This bill amends section 223 of the Internal Revenue Code to change how health savings accounts (HSAs) operate for taxpayers and trustees. Key changes: an income-based reduction of deductible HSA contributions, removal of a penalty-free distribution exception, a two-year window for reimbursements, new substantiation duties placed on trustees, explicit exclusions for spa and large exercise-equipment expenses, additional payroll-tax treatment for certain employer-provided HSA payments, and a new excise tax and reporting regime aimed at excessive HSA fees.
The package is consequential because it narrows who benefits from tax-preferred HSA contributions, shifts compliance obligations onto trustees and providers, and creates a new enforcement pathway (tax on excessive fees plus expanded trustee reporting). For tax, benefits, and financial institutions that administer HSAs, the bill raises operational and recordkeeping stakes while changing the tax calculus for higher-income taxpayers who currently use HSAs as tax-advantaged savings vehicles.
At a Glance
What It Does
Reduces deductible HSA contributions above specified modified AGI thresholds using a phaseout formula, eliminates a statutory exception that allowed some penalty-free distributions, requires that reimbursements be claimed within two years, and mandates substantiation of qualified medical expenses with a trustee determination process. It also creates an excise tax on 'excessive' HSA fees and requires trustees to report fee categories and demographic breakdowns, plus reporting of average yields on cash balances.
Who It Affects
HSA account holders (especially higher-income filers), HSA trustees and custodians (banks, broker-dealers, fintechs), employers that make contributions or facilitate payroll deductions, health-care providers asked to substantiate expenses, and the IRS (enforcement and rulemaking).
Why It Matters
The bill shifts tax benefits toward lower- and middle-income filers through an AGI-linked reduction, tightens anti-abuse controls by imposing substantiation and timing limits, and creates direct regulatory and financial incentives for trustees to limit fees — all of which change operational risk and product design for HSA suppliers.
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What This Bill Actually Does
The bill makes a suite of technical but material changes to how HSAs work. It adds an income-based phaseout that reduces the deductible contribution available under section 223 once a taxpayer’s modified adjusted gross income exceeds a threshold tied to filing status.
The reduction is proportional and caps out relative to fixed dollar amounts, meaning higher earners will see their HSA deduction shrink before being eliminated. The bill defines ‘modified adjusted gross income’ for this purpose by excluding certain foreign-income provisions so the phaseout uses domestic AGI as its base.
The bill also tightens the connection between distributions and actual medical spending. It removes an existing statutory exception to the rule that penalty-free distributions must be for qualified medical expenses, and it requires that reimbursements be taken within two years of when the underlying medical expense was paid.
Beyond timing, the bill requires that any distribution claimed as a qualified medical expense be substantiated. Where provider opinions are relied upon, those opinions must stem from a bona fide provider–patient relationship and be based on an assessment that is either in-person or of a type that accepted medical standards do not require in-person.
The trustee of the HSA is explicitly tasked with determining whether distributions meet these substantiation rules.On the tax-administration side, the bill changes payroll-tax treatment to bring certain employer HSA-related payments within FICA and railroad retirement tax regimes under specific conditions, clarifies the tax treatment of non-deductible contributions and coordinates with the 4973 excise tax on excess contributions, and imposes an excise tax on trustees that charge fees deemed ‘excessive.’ The Secretary of the Treasury is directed to specify what fees are reasonable for various categories, and trustees must report fee volumes and demographics under a new information reporting section. The bill also requires trustees to include in periodic account reports the average yield on cash balances alongside a national average yield to enable comparisons.Most provisions carry an effective date for amounts or taxable years beginning after December 31, 2025, with payroll-tax changes targeted to payments made after that date.
Several provisions delegate substantial rulemaking authority to the Secretary — for example, to define reasonable fees and to issue regulations implementing substantiation and trustee reporting — which means many practical details will be set in later administrative guidance.
The Five Things You Need to Know
The bill adds section 223(b)(9), which phases down the deductible HSA contribution once a taxpayer’s modified adjusted gross income exceeds filing-status thresholds: $300,000 (joint), $250,000 (head of household), $150,000 (separate), and $200,000 (single), with a proportional reduction using $40,000 ($20,000 for married filing separately) as the phaseout base.
Reimbursements from HSAs must be claimed no later than two years after the date the underlying qualified medical expense was paid; distributions after that window are not treated as for qualified medical expenses.
Trustees must substantiate that distributions are for qualified medical expenses; provider opinions count only if based on a bona fide provider–patient relationship and an assessment either done in-person or of a type that accepted medical standards permit remotely, and trustees must make the determination.
The bill creates a new excise tax on trustees for any HSA fees that exceed the Secretary’s ‘reasonable’ amount by category (maintenance, transfers, paper statements, checks, replacement cards, withdrawals, NSF fees and others the Secretary identifies) and imposes a new information return (sec. 6039M) requiring fee descriptions, counts, aggregates, and demographic breakdowns.
Payroll-tax rules are adjusted so that certain employer-provided payments excludable under section 106(d) can be treated as wages for FICA and railroad retirement taxes in specified circumstances, and reports must show average yield on HSA cash balances alongside a national average.
Section-by-Section Breakdown
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Remove exception to penalty-free distribution rule
This section strikes subparagraph (C) of 223(f)(4), eliminating a statutory exception that previously allowed certain penalty-free distributions not explicitly tied to qualified medical expenses. The practical effect is to narrow the universe of penalty-free distributions: moving forward, the statutory safe harbor requires distributions to meet the qualified-medical-expense standard unless another explicit exception remains in the Code. Administratively, taxpayers and trustees should expect increased IRS scrutiny of distributions previously defended under the struck exception.
Income-based reduction of deductible HSA contributions
Adds a new paragraph establishing a modified AGI phaseout for the deduction under section 223(a). The reduction formula compares the taxpayer’s modified AGI to filing-status thresholds and scales the allowable deduction down proportionally based on a $40,000 (or $20,000 separate filer) phaseout range. It also amends related provisions: it changes distribution rules for non-deductible contributions to reference section 72 rules, coordinates the 4973 excess-contribution rules, and amends FICA and railroad-tax chapters to treat certain section 106(d) payments as wages or potentially as wages where reasonable belief of exclusion exists. The cross-cutting amendments mean payroll systems, benefits accounting, and tax reporting will all need updates if implemented as written.
Two-year limit on reimbursement timing
Modifies 223(d)(2) to require that an HSA reimbursement be taken within two years of when the underlying expense was paid. This is a strict statute-of-limit style rule for reimbursement timing; it eliminates indefinite reimbursement strategies where long-held receipts are later reimbursed tax-free. For account holders who historically used HSAs as long-term tax-advantaged savings for past medical costs, the change forces earlier claiming or risk of taxable distributions.
Substantiation requirement and trustee determination
Imposes an express substantiation requirement: distributions are not qualified unless documented. Provider opinions can support substantiation only if they stem from bona fide provider–patient relationships and are based on assessments that are in-person or of a type that generally accepted medical standards permit to be remote; additionally, the expense must be typically recommended under accepted standards. The trustee is assigned the duty to determine whether distributions meet these rules, turning trustees into active gatekeepers. The Secretary is given rulemaking authority to flesh out documentation and process standards, which will determine practical compliance burdens.
Specific exclusions from qualified medical expenses
Adds explicit exclusions for spa and beauty treatments and for exercise equipment expenses above $500 in any taxable year. By listing these exclusions, the bill reduces ambiguity for common borderline items, but it also creates a bright-line cap that account holders and trustees must track for equipment purchases. Financial institutions will likely need to alter customer education and systems to detect and report these disallowed amounts.
Excise tax on excessive fees, trustee reporting, and yield disclosure
Creates a new Chapter 50B imposing a tax on trustees equal to the amount by which a charged fee exceeds the Secretary-determined reasonable fee for each fee category, and inserts a new section 6039M requiring trustees to file an annual return listing fee categories, counts, aggregate amounts, and demographic breakdowns. It also requires account reports to state the average yield on cash balances compared with a national average yield. The Secretary is tasked with defining fee categories and reasonable amounts; that delegated authority will determine how aggressive enforcement is and whether common bank fees are swept into the excise tax. The reporting obligations create both transparency and compliance costs for trustees.
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Explore Healthcare in Codify Search →Who Benefits and Who Bears the Cost
Every bill creates winners and losers. Here's who stands to gain and who bears the cost.
Who Benefits
- Middle- and lower-income HSA holders: The AGI-linked reduction targets higher earners, which effectively preserves more of the deduction’s value for those below the thresholds and reduces a subsidy that disproportionately accrued to high-income taxpayers.
- Consumers of small-balance HSAs and savers with minimal account yields: Fee reporting, a tax on excessive fees, and yield disclosure increase competitive pressure on trustees to lower fees and improve yields, potentially lowering costs for consumers.
- IRS and federal policymakers: The Bill centralizes administrative levers (substantiation rules, trustee reporting, excise tax) that make enforcement of qualified-expense rules and fee oversight more practicable.
- Employers seeking clearer payroll-tax treatment: The statutory adjustments to FICA and railroad-tax definitions clarify when certain HSA contributions may be treated as wages, reducing ambiguity for payroll departments.
Who Bears the Cost
- HSA trustees, custodians, and administrators: They face new compliance and reporting obligations (sec. 6039M), potential exposure to an excise tax if fees exceed Secretary-set reasonable levels, and operational changes to support trustee determinations on substantiation.
- Higher-income account holders: Taxpayers above the modified AGI thresholds will see a reduced deductible contribution, increasing their after-tax cost of HSA funding.
- Health-care providers and clinicians: When provider opinions are used to substantiate expenses, clinicians will be asked to document bona fide relationships and assessments that meet the statutory test, potentially increasing administrative paperwork and liability considerations.
- Plan sponsors and payroll processors: Changes to payroll-tax treatment and coordination with employer-provided HSA payments could trigger changes to payroll systems and employer tax withholding processes, increasing administrative burden and potential costs.
Key Issues
The Core Tension
The central dilemma is balancing anti-abuse, consumer-protection goals against preserving HSAs’ value as a flexible, long-term, tax-advantaged vehicle: stricter substantiation, timing limits, and fee controls reduce misuse and financial friction for many consumers, but they also impose compliance costs on trustees, constrain taxpayer planning (especially long-term medical savings strategies), and put discretionary power in administrative rulemaking rather than in the statute’s text.
The bill trades broader HSA flexibility for tighter anti-abuse measures and consumer protections, but it leaves critical implementation details to Treasury rulemaking. The Secretary’s authority to define ‘‘reasonable’’ fees and to issue substantiation regulations is the hinge on which the bill’s practical effect will swing: an expansive interpretation could subject standard bank servicing practices to excise tax exposure, while a narrow one could blunt enforcement.
Trustees will need to build or buy systems to capture fee categories, demographic breakdowns, and to make and document substantive determinations about distributions — a nontrivial compliance investment, especially for smaller custodians.
The two-year reimbursement window and stricter substantiation may curb long-duration reimbursement strategies, but they also risk penalizing legitimate taxpayers who retain receipts but lack contemporaneous provider documentation. The provider-opinion qualification creates tension with telehealth and modern remote-assessment practices because the statute allows non–in-person assessments only when accepted standards do not require in-person care; how that exception is applied will materially affect behavioral and technological practices.
Finally, the interaction of the new payroll-tax treatment with existing FICA and railroad rules raises questions about employer withholding, reporting synchronization, and the timing of gross-to-net determinations that could produce transitional compliance headaches.
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