Is a bank required to monitor health savings accounts for potential prohibited transactions? What responsibilities does a bank have regarding transactions going through the account?

No and none.

Thank you for the feedback!

What if we know an account has prohibited transactions, should the bank take any action?

Your HSA agreement should state what action you will take as a custodian in the event you become aware of the account beneficiary engaging in a prohibited transaction. As the custodian you must treat the account as if it was distributed to the beneficiary as of the first day of the taxable year in which the prohibited transaction occurred.

"in the event you become aware of the account beneficiary engaging in a prohibited transaction. As the custodian you must treat the account as if it was distributed to the beneficiary as of the first day of the taxable year in which the prohibited transaction occurred."

Not that I don't believe you, as it has been several years since I was personally active in the management of an HSA portfolio, but could you possible provide any IRS citations that state or support this fact?

No worries rlcarey! Prohibited transactions are covered in Internal Revenue Bulletin 2008-29: http://www.irs.gov/irb/2008-29_IRB/ar11.html#d0e1258


Q-37. What are the consequences if account beneficiaries or other disqualified persons enter into a prohibited transaction with an HSA?

A-37. Section 223(e)(2) provides that rules similar to the rules of §§ 408(e)(2) and (4) apply to HSAs. Therefore, account beneficiaries may not enter into “prohibited transactions” with an HSA (e.g., the account beneficiary may not sell, exchange, or lease property, borrow or lend money, pledge the HSA, furnish goods, services or facilities, transfer to or use by or for the benefit of himself/herself any assets of the HSA, etc.). If an account beneficiary engages in a prohibited transaction with his or her HSA the sanction, in general, is disqualification of the account. Thus, the HSA stops being an HSA as of the first day of the taxable year of the prohibited transaction. The assets of the beneficiary’s account are deemed distributed, and the appropriate taxes, including the 10 percent additional tax under § 223(f)(4) for distributions not used for qualified medical expenses, apply.


It also mirrors the prohibited transaction rules for IRAs, for which it's been clarified several times to me direcly from persons at the IRS that a custodian is responsible for issuing a 1099-R as if the account was distributed as of the first day of the taxable year in which the prohibited transaction occurred.

I am well aware of that Q&A and unless I see something in writing that says the custodian is responsible for making that determination on an HSA, I would not be taking those actions. IRA's are totally different.

I can spend money on a medical expense through other means and spend a like amount of money out of my HSA on anything that I want. The bank making a determination that any specific transaction conducted by the cusotmer is prohibited is impossible.

The only prohibited transactions that I see on a HSA account that the custodian can be sure is a prohibited transaction is when the Bank pays the HSA into the overdraft. Other than that, I would not be worrying about any payee on any payment going out of a HSA.

Are we really talking about prohibited transactions or a non-qualified health expense? Two very different things and it is absolutely not the responsibility of the HSA custodian to monitor transactoins for non-qualified expenses, nor even for prohibited transactions. If a custodian knows for certain that a prohibited transaction occurred, such as an extention of credit from the custodian to the HSA beneficiary, then the custodian would have to report that on a 1099-R.

A non-qualified health expense does not equal a prohibited transaction.

Good point, I guess it depends on actually what we are talking about. Most times when someone starts talking about a customer engaging in prohibited transactions it is because they see them use their HSA debt card at McDonalds.

Does anyone see any problems with allowing a customer to make transfer to and from their HSA using electronic banking?

How do you plan to code the deposits that are made? Will you make the client sign an agreement that all deposits will be considered a contribution? Can your system restrict contributions to the maximum allowable or will it be the responsibility of the client to not make an excess contribution. For withdrawals, will they all automatically be coded as distributions? Just a few things to think about.