP for his family for the entire year in 2000 and the annual deductible was $3,500. Based on the annual deductible, the maximum contribution to his Archer MSA would have been $2,625 (75% × $3,500). However, after deducting his business expenses, Joe's net self-employment income is $1,950 for the year. Therefore, he is limited to a contribution of $1,950.

Reporting contributions on your return. Report all contributions to your Archer MSA on Form 8853 and attach it to your Form 1040. Follow the instructions for Form 8853 and complete the Line 5 Limitation Worksheet.

You should receive Form 5498-MSA, MSA or Medicare + Choice MSA Information for 2000, from the trustee showing the amount you (or your employer) contributed during the year. You can make contributions to your Archer MSA until April 15 (or the next business day if April 15 is a Saturday, Sunday, or holiday) of the following year and deduct them on your Form 1040 for the preceding year to the extent your total contributions do not exceed your limitation.

Excess contributions. You must generally pay a 6% excise tax on contributions you or your employer make to your Archer MSA that are greater than the limits discussed earlier. See Form 5329, Additional Taxes Attributable to IRAs, Other Qualified Retirement Plans, Annuities, Modified Endowment Contracts, and MSAs, to figure the excise tax.

Excess contributions you make. You may withdraw some or all of your excess contributions and not pay the excise tax on the amount withdrawn if you:

• Withdraw these excess contributions by the due date, including extensions, of your tax return,
• Also withdraw any income earned on the withdrawn contributions and include the earnings in "other income" on your tax return for the year you withdraw the contributions and earnings, and
• Do not claim a deduction on your Form 1040 for the amount of the withdrawn contributions.

Excess contributions your employer makes. If your employer makes an excess contribution and the excess was not included in box 1, Form W-2, you must report the excess as "other income" on your tax return. However, you may withdraw some or all of the excess employer contributions and not pay the excise tax on the amount withdrawn if you:

• Withdraw these excess contributions by the due date, including extensions, of your tax return,
• Also withdraw any income earned on the withdrawn contributions and include the earnings in "other income" on your tax return for the year you withdraw the contributions and earnings, and
• Do not claim an exclusion from income for the amount of the withdrawn contributions.

Receiving Distributions

You will generally pay medical expenses during the year without being reimbursed by your HDHP until you reach the annual deductible. When you pay medical expenses during the year that are not reimbursed by your HDHP, you can ask the trustee of your Archer MSA to send you a distribution from your Archer MSA.

A distribution is money you get from your Archer MSA. The trustee will report any distribution to you and the IRS on Form 1099-MSA, Distributions From an MSA or Medicare + Choice MSA.

How to report distributions on your tax return. How you report your distributions depends on whether or not you use the distribution for qualified medical expenses (defined later).

• When you use a distribution from your Archer MSA for qualified medical expenses, you do not pay tax on the distribution but you have to report the distribution on Form 8853. Follow the instructions for the form and attach it to your Form 1040.
• When you do not use a distribution from your Archer MSA for qualified medical expenses, you must pay tax on the distribution and report the amount on Form 8853. Follow the instructions for the form and attach it to your Form 1040. You must also report and pay an additional tax on your Form 1040 unless you meet one of the exceptions listed later under Exceptions to the additional tax.

If an amount is contributed to your Archer MSA this year (by you or your employer), you also must report and pay tax on a distribution you receive from your Archer MSA this year that is used to pay for medical expenses of someone who is not covered by an HDHP, or is also covered by another health plan that is not an HDHP, at the time the expenses are incurred. See the instructions for Form 8853 for more information.

Reporting and paying the additional tax. There is a 15% additional tax on the part of your distributions not used for qualified medical expenses. You report the additional tax in the Other Taxes section of your Form 1040.

Exceptions to the additional tax. There is no additional tax if you are disabled, age 65 or older, or die during the year.

Death of the Archer MSA holder. You should choose a beneficiary when you set up your Archer MSA. What happens to that Archer MSA when you die depends on whom you designate as the beneficiary.

Spouse is the designated beneficiary. If your spouse is the designated beneficiary of your Archer MSA, it will be treated as your spouse's Archer MSA after your death.

Spouse is not the designated beneficiary. If someone other than your spouse is the designated beneficiary of your Archer MSA, on the date you die:

1. The account stops being an Archer MSA, and
2. The fair market value of the Archer MSA becomes taxable to the designated beneficiary.

No designated beneficiary. If you have no beneficiary, the fair market value of the Archer MSA will be included on your final income tax return after your death.

Qualified Medical Expenses

Qualified medical expenses are explained in Publication 502, Medical and Dental Expenses. Examples include amounts paid for doctors' fees, prescription medicines, and necessary hospital services.

You cannot deduct qualified medical expenses as an itemized deduction on Schedule A (Form 1040) if you pay for them with a tax-free distribution from your Archer MSA. You also cannot claim a deduction if you use other funds equal to the amount of the distribution.

Special rules for insurance premiums. Generally, you cannot treat insurance premiums as qualified medical expenses for Archer MSAs. You can, however, treat premiums for long-term care, health care coverage while you receive unemployment benefits, or health care continuation coverage required under any federal law as qualified medical expenses for Archer MSAs.

Recordkeeping. For each qualified medical expense you deduct as an itemized deduction on Schedule A or pay with a distribution from your Archer MSA, you must keep a record of the name and address of each person you paid and the amount and date of the payment. Do not send these records with your tax return. Keep them with your tax records.

Filing Form 8853

You must file Form 8853 and attach it to Form 1040 if you (or your spouse, if married filing a joint return) had any activity on your Archer MSA during the year. You must file the form even if your employer or your spouse's employer made contributions to the Archer MSA.

Employer Participation

This section contains the rules that employers must follow if they decide to make Archer MSAs available to their employees. Unlike the previous discussions, "you" refers to the employer, and not to the employee.

Health plan. If you want your employees to be able to have an Archer MSA, you must make an HDHP available to them. You can provide no additional coverage other than those exceptions listed previously under Other health insurance.

Contributions. You can make contributions to your employees' Archer MSAs. You deduct the contributions on the "Employee benefit programs" line of your business income tax return for the year you make these contributions.

Comparable contributions. If you decide to make contributions, you must make comparable contributions to all comparable participating employees' Archer MSAs. Your contributions are comparable if they are either:

• The same amount, or
• The same percentage of the annual deductible limit under the HDHP covering the employees.

Comparable participating employees. Comparable participating employees:

• Are covered by your HDHP and are eligible to establish an Archer MSA,
• Have the same category of coverage (either self-only or family coverage), and
• Have the same category of employment (either part-time or full-time).

Additional tax. If you made contributions to your employees' Archer MSAs that were not comparable, you must pay an additional tax of 35% of the amount you contributed. Get Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, to report and pay this tax.

Employment taxes. Amounts you contribute to your employees' Archer MSAs are generally not subject to employment taxes. You must report the contributions in box 13 of the Form W-2 you file for each employee during the calendar year. Enter Code "R" in box 12.

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