Closing US Health savings account (HSA)

[skarme312]

I use to live and work in the States but have returned to Canada just before the pandemic.

I have about 18 K USD sitting in a low interest savings account (0.05% interest) in the US. I have not had the need to withdraw funds even once for qualified expenses here in Canada as insurance from my spouse's employer has been more than enough to cover our needs. The HSA provider also does not allow for a Canadian address on file so I have to rely on family to send me new debit cards, statements, etc.

In short, it's proving to be a pain to deal with the HSA and if I close the account and move the funds to Canada and put them in a higher interest account or the stock market I may see it grow and offset the taxes and penalties rather than have it sit in a low interest account and see virtually no growth. This brings me to taxes and penalties. From my research, all the funds I withdraw from the HSA will count as income and I will need to pay federal tax on that. Additionally I will incur a 20 % penalty for early withdrawal as I'm under 65. My confusion is regarding the 20 % penalty. I reached out to a few cross border tax folks and got conflicting answers regarding if the penalty will be allowed as a tax credit on the Canadian return. Researching online has info for 401k to RRSP rollovers which does allow for the penalties to be claimed as tax credit, but no real info on HSA. Any suggestions on what to do in this case and if the HSA early withdrawal penalty will be considered as tax credit on Canadian returns.

[nelsona]

The same rule that applies for 401k/IRA penalties applies to any other penalties arising on early withdrawals. The "penalties" thet CRA does not accept is for late/delinquent filing.

[skarme312]

nelsona wrote:
> The same rule that applies for 401k/IRA penalties applies to any other
> penalties arising on early withdrawals. The "penalties" thet CRA
> does not accept is for late/delinquent filing.

Thank you so much for your reply. I did ask the CRA and they got back to me right away saying that there was a ruling for 401k/IRA and providing me with a doc which is the same as:

https://taxinterpretations.com/node/393060

For HSA they said they will get back to me. I guess it was an odd ball for them.

[nelsona]

I think you can safely assume that it is a tax rather than a penalty for an HSA.
Keep us informed.

[skarme312]

CRA informed me after some calls and delays that HSA early withdrawal penalty cannot be claimed as tax credit on the Canadian side. As mentioned previously it seemed like an odd ball and the individual on the phone was not as confident as with the case of 401 k. I did call/email some cross border tax accountants and got mixed feedback but most claimed closing HSA does NOT have favorable tax outcome. Still left a bit confused :(

[nelsona]

CRA telephlunkies are notoriously incorrect and/or ambiguous in there responses on international and treaty matters.

Simply claim it and it will be accepted. OR use the Health account as it was intended, as the accountant suggested. it is a great tax-free account.

[brianbbc]

This is an ongoing headache with me also, mostly because the cra has not taken the time to clarify their position. I’ve heard from tax specialists that yearly dividends, interest and capital gains in the hsa are to be reported in Canada on the yearly tax return. But when you take a non medical distribution at age 65(without a penalty from the irs ), you are taxed as regular income in the US (and take the cra tax credit on your T1.). However, you don’t claim it with the cra as regular foreign income, but as foreign capital gains, depending on what the account was worth when re-entering Canada and the date you sold it. Seems like a double taxation to me, in a similar sense of taxing dividends in a RRSP, then taxing the distribution when you take it out of the account. Then theres the issue reporting only qualified medical deductions to the cra, the tax specialists and the cra cannot agree on this, at least that’s what I found after speaking to half dozen of them

[nelsona]

The treaty (XVIII.7) is clear that US accounts created to provide employee benefits is not to be taxed in Canada until withdrawn, and. by the rest of Article XVIII. then only to the extent that it is taxed in US.

I wouldn't worry about asking CRA to flail around trying to give you an answer.

[brianbbc]

I was originally referencing a post on March 7 2024 in which you referred to article XX1(2) as the case for hsa. Of course the cra competency authorities told me this doesn’t exist. Article XV111.7 you mentioned is clear on this topic. Thanks again.

[brianbbc]

I was originally referencing a post on March 7 2024 in which you referred to article XX1(2) as the case for hsa. Of course the cra competency authorities told me this doesn’t exist. Article XV111.7 you mentioned is clear on this topic. Thanks again.

[brianbbc]

I’ve previously spoke to a border “tax expert”, he told me the CRA views the HSA as similar to other investment accounts: when individuals move to Canada, they receive a step-up on the adjusted cost basis (ACB) of the investments within the HSA based on the fair market value (FMV) of the account at the time they become a Canadian tax resident.When assets within the HSA are sold, resulting capital gains are taxable on the individual's Canadian tax return. Also, years in which there are no withdrawals from the HSA account, any interest, dividends, and realized capital gains within the account are subject to taxation in Canada. I’m thinking cross border tax experts who take this stance are not willing or don’t know, how to apply XVIII.7 properly in this case?

[nelsona]

Yeah. The principles are that these accounts are tax deferred in Canada by XVIII.7 , and that since they are listed in the Pensions sections, are taxable to the same extent as the account would be in US.

Otherwise, CRA would have issued a ruling stating otherwise.

[brianbbc]

Out of curiosity, I couldn’t find health savings account actually listed in XVIII. I am assuming the rational is that they fall under “employee benefits” statement to be taxed in Canada as they are taxed in the USA. I’m convinced your about hsa taxation conclusion vs the tax advisers I’ve consulted (who state it is not part of the treaty) is valid, otherwise why would the cra even list “employee benefits” in the first place if you can’t apply it to such a case

[nelsona]

"employee benefits" covers it.

Btw, Canada now has a form of HSA, so how they handle it in Canada would likely be similar.

[brianbbc]

When filing the T4, do I use line 11500 -Foreign Pension Income- for a USA based HSA qualified (non medical) distribution? The same line when reporting an IRA distribution. Does a qualified Roth distribution also need to be reported line 11500?