Wednesday, October 24, 2007


If it’s Wednesday it must be Ask The Tax Pro! How about another New Jersey state question this week.

Q. NJ recognizes the older Archer MSAs (NJSA54A:3-4, and it's covered in the NJ-1040 instructions) but not the newer Health Savings Account, although a bill is pending to do that, Assembly Bill 724. So there is no NJGIT deduction for HSA contributions.

For federal tax purposes, taxpayers are told not to include the HSA payments in their deductible medical expenses, as the amounts have already been deducted. A lot of taxpayers are like me, do their federal returns first and then copy over the base numbers to the NJ return without doing a lot of thinking.

I have learned that the NJ deduction of medical expenses in excess of 2% of taxable income (under NJSA 54A:3-3) is a lot better than the federal threshold of 7.5% of AGI. Shouldn't NJ taxpayers be advised to add HSA contributions to the deductible medical expenses for NJ purposes?

I thought you would know if my analysis is right, whether practitioners are already giving this advice, and if accurate and not already out there how to promulgate it.


A. Your analysis is not quite right.

As you mention, you can deduct medical expenses on your NJ-1040 to the extent that the total exceeds 2% of your NJ Gross Income. This is indeed “more better” than the federal 7½% of AGI exclusion. You may deduct medical expenses on your NJ-1040 even it you do not itemize and claim medical deductions on your federal Form 1040.

Two items are deductible in full as a medical expense on the NJ-1040. They are not subject to the 2% of NJ Gross Income exclusion. They are the Self-Employed Health Insurance Deduction and contributions to an Archer Medical Savings Account (MSA).

New Jersey follows the federal rules for contributions to an Archer Medical Savings Account – created by the Health Insurance Portability and Accountability Act of 1996. If you fill out federal Form 8853 for 2007 you can deduct the qualified Archer MSA contribution reported on this form on your NJ-1040, without regard to the 2% of NJ Gross Income exclusion. You must include a copy of your federal Form 8853 with the filing of your 2007 NJ-1040.

Here is how deducting medical expenses on the NJ return works. First you add up your total allowable medical expenses, without any qualified self-employed health insurance premiums or MSA contributions. From this total you subtract 2% of your NJ Gross Income (line 28 of your NJ-1040). If the result is less than “0” you would use “0”. Now you add your self-employed health insurance premiums and Archer MSA contributions (the same amounts as allowed as “above-the-line” adjustments to income on your federal Form 1040). The total is the amount you can claim as a medical deduction on your NJ-1040. There is a worksheet for doing this calculation in the NJ-1040 instruction package.

As you state, qualified contributions to a Health Savings Account (HSA), while deductible as an adjustment to income on the federal Form 1040, are not deductible on the NJ-1040. The HSA was created by the Medicare bill signed into law by President Bush in 2003. You can not add your HSA contributions to the allowable NJ medical expenses subject to the 2% exclusion.

The medical expenses deductible on your NJ-1040 subject to the 2% exclusion would be the same as the total medical expenses deductible on the federal Schedule A before deducting the 7½% of AGI exclusion (Line 1 of the federal Schedule A). So carrying over this base number from your federal return to your NJ-1040 is not a problem. To repeat what I said above, you would not add your HSA contributions to this amount for the NJ return.

Here is where HSA activity comes into play on the NJ-1040:

On the federal return, as qualified contributions to both the MSA and HSA are deductible up front, you must reduce your medical expenses by any reimbursements you receive from an Archer Medical Savings Account or a Health Savings Account, as well as reimbursements from your insurance provider or from your employer under a medical reimbursement or pre-tax flexible benefit plan.

But because HSA contributions are not deductible on the NJ state return, you do not have to reduce the medical expenses claimed on the NJ-1040 by any reimbursements or payments from a Health Savings Account.

If your medical expenses for the year total $10,000 and you received a reimbursement of $2,000 from a Health Savings Account, only $8,000 can be used to determine your federal Schedule A deduction. But the full $10,000 can be deducted on your NJ-1040, minus, of course, the 2% of NJ Gross Income exclusion.

FYI, just as HSA contributions are not deductible on the NJ-1040, New Jersey does not treat employee contributions to a Section 125 employer-sponsored medical Flexible Spending Account (FSA) as “pre-tax”. If your gross wages for the year are $100,000 and you contribute $5,000 to your medical FSA, your federal taxable wages are $95,000, but your NJ state taxable wages are $100,000. Therefore, you also do not have to reduce your NJ medical expenses by reimbursements received during the year from your medical FSA.

As for what other tax professionals are advising their clients regarding HSAs - I haven’t a clue. I only know what I advise my clients.

I have just “promulgated” the appropriate advice concerning the NJ tax treatment of HSA activity here in this posting to THE WANDERING TAX PRO! And, if I may be permitted a plug – NJ taxpayers can learn more about deducting medical expenses on their NJ-1040 by ordering my special report “DEDUCTING MEDICAL EXPENSES ON YOUR 2007 NEW JERSEY STATE INCOME TAX RETURN”. Order by October 31st and it is yours for only $1.00!

I hope my answer has cleared up this issue for you. Please let me know if you need any further clarification.



Anonymous said...

That was great! The NJ-1040 instructions are cryptic even for initiates, and I really like the way you expanded the topic to cover the NJ-1040 medical expense field.

I've only been reading your blog for a couple of weeks and I'm hooked.

Chris Johnson, EA said...

Just thought I'd leave a comment on the subject related to health expenses and taxes. The Health Savings Account (HSA), when you think about it, is the "ultimate" tax shelter against federal taxes, perhaps even better than any IRA or 401k (which you should still contribute to as well). Money contributed to a Health Savings Account gets deducted from your gross income, if invested wisely, grows tax free, and as long as the money is used for health-related expenses, you will never pay any federal tax on the withdrawals, unlike withdrawals from IRAs and 401k plans (state tax laws may vary). If you contribute the maximum amount to an HSA ($6750 for most families in 2016) and never use any of the money for health expenses during the year, you are getting the best deal of all because the money will simply roll over, continue to grow tax-free and will always be available to you for un-reimbursed medical expenses, which are likely to be more substantial by the time you retire. This can work well for the rest of us who don't have the ability or means to set up a dummy corporation in the Cayman Islands or Bermuda for sheltering our investment income. I intend to write further about this on my own blog.