To qualify for a Medicare+Choice Medical Savings Account (M+C MSA), you must be eligible for Medicare and have a high deductible health plan (HDHP) that meets the Medicare guidelines outlined below. If you have additional health insurance coverage that would cover your deductible, you cannot keep the additional coverage and still enroll in an M+C MSA plan.

M+C MSAs are administered through the Federal Medicare program. The Health Care Financing Administration (HCFA) has more information about this program. You can get this information by calling 1-800-318-2596. You can also reach HCFA through the Internet at www.medicare.gov.

Understanding M+C MSAs

To understand M+C MSAs, you will want to know what an M+C MSA is and what the benefits are of having one. You will also need to know whether you meet the rules for starting an M+C MSA. If you meet the rules, then you may want to read the section titled Setting Up the M+C MSA.

What is an M+C MSA? An M+C MSA has two parts. One part is a tax-exempt trust or custodial savings account that you set up with a financial institution (like a bank or an insurance company) in which the Medicare program can deposit money for qualified medical expenses. The money in your account is not taxed if it is used for qualified medical expenses, and it may earn interest or dividends.

In an M+C MSA plan, qualified medical expenses do not include amounts paid for medical care for any individual other than the account holder.

The other part of an M+C MSA is an M+C MSA Health Policy. This is a special health insurance policy that has a high deductible. See M+C MSA High Deductible Health Plan (M+C MSA HDHP), later.

What are the benefits of an M+C MSA? You may enjoy several benefits from having an M+C MSA.

• The Medicare program, not you, makes a tax-free deposit to your account each year.
• The Medicare program, not you, pays a monthly premium to the insurance company for your policy.
• The interest or other earnings on the assets in your M+C MSA are tax-free.
• The contributions remain in your M+C MSA account from year to year until they are used regardless of whether you are still enrolled in the program.

Example. In 1999, Jane chooses an M+C MSA plan and sets up an account. With this plan, Jane receives a $1,200 yearly deposit from the Medicare program into her account. This amount is deposited into her account on January 1, 2000. During 2000, Jane has a routine check-up, dental check-ups, and fills her regular prescriptions (benefits not covered by the original Medicare plan). She pays for these services by using $300 of the $1,200 which the Medicare program had deposited into her account. At the end of the year, Jane still has $900 in her account. On January 1, 2001, another $1,200 deposit is made to her account by the Medicare program. Now Jane has $2,100 (plus any interest earned) in her account for medical expenses.

Rules for Starting an M+C MSA

You need to meet the following conditions before you can start an M+C MSA.

1. You must be eligible for Medicare.
2. You must have an M+C MSA HDHP which is approved by Medicare.
3. You must have an account set up with a bank or other institution which is registered with the Medicare program to set up M+C MSA accounts.

Call 1-800-318-2596 for a list of insurers and their phone numbers, or look for this information on the Internet at www.medicare.gov.

M+C MSA High Deductible Health Plan (M+C MSA HDHP). To be eligible for an M+C MSA, you must have an M+C MSA HDHP. You generally cannot have another health insurance plan. You choose the policy you want to use as part of your M+C MSA plan. However, the policy must have been approved by the Medicare program.

Definition. An M+C MSA HDHP:

1. Has a higher annual deductible than typical health plans, and
2. Must have been designed to work as part of an M+C MSA plan.

In 1999 and 2000, the annual deductible for the policy cannot exceed $6,000 and $6,300 respectively.

Other health insurance. An M+C MSA account holder generally cannot have any other health plan that is not an HDHP. However, this rule does not apply if the other health plan(s) only covers the following items.

1. Accidents.
2. Disability.
3. Dental care.
4. Vision care.
5. Long-term care.
6. Benefits related to workers' compensation laws, tort liabilities, or ownership or use of property.
7. A specific disease or illness.
8. A fixed amount per day (or other period) of hospitalization.

Setting Up the M+C MSA

When you set up an M+C MSA, you choose the bank or other institution where the account will be. The organization you choose will be the trustee or custodian of your account. The bank or institution must be registered with the Medicare program to set up M+C MSAs. The trustee can be a bank, insurance company, or anyone already approved by the IRS to be a trustee of individual retirement arrangements.

You choose the insurance policy you want to use as part of your M+C MSA plan. This policy must have been approved by the Medicare program. The policy is offered to you by an insurance company and it must be designed to work as part of an M+C MSA plan. It must have a high annual deductible which cannot be more than $6,000 in 1999 or $6,300 in 2000. Every month, the Medicare program (not you) pays the premium for your policy directly to the insurance company.

Who can contribute to my M+C MSA? At the beginning of the year, the Secretary of Health and Human Services, through the Medicare program, makes a deposit to your account for the entire year. See Making Contributions to an M+C MSA, later.

How can I make withdrawals from my M+C MSA? You can make tax-free withdrawals from your M+C MSA to pay for qualified medical expenses (discussed later). If you make withdrawals for other reasons, the amount you withdraw will be subject to income tax and may be subject to an additional penalty tax as well. See Receiving Distributions from an M+C MSA, later. You do not have to make withdrawals from an M+C MSA each year.

Making Contributions to an M+C MSA

The amount of the annual tax-free deposit made by the Medicare program to your M+C MSA will depend on the policy that you select and the area in which you live. The deposit may also vary depending on the services your policy covers. Each insurance company that offers a policy will tell you the exact amount of the deposit you will receive.

If you should set up an M+C MSA with one trustee and then later set up another M+C MSA with a different trustee, you can have the assets transferred from one account to the other without becoming liable for taxes. However, the transfer must be made only by the trustees and only between your own M+C MSAs.

Are there any limits to contributions? Only the Secretary of Health and Human Resources, through the Medicare program, can make deposits to your M+C MSA. The appropriate deposit will be made in one lump sum at the beginning of the year.

Note. If a mistake is made and too much money is deposited into your M+C MSA, the excess contribution can be returned to the Secretary of Health and Human Resources (along with any interest or dividends earned on the overpaid amount) without you having to pay any extra tax or penalty on that amount.

Receiving Distributions from an M+C MSA

You will generally pay medical expenses during the year without being reimbursed by your HDHP until you reach the annual deductible. When you pay medical expenses during the year that are not reimbursed by your HDHP, you can ask the trustee of your M+C MSA to send you a distribution from your M+C MSA.

A distribution is money you get from your M+C MSA. The trustee will report any distribution to you and the IRS on Form 1099-MSA, Distributions From Medical Savings Accounts.

How to report distributions on your tax return. How you report your distributions depends on whether or not you use the distribution for qualified medical expenses, defined later.

• When you use a distribution from your M+C MSA for qualified medical expenses, you do not pay tax on the distribution. Report distributions on Form 8853, Section B. Follow the instructions for the form and attach it to your Form 1040. You cannot file Form 1040A or Form 1040EZ.
• When you do not use a distribution from your M+C MSA for qualified medical expenses, you must pay tax on the distribution and report the amount on Form 8853, Section B. Follow the instructions for the form and attach it to your Form 1040.

Note. If you are married filing jointly and both you and your spouse received distributions from an M+C MSA, attach a separate Section B of Form 8853 for each spouse. Get Instructions for Form 8853.

Reporting and paying the 50% penalty tax. You may have to pay a 50% penalty tax on the part of your distributions not used for qualified medical expenses. You report the penalty tax on your Form 1040 unless you meet one of the following exceptions.

Exceptions to the 50% penalty tax. There is no 50% penalty tax if you are disabled or die during the year.

Figuring the M+C MSA 50% penalty tax. Refer to Section B -- Medicare + Choice MSA Distributions in the Instructions for Form 8853 to figure whether you owe the 50% penalty tax and how much the 50% penalty tax is if you do owe it. Since the penalty computation method may vary depending on which year you are reporting distributions for, be sure to use the instructions for the specific year in which the distributions were made.

Death of the M+C MSA holder. What happens to your M+C MSA when you die depends on whom you designate as the beneficiary.

When your spouse is the designated beneficiary. If your spouse is the designated beneficiary of your M+C MSA, it will be treated as your spouse's MSA after your death. However, no further contributions will be made by the Secretary of Health and Human Resources and distributions will be subject to the rules of regular MSAs, not M+C MSAs.

When your spouse is not the designated beneficiary. If someone other than your spouse is the designated beneficiary of your M+C MSA on the date you die, then:

1. The account stops being an M+C MSA, and
2. The fair market value of the M+C MSA becomes taxable to the designated beneficiary.

When you do not name a designated beneficiary. If you do not name a designated beneficiary of your M+C MSA, the fair market value of the MSA will be included on your final income tax return after your death.

Qualified Medical Expenses

Qualified medical expenses are explained in Publication 502. Examples include amounts paid for doctors' fees, prescription medicines, and necessary hospital services.

You cannot deduct qualified medical expenses as an itemized deduction on Schedule A (Form 1040) if you pay for them with a tax-free distribution from your M+C MSA. You also cannot claim a deduction if you use other funds equal to the amount of the distribution.

Special rules for insurance premiums. Generally, you cannot treat insurance premiums as qualified medical expenses for M+C MSAs. You can, however, treat premiums for long-term care or health care coverage while you receive unemployment benefits as qualified medical expenses for M+C MSAs. This includes COBRA-type continuation coverage required under any Federal law.

Recordkeeping. For each qualified medical expense you deduct or pay with a distribution from your M+C MSA, you must keep a record of the name and address of each person you paid and the amount and date of the payment. Do not send these records with your tax return. Keep them with your tax records.

Filing Form 8853

You must file Form 8853 and attach it to Form 1040 if you (or your spouse, if married filing a joint return) received distributions from an M+C MSA during the year. If both you and your spouse received distributions from an M+C MSA, attach a separate Section B of Form 8853 for each spouse. For more information, see the Instructions for Form 8853.

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