March 2026
Diana Craig, Director, Benefits Compliance
Health savings accounts (“HSAs”) are tax-favored trust or custodial accounts that can be contributed to by, or on behalf of, “eligible individuals” who are covered by certain high-deductible health plans (“HDHPs”) and used to pay for certain otherwise unreimbursed medical expenses on a tax-favored basis. Importantly, under federal tax law, contributions to HSAs can be made on a tax-favored basis. Those amounts, if invested, can grow on a tax-favored basis, and HSA funds withdrawn for qualified medical expenses escape all federal taxation. Federal tax rules governing HSAs are found in Internal Revenue Code § 223.
Although most states extend the same or similar favorable tax treatment to HSAs, California does not extend state tax-favored status to HSAs. As a result, California taxpayers must reverse the federal treatment of deductions, interest, and contributions related to their HSA on their California income tax return (CA Form 540). These adjustments can include:
Payroll taxes: Employer contributions to an HSA on behalf of an employee and any employee salary reduction election contributions to an HSA are subject to state payroll taxes. This means that an employee’s wages, as reflected on California payroll tax filings, will not match the wages on their federal payroll tax filings.
Contributions: Federal law allows taxpayers a deduction for contributions to an HSA. Contributions made on behalf of an eligible individual by an employer are also excluded from income/wages. California does not conform to this provision of federal tax law so any contribution to an HSA by an employer or by an employee through salary reduction election must be added to the adjusted gross income of the employee on their California income tax return.
Employer action items
- Communicate with employees. Employer plan sponsors facilitating access to HSAs for employees residing in California should educate those employees on required state tax filing adjustments.
- Work with tax and payroll advisors. Employers should make sure that any additional California state payroll taxes are deducted and remitted to the state.
- Stay informed. Monitor state legislation and California Franchise Tax Board publications as there are frequent proposals to change this California tax rule but none have been successful to date.
Additional information and resources
- Instructions for Schedule CA (540) | FTB.ca.gov
- FTB Bill Analysis, SB 230 (2024); Health Savings Account Deduction Conformity
For more information
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