Your Health Savings Account Might Not Be Exempt

A debtor’s funds held in a Health Savings Account (“HSA”) or Flexible Spending Account (“FSA”) do not appear to be exempt under either New York state exemption law or Section 522 of the Bankruptcy Code. This means that a debtor with a Health Savings Account or Flexible Spending Account might find the funds liquidated by a Chapter 7 Trustee.

A Health Savings Account is a tax-exempt account funded by a debtor, his employer or both, to be used to pay the debtor’s non-insured medical expenses. The debtor owns the account, and the funds in the account belong to the debtor and follow the debtor should he obtain employment elsewhere. In addition, the funds can accumulate from one year to the next—there is no “use it or lose it” provision. When funds from a Health Savings Account are used to pay medical expenses it is not a taxable event.

Some states do provide a specific exemption statute for a Health Savings Account, but New York is not one of them. The most common argument proffered for exemption is that a Health Savings Account is akin to a retirement fund and therefore is exempt for the same reasons that retirement funds are. However, in New York a “retirement fund” is exempt only if “qualified” for tax-exempt status under Internal Revenue Code (“IRC”) sections 401, 402, 403, 408, 408A, 414, 457 or 501(a). Since the tax status of a Health Savings Account is governed by IRC § 223(d), this argument seems destined to fail. Another argument proffered is that a Health Savings Account is akin to a health aid, and should be exempt for that reason. However, the list of health aids exempt in New York is a very narrow one covering essentially prosthetics and guide dogs, and HSA’s do not appear on the statutory list. If a New York debtor does not claim a homestead exemption the state “wild card” exemption of $1,000.00 can be applied to protect an HSA, but any funds above that $1,000.00 figure would be fair game for the Chapter 7 Trustee.

An attempt to claim Health Savings Accounts as exempt under federal bankruptcy law does not seem to fare much better. Since a Health Savings Account is not created “on account of illness, disability, death, age or length of service”, and its tax-exempt status is not derived from IRC sections 401, 402, 403, 408, 408A, 414, 457 or 501(a), it is not exempt as a retirement fund. Further, only “professionally prescribed health aids” are exempt under the federal scheme. It is difficult to imagine that a fund established by the debtor to pay non-insured medical expenses would be deemed “prescribed” by a medical professional, so an HSA is probably not exempt under this section either. In instances where the federal homestead exemption is not being fully used a debtor can employ their federal “wild card” exemption to exempt up to $11,975.00 (increased to $12,725.00 on April 1, 2013) in any asset, including an HSA. Any funds above the “wild card” exemption figure would be fair game for the Chapter 7 Trustee.

A Flexible Spending Account (“FSA”) is a tax-deferred savings account established by an employer to pay a debtor’s medical expenses not paid by insurance. Money withdrawn from an FSA to pay for a debtor’s qualified medical-related expenses is done so tax-free. Unlike an HSA, there is a “use it or lose it” quality to a Flexible Spending Account. Funds in an FSA are forfeited to the employer if not used in the benefit year. While this writer has not seen any reported cases on the issue of whether a Flexible Spending Account is exempt, it is believed that the above analysis concerning Health Savings Accounts applies equally to Flexible Spending Accounts.

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