Four types of tax-advantaged accounts can be used to pay for qualifying unreimbursed medical expenses: Health Care Flexible Spending Accounts (FSAs), Health Reimbursement Accounts (HRAs), Health Savings Accounts (HSAs), and Medical Savings Accounts (MSAs). Qualifying medical expenses typically include deductibles, copayments, and goods and/or services not covered by insurance. (More details are given below.) This report describes current law surrounding these accounts and provides a side-by-side comparison of their key features. The report also provides an indication of the relative prevalence of the accounts. There are two broad categories of tax provisions that can lower an individual's tax liability because of qualifying medical expenses. First, qualifying medical expenses can be a tax deduction. Tax filers can itemize medical expenses incurred by him- or herself, spouse, and dependents if these expenses are over the legislative minimum. Second, tax filers can use one (or occasionally more) of the tax-advantaged accounts discussed in this report. Although the accounts differ in many ways, each account contains contributed income that the account holder uses to pay for qualifying medical expenses. Each account provides tax savings to the account holder because the money contributed to the account is not considered a part of the individual's adjusted gross income. Therefore, no taxes are paid on this income, and for those arrangements where the income is placed in an account, no taxes are paid on interest earned on the income in the account. Moreover, the tax filer does not need to itemize deductions to receive tax savings from the account. Itemized deductions cannot be funded through a tax-advantaged account, and expenses funded through an account cannot be declared as itemized deductions. In other words, "double counting" is prohibited. In general, qualifying medical expenses are defined in the Internal Revenue Code (IRC) at Section 213(d) and typically include deductibles, copayments, and goods and/or services not covered by insurance. The goods and/or services can include medical services rendered by physicians, surgeons, dentists, and other medical practitioners. The costs of equipment, supplies, devices, and prescription drugs are also qualifying expenses. To qualify, the medical care must be primarily used to alleviate or prevent a physical or mental defect or illness. Care used to benefit general health (e.g., exercise equipment, vitamins, and vacations) is not a qualifying medical expense. Some examples of qualifying medical expenses are breast reconstruction surgery, disabled dependent care expenses, fertility enhancement (as specified), hospital services, lifetime care--advance payments, long-term care, psychiatric care, special education, and transplants. Some examples of expenses that are not qualifying medical expenses are cosmetic surgery, funeral expenses, health club dues, and household help. Over-the-counter medications are not qualified medical expenses unless prescribed by a physician. Finally, insulin is always a qualifying medical expense, whether or not it is purchased with a prescription. Table 1 provides a more detailed side-by-side comparison of the laws and regulations governing each account. In each case, the reimbursement is for qualifying medical and dental expenses not covered by insurance. The beneficiaries for all accounts are the employee, spouse, and dependents. FSAs are employer-established arrangements that reimburse employees for qualifying expenses. FSAs are usually funded through salary reduction agreements in compliance with Section 125(i) of the IRC, under which employees receive lower monetary wages in exchange for equivalent contributions to their flexible spending accounts. For example, employees may forgo $100 a month in their 2013 paychecks, which will result in a $1,200 annual contribution to their FSA. The entire annual amount of an FSA must be made available to employees at the beginning of the year. Suppose the above employee had surgery during February, and incurred over $1,500 in unreimbursed qualifying medical expenses. The employee could use the full $1,200 annual FSA contribution to help pay for these expenses, even though he or she may have contributed only $200 into the account by that point in the year. Beginning in 2013, contributions are limited to $2,500 per employee. If each member of a married couple is eligible to enroll in an FSA, then each member can contribute up to $2,500. The FSA limits are adjusted for inflation yearly using the Consumer Price Index for All-Urban Consumers (CPI-U). Prior to 2013, the IRS did not set a maximum annual contribution. Plans typically had a dollar or percentage maximum for elective contributions from salary reductions. Within these limits, employees choose how much to put into their accounts, and this amount can vary from year to year. Employers can choose one of three mutually exclusive policies for the treatment of contributions in any given year that were not used to reimburse qualifying medical treatment in that year: employees forfeit unused balances at the end of the year, employees have a grace period for additional claims of up to 2 1/2 months after the end of the year (i.e., so medical expenses incurred by March 15, 2013, could be reimbursed from the FSA from the 2012 contribution), or employees have a carry-over period where they can transfer up to $500 in unused contributions into an FSA for the next plan year; the employer may specify a lower carry-over amount. This third option is newly available for plan-years beginning in 2013 or later. While compensation received as wages is subject to income taxes, as well as Social Security and Medicare taxes, compensation received as FSA contributions is not subject to these taxes. For this reason, employees who anticipate having health expenses not covered by insurance may prefer FSAs over monetary wages. As mentioned above, many FSAs are funded by salary reduction agreements. These FSAs are governed by Section 125 of the IRC, which exempts contributions from taxes even though the employees have the choice to receive taxable wages. However, if FSAs are funded by nonelective employer contributions then their tax treatment is not governed by the cafeteria plan provisions in Section 125; in this situation, the employee does not have a choice between receiving cash and a normally nontaxable benefit. Instead, the benefits are nontaxable since they are directly excludable under some other provisions of the Code. For example, nonelective employer-funded FSAs for health care are tax-exempt under Sections 105 and 106. Most rules regarding FSAs are not spelled out in the IRC; they were initially included in proposed regulations issued by the Internal Revenue Service (IRS) in 1984 and 1989, and have been subsequently modified. HRAs are employer-established accounts used to reimburse employees and in some instances former employees for qualifying medical expenses. Health reimbursement accounts are sometimes termed health reimbursement arrangements . As is the case with FSAs, contributions are not subject to either income or employment taxes. However, contributions cannot be made through the employees' salary reduction agreements; only employers may contribute. HRAs differ from FSAs in several important respects. Employers may restrict the types of medical and health services that are eligible for reimbursement from the list of qualified medical expenses. For example, an employer may choose not to reimburse expenses associated with acupuncture treatments even though the IRS considers acupuncture a qualifying medical expense. Employers need not actually fund HRAs until employees draw upon them, and the total reimbursement amount for a coverage period need not be available at all times during the period. In addition, the coverage period for the reimbursement amount may be less than a year, and HRAs reimbursements can be limited to amounts previously contributed. Unused HRA balances may be carried over indefinitely, although employers may limit the aggregate carryovers and the carryovers must be used for qualified medical expenses. Finally, employees who change jobs or retire may take the funds in their HRA with them, if their employer has set up an account which allows for this. The provisions in this paragraph, however, are optional (not required) for the employer. HRAs are governed by Section 105 of the IRC, which allows health plan benefits used for medical care to be exempt from taxes, and Section 106 of the IRC, which allows employer contributions to those plans to be tax-exempt. Rules regarding HRAs were spelled out by the IRS in 2002. HSAs are tax-exempt accounts that are used to pay for qualifying medical expenses. Unlike FSAs and HRAs, they are established by individuals with an insurance plan meeting certain criteria. In particular, the individual must have a high deductible health (insurance) plan (HDHP). For those individuals with employer-sponsored insurance, the employer must offer an HSA-qualified plan for the employee to be eligible for an HSA. An individual may also purchase an HSA-qualified insurance plan through the individual insurance market. To be HSA-qualified, the HDHP must meet certain requirements. In 2013, an HDHP must have a deductible of at least $1,250 for self-only coverage and $2,500 for family coverage. The deductible is indexed annually for inflation using the CPI-U. There are other criteria including that the plan holder have no other major medical health insurance policy. In 2013, HSA contributions are limited to $3,250 for self-only coverage and $6,450 for family coverage. These limits are indexed annually by the CPI-U. An additional annual contribution of $1,000 is allowed for people who were age 55 and older at the end of their last tax year and not enrolled in Medicare as of the current month; this contribution is not indexed for inflation. HSA holders cannot contribute to their account in any month they do not have qualifying HDHPs as of the first day of the month. On the other hand, HSA holders can draw funds from their accounts even if they are not permitted to contribute. HSAs can carry significant tax advantages. Contributions made by employers are exempt from income and employment taxes. Account owners may deduct contributions they make from adjusted gross income; in other words, owners do not have to itemize deductions to take advantage of this tax savings. Withdrawals for qualifying medical expenses are not taxed; those used for any non-medical purpose are taxable. In addition, withdrawals for non-medical purposes are subject to a 20% penalty except in cases of disability, death, or attaining age 65. Unused balances may be carried over from year to year without limit. HSAs were first authorized by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA, P.L. 108-173 ). Most statutory rules are in Section 223 of the IRC. The Treasury Department provides revenue guidance as well. MSAs, also known as Archer MSAs, are a precursor to HSAs. Like HSAs, MSAs can be established and contributions made only when insurance plan holders have an HDHP and no other coverage, with some exceptions. Contributions made by employers are exempt from income and employment taxes. Contributions made by account owners (allowed only if the employer does not contribute) are deductible for income-tax purposes even if the account owner does not itemize deductions. Withdrawals are not taxed if used for medical expenses; those used for non-medical purposes are taxable and are subject to a 20% penalty except in cases of disability, death, or attaining age 65. Unused balances may be carried over from year to year without limit. The principal difference between HSAs and MSAs is that MSA eligibility is limited to people who are self-employed or employed by a small employer (50 or fewer employees, on average). In addition, the MSAs' minimum deductible levels are higher and the contribution limits are lower. MSAs were first authorized by the Health Insurance Portability and Accountability Act of 1996 (HIPAA, P.L. 104-191 ). HIPAA limited the total number of MSAs that could be created by all employers. With one exception, no MSAs could be created after December 31, 2007, although MSAs existing at that time were grandfathered. The exception is that an employee who begins to work for an employer that already sponsors MSAs is permitted to open an MSA. Most statutory rules governing MSAs are in Section 220 of the IRC. The Patient Protection and Affordable Care Act (ACA, P.L. 111-148 , as amended) specified that health insurance plans cannot include a cap on benefits. Because HRAs do cap benefits, some have questioned whether HRAs are permitted after the ACA market reforms take effect on January 1, 2014. The IRS has ruled that HRAs are permitted when they are integrated with the other employer-provided coverage, and are not permitted when they are stand alone accounts. An integrated HRA is one where the employees are enrolled in the primary group health plan coverage and no one but the employees are permitted to enroll in the primary group health plan coverage. Most other HRAs are stand-alone HRAs and will not be permitted coverage on or after January 1, 2014. For example, it is not permitted for an employer to provide employees with HRA funding to purchase coverage on the individual market. Data limitations make it difficult to compare measures of account usage across the four accounts. Nevertheless, this section provides a brief overview of the available information, distinguishing between the accessibility of the account and the enrollment in the account. It is easier for each individual employer to report whether it offers one of these accounts than to report the number of employees actually enrolled. For this and perhaps other reasons, published data are more readily available on access than on enrollment. Because very few new MSAs are being created, and because the number of MSAs has always been limited, there are almost no data available on their number. The report also presents measures of the enrollment in each of the four account types. It should be emphasized that the data are not comparable across the accounts. The National Compensation Survey, a survey of employers conducted by the Bureau of Labor Statistics (BLS), reports the percent of workers who have access to health care FSAs. According to the BLS survey, 40% of all civilian workers in 2012 had access to a health care FSA. When viewed by firm size, 53% of civilian workers in firms with 100 or more workers had access to an FSA. The accounts were not as common for civilian workers in small businesses. In establishments with fewer than 100 employees, 20% of the workers had access to a health care FSA. The definition of accessibility is not as straightforward for HSAs and HRAs. Unlike with FSAs, those who hold HSAs must have HDHPs. One measure of HSA accessibility is therefore possession of an HDHP that qualifies for an HSA. According to a survey of private employers conducted by the Kaiser Family Foundation and the Health Research & Educational Trust (KFF/HRET) in 2012, 26% of firms offering health benefits offered an HSA-qualified HDHP. This percent was 12% in 2010 and 18% in 2011. Workers in larger firms were more likely to have access to an HDHP than those in smaller firms. Although employers are not required to restrict HRA benefits to employees with HDHPs, most employers chose to do so. Of employers offering health benefits, there was no discernible upward or downward trend in the percent who offered an HDHP and an HRA; the percentage was 4% in 2010, 7% in 2011, and 5% in 2012. The Employee Benefit Research Institute conducts annual internet surveys of adults ages 21 to 64, inclusive. The survey measures the number of adults with either an HSA or an HRA. The results are then extrapolated. The research concluded that the combined number of adults with either an HSA or an HRA was 4.8 million in 2009, 5.4 million in 2010, 8.5 million in 2011, and 11.6 million in 2012. A substantial majority of these individuals are likely to be HSA holders.

Summary:
Four types of tax-advantaged accounts can be used to pay for unreimbursed qualifying medical expenses: health care flexible spending accounts (FSAs), health reimbursement accounts (HRAs), health savings accounts (HSAs), and medical savings accounts (MSAs). Qualifying unreimbursed medical expenses are defined in the Internal Revenue Code (IRC) and typically include deductibles, copayments, and goods and/or services not covered by insurance. The goods and/or services can include medical services rendered by physicians, surgeons, dentists, and other medical practitioners. The costs of equipment, supplies, diagnostic devices, and prescription drugs are also qualifying medical expenses. Although these four tax-advantaged health accounts share some common features, they also differ in important respects. This report provides brief summaries of the tax-exempt accounts and compares them with respect to eligibility, contribution limits, use of funds, and other characteristics for tax year 2013. A basic discussion of the four accounts is followed by a side-by-side comparison of their key features. The accounts can be summarized as follows, where all accounts reimburse qualifying medical and dental expenses not covered by insurance. FSAs are employer-established accounts that reimburse employees for qualifying expenses. They are usually funded through salary reduction agreements under which employees receive lower monetary wages in exchange for equivalent contributions to their FSAs. HRAs are employer-established arrangements that reimburse employees for qualifying expenses. Contributions cannot be made through the employees' salary reduction agreements; only employers may contribute. Health reimbursement accounts and health reimbursement arrangements are synonyms. HSAs are savings accounts that the account holders use to pay for qualifying expenses. They are established by individuals who must hold high-deductible health plans (HDHPs) in order to establish or contribute to the HSA. Contributions to the accounts can be made by any individual or firm. MSAs are accounts that the account holders use to pay for qualifying expenses. They were established by individuals who held high-deductible health plans (HDHPs) in order to establish or contribute to the MSA. Individuals generally cannot open MSAs after December 31, 2007, but those who had accounts by this date may maintain them. MSA eligibility was limited to people who were self-employed or employed by an employer with fewer than 50 employees. Contributions may be made by the employer or account holder, but not both in the same year. The report concludes with a brief discussion of the usage in these four accounts. Comparing usage is difficult because no single data source contains comparable information on all four accounts and the years of data availability differ across data source. In broad terms, 40% of all civilian workers in 2012 had access to a health care flexible spending account. Of those private firms offering health benefits in 2012, 26% offered an HSA-qualified HDHP.