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Health Savings Accounts: Don’t miss this one-time break

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in Small Business Tax,Small Business Tax Deduction Strategies

With all the talk about health insurance in the national political campaigns, maybe it’s time to take another look at Health Savings Accounts (HSAs). With an HSA, distributions to pay qualified medical expenses are tax-free.

A tax law enacted a little over a year ago—the Tax Relief and Health Care Act of 2006—included several key improvements for HSAs.

Strategy: When it makes sense, roll over funds from an IRA to an HSA. The transfer is tax-free. Then you can take tax-free distributions from the HSA to pay for qualified medical expenses. This special tax break (i.e., tax-free distributions to pay medical expenses) is only available to HSA owners. IRA distributions for medical expenses are taxable. But there’s a catch: You can only do this once in your lifetime.

Similar rules apply to rollovers from a flexible spending account (FSA) or health reimbursement arrangement (HRA).

Here’s the drill: Normally, a distribution from an IRA is subject to tax at ordinary income rates. But the 2006 law allows you to transfer IRA funds to an HSA—just once—completely tax-free. Moreover, the usual 10% penalty on preage 59 1/2 withdrawals doesn’t apply. You can’t roll over more than the maximum HSA contribution for the year. For 2008, the contribution cap is $2,900 for an individual; $5,800 for family coverage. Anyone overage 55 can chip in an extra $900.

Tip: Once the rollover election is made, it’s irrevocable. There’s no going back!

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