Does an HSA contribution offset ordinary income first like the standard deduction?

[b1stauf]

The federal standard deduction offsets ordinary income, reducing your taxable income before capital gains & qualified income are "stacked" on top of your ordinary income in order to calculate final taxable income (taking the simplified view).  See this excellent explanation for more details https://www.fiphysician.com/cap[product key removed]-on-top-of-ordinary-income/

My question is, does the HSA deduction work the same way?  It's not accurate to just say "it reduces taxable income" because ordinary and qualified income are taxed at different rates so it's important to understand the distinction.  If after your standard deduction you have $6,000 of ordinary income subject to 10% taxes, and you contributed $6,000 to your HSA, does that HSA deduction then finish ofsetting your ordinary income, leaving you with only qualified income?  In that case you could have up to $83,550 of income from qualified income and/or long term capital gains and still pay zero taxes.  If the HSA deduction doesn't come in until the very end, AFTER qualified/ltcg is added in, then you will still pay taxes on that $6,000 of ordinary income.

Thanks for reading and thinking about this.

[NCperson · Accepted solution]

direct payments to your HSA reduces you ORDINARY income.  

 look at the Qualdiv/ cpgain report, worksheet (which I do not think is visible in the online version until after you pay the fees), the worksheet begins with taxable income on line 1, separates out the capital gains and dividends on lines 2 and 3, calclates he income tax on that portion on lines 4-21 and then comes around to calculate the ordinary tax on the remainder on line 22.  Which is a long way of saying the HSA reduction is part of the Ordinary calculation.

[dmertz]

If your ordinary income is less than your directly-made HSA contribution, after offsetting all of your ordinary income the remaining portion of the HSA contribution will then offset income taxed at long-term capital-gains rates.

[b1stauf]

Thanks very much for the clear and complete answer!

[b1stauf]

Thanks dmertz, great answer.  I could only pick one as best so i gave it to the answer that detailed the calculation method. I appreciate your help. 

[Critter-3]

The HSA deduction is an ADJUSTMENT  to your AGI.   AGI  - adjustments =  MAGI -  standard or itemized deduction = taxable income     Read/review the form 1040  to see how it works.  

[b1stauf]

Thanks for weighing in Critter-3.