So, you’re finally on the HSA bandwagon.  You now realize it’s the only account within which to build tax-free wealth.  It’s the new 401(k).  You now realize that you need to actually invest the money in your HSA if want to build tax-free wealth and get the triple-tax advantage. You now have taken the extra step of simply paying your medical costs out of pocket and delaying reimbursements from your HSA…until…well, a long time from now, because you want to maximize the tax-free investment gains.

And now you have a problem. You need to keep track of all those receipts for future tax-free distributions from your HSA.  OR DO YOU!?!? [enter twilight zone sound effects]

Ok, yes, you do.  But seriously, don’t get strung out about this.  It’s not as hard as you think, nor do you need to keep some amazingly detailed and up-to-date spreadsheet; nor do you need to take a picture of every receipt and upload it into the cloud somewhere – but you can if that’s your thing.

One of the pushbacks we receive quite often when talking about the magical* essence of HSAs, and how to maximize that magic*, is that people don’t want to do all the recordkeeping of keeping track of their medical receipts.  It’s just such a burden.

I get it.  But I don’t.

Here’s the thing to keep in mind.  The only reason you actually need documentation of your receipt (or documentation of your qualified HSA-reimbursable medical expense) is if you need to prove it to the IRS, which would only happen if the IRS audited your tax return.  See, everything is self-reported on Form 8889 as a part of your IRS tax package. Line 14a basically asks, “how much did you take out of your HSA?” and then Line 15 asks, “and of the amount you took out of your HSA…how much was for qualified medical expenses?”. Line 16 then asks, “so how much was NOT for qualified medical expenses?” because “you’re going to pay us taxes on that amount son!”.  Of course, Line 16 will always be $0, right? I sure hope so. And that’s it.  You don’t need to submit any documentation to the IRS.  You don’t need to prove anything to the IRS about what you noted on line 15…unless they ask you to through an audit.

Now, don’t get me wrong.  I’m not saying pull out money that is NOT for qualified medical expenses, nor am I saying not to have the backup to prove it to the IRS. 

Rather, I’m simply suggesting to minimize the chances of getting audited and also to minimize your recordkeeping efforts unless you actually get audited.  Like, don’t do the work unless you need to, ok?

Now, I don’t work for the IRS and I’m not suggesting I know all their flags to start an audit.  But I have thought of the types of flags I would create if I did work at the IRS.  As an example, if someone took a $150,000 distribution from their HSA (reporting $150,000 on Line 14a of their Form 8889) and then reported $0 as taxable income ($0 on Line 16)…I’d be like, “wait a minute, how is that possible.  Johnny, go check out this guy reporting $150,000 as tax-free distribution from his HSA, because that is unlikely!” But if someone reported $5,000 as a tax-free distribution, I’d be like “oh yeah, that makes sense.  Nothing to find here Johnny.”

So where’s the line? I’d look at what the IRS considers to be a High-Deductible Health Plan in the first place. For 2020, the IRS defines a high deductible health plan as any plan with a deductible of at least $1,400 for an individual or $2,800 for a family. An HDHP’s total yearly out-of-pocket expenses (including deductibles, copayments, and coinsurance) can’t be more than $6,900 for an individual or $13,800 for a family. (This limit doesn’t apply to out-of-network services.)

Given those figures, I would then cap my annual HSA reimbursement at $13,800 (or, if you reported being able to only contribute the “single” limit of $3,550 on the top part of the Form 8889, then I’d cap my reimbursement at $6,900). The IRS is likely only looking at things on an annual basis. And if you took a distribution of $13,800 in any single year, they’d be like, “Oh yeah, makes sense.  That person hit their out-of-pocket max this year on their health plan.  Bummer.  But there’s nothing to see here Johnny.”

Of course, you savvy financial folk on the HSA bandwagon know that there is no time limit to seek a reimbursement from your HSA for a qualified medical expense.  And yes, you may have accumulated $150,000 of unreimbursed medical expenses over the past 25 years while banking those tax-free investment earnings, but I still think it’s a good idea to cap your annual reimbursement at the $13,800 – or whatever the IRS max out-of-pocket number is indexed to in a future calendar year.

So, what if you do get audited? Either because the IRS got trigger-happy or because you decided that $150,000 HSA reimbursement was a good idea?

Don’t worry, you’ve kept all your receipts.  Because I didn’t tell you not to keep them. I mean, keep them! But don’t waste your time keeping them. Here’s how I would do it.  In fact, here’s how I actually do keep my receipts.  Are you ready for this?

Every time I pay a bill, I just write down “paid date” on the bill and stash that bill in a box in my furnace room.  It’s becoming a big box, but it only takes me 3 seconds to do it.  I’m not spending the time keeping detailed records or tidy records or a detailed log of every expense in excel or in some cloud somewhere.  It’s just a box of papers, and I haven’t wasted any time keeping track.  Yes, I have a rough idea in my head of how much I can reimburse myself, but I’m also not planning on any HSA distribution until a very long time from now…like retirement. I’m also not planning on getting audited, so I have no plans to sift through that box of papers either.  I don’t ever actually want to do any work on this.  I just want to build up some tax-free wealth. So that’s what I’m doing.  But I also know that if I ever do get audited, I have the ability to spend some time sifting through papers and proving my tax-free money really is tax-free. If I ever actually get to that bridge…then I’ll cross it.  But no point in trying to cross a bridge over miles and miles of perfectly mowed pasture grass.

*and by magic, we mean tax-free-ness

Contributed by Brian Riefepeters, FSA, EA