Are HSA funds taxable to heirs

I recently met with Emily, a successful physician, who was devastated to learn her meticulously planned estate might be facing a significant, unexpected tax liability. Her father, a retired engineer, had passed away with a substantial Health Savings Account (HSA), and Emily was named as the beneficiary. She assumed, understandably, that because the funds were designated for healthcare expenses, they would simply pass to her tax-free. Unfortunately, that’s not necessarily the case, and the rules can be complex, especially with upcoming changes.

What Happens to an HSA Upon Death?

The fate of HSA funds after death depends heavily on who the beneficiary is and how the funds are distributed. As a CPA as well as an Estate Planning Attorney with over 35 years of experience here in Corona, California, I can tell you that understanding the nuances is critical. If you name a spouse as the beneficiary, the HSA generally rolls over into a new HSA owned by the surviving spouse, maintaining its tax-advantaged status. This is the simplest and most straightforward scenario.

Tax Implications for Non-Spouse Beneficiaries

However, when the beneficiary is not a spouse – as in Emily’s case – the situation shifts. The HSA assets become subject to income tax. The funds are treated as if the beneficiary received a distribution and must report the amount as income on their tax return. This can create a substantial, unexpected tax bill, especially with larger HSA balances. While the funds were intended for healthcare, the IRS views them as ordinary income when inherited by a non-spouse.

Furthermore, consider that the HSA funds were likely accumulated with pre-tax dollars. This means the entire amount distributed to the beneficiary is taxable. There’s no “step-up” in basis for HSAs as there is with most other assets like stocks or real estate. This is where my CPA background truly benefits clients; I can proactively model these tax scenarios to minimize the impact.

The Impact of AB 2016 and the Small Estate Affidavit

In California, accessing and distributing HSA funds, like any other asset, can be complicated by the probate process. If the deceased’s total assets, including the HSA, exceed the limits for simplified procedures, a formal probate proceeding may be required. For deaths occurring on or after April 1, 2025, AB 2016 will allow beneficiaries of a primary residence valued up to $750,000 to utilize a ‘Petition for Succession’ instead of full probate. However, it’s vital to remember that this Petition requires a Judge’s Order, unlike the Small Estate Affidavit, which is reserved for real property under $69,625. It’s also crucial that the decedent’s other non-real estate assets, including the HSA, remain below the $208,850 limit for the Small Estate Affidavit to be viable.

Protecting Digital Assets & HSA Access

We are seeing more and more HSAs managed digitally. A critical but often overlooked issue is access to these accounts. Without specific RUFADAA language in your estate planning documents, service providers like Fidelity or Optum can legally deny your executor access to your digital HSA assets. This can delay distributions and complicate tax filings. We routinely incorporate RUFADAA-compliant provisions into our Wills and Trusts.

Planning for a Larger Estate and Potential Tax Law Changes

For clients with larger estates, it’s essential to consider the potential impact of the Federal Estate Tax. The OBBBA has permanently increased the exemption to $15 million per person effective Jan 1, 2026, offering some relief, but careful planning is still essential. We also regularly review estate plans to account for evolving tax laws and regulations.

Emily’s situation, while stressful, highlighted the importance of proactive estate planning. We’re revising her father’s plan to minimize the tax impact on the HSA distribution, exploring strategies like qualified disclaimers and carefully documenting eligible medical expenses. The key is to address these issues before a crisis occurs.

What standards do California judges use to determine a will’s true meaning?

In California, a last will and testament operates within a probate system that emphasizes intent, clarity, and procedural compliance. When properly drafted, a will does more than distribute property—it creates legally enforceable instructions that guide courts, fiduciaries, and beneficiaries through administration with fewer disputes and less uncertainty.

To distribute property effectively, you must define what is in the estate, clarify who inherits, and understand how debts and taxes impact the final distribution.

When a will is drafted with California probate review in mind, it becomes a stabilizing roadmap rather than a source of conflict. Clear intent, proper authority, and compliant execution protect both families and estates.

Resources for Asset Management & Transfer

• Property Tax Reassessment: California State Board of Equalization (Prop 19)
  This page details the “Base Year Value Transfer” rules. It explains that heirs can only avoid a property tax reassessment if the inherited home becomes their primary residence and a claim is filed within one year of the date of death.
• Real Estate Probate (AB 2016): California Probate Code § 13151 (Petition for Succession)
  The specific statute for the AB 2016 process. It outlines the requirements for using a court-approved “Petition” (not an affidavit) to transfer a primary residence worth $750,000 or less (gross value) for deaths occurring after April 1, 2025.
• Small Estate Affidavit: California Probate Code § 13100 (Personal Property)
  Access the statutory language for the “Small Estate Affidavit.” This procedure is strictly for Personal Property (cash, stocks, vehicles) and is limited to estates with a total value of $208,850 or less (effective April 1, 2025).
• Federal Estate Tax: IRS Estate Tax Guidelines
  The authoritative federal resource for estate valuation. It reflects the 2026 exemption increase to $15 million per person established by the One Big Beautiful Bill Act (OBBBA), which is critical for high-net-worth asset planning.
• Unclaimed Assets: California State Controller – Unclaimed Property
  The primary portal for executors and heirs to search for “lost” assets—such as forgotten bank accounts, uncashed dividends, and insurance benefits—that have been remitted to the State of California for safekeeping.
• Business/LLC Compliance: FinCEN – Beneficial Ownership Information (BOI)
  The official portal for corporate transparency reporting. While many domestic U.S. LLCs received exemptions in 2025, executors managing foreign-registered entities or specific non-exempt structures must still consult this resource to ensure compliance.