Merritt Personal Lines Manual: Health coverage tax credit.

You cannot claim this credit for premiums that you pay with a tax-free distribution from your HSA. See Publication 502 for more information on this credit.

Deemed distributions from HSAs. The following situations result in deemed taxable distributions from your HSA.

• You engaged in any transaction prohibited by section 4975 with respect to any of your HSAs, at any time in 2006. Your account ceases to be an HSA as of January 1, 2006, and you must include the fair market value of all assets in the account as of January 1, 2006, on Form 8889, line 12a.
• You used any portion of any of your HSAs as security for a loan at any time in 2006. You must include the fair market value of the assets used as security for the loan as income on Form 1040, line 21.

Records you should keep Recordkeeping. You must keep records sufficient to show that:

• The distributions were exclusively to pay or reimburse qualified medical expenses,
• The qualified medical expenses had not been previously paid or reimbursed from another source, and
• The medical expenses had not been taken as an itemized deduction in any year.

Do not send these records with your tax return. Keep them with your tax records. Reporting Distributions on Your Return How you report your distributions depends on whether or not you use the distribution for qualified medical expenses (defined earlier).

• If you use a distribution from your HSA for qualified medical expenses, you do not pay tax on the distribution but you have to report the distribution on Form 8889. However, the distribution of an excess contribution taken out after the due date, including extensions, of your return is subject to tax even if used for qualified medical expenses. Follow the instructions for the form and file it with your Form 1040.
• If you do not use a distribution from your HSA for qualified medical expenses, you must pay tax on the distribution. Report the amount on Form 8889 and file it with your Form 1040. If you have a taxable HSA distribution, include it in the total on Form 1040, line 21, and enter "HSA" and the amount on the dotted line next to line 21. You may have to pay an additional 10% tax on your taxable distribution.

Additional tax. There is an additional 10% tax on the part of your distributions not used for qualified medical expenses. Figure the tax on Form 8889 and file it with your Form 1040. Report the additional tax on Form 1040, line 63, and enter "HSA" and the amount on the dotted line next to line 63.

Exceptions. There is no additional tax on distributions made after the date you are disabled, reach age 65, or die.