I'm looking at https://www.bogleheads.org/wiki/Health_savings_account#State_taxation_of_HSAs where it says "you are required to keep good records, track the state cost basis manually, and report HSA gains/losses on your state tax return."

Is that different from simply taking my Adjusted Gross Income from my federal tax return, adding the money I contributed to the account plus net income/loss that the account experienced from investments and fees, and then reporting the result as my AGI on my California income tax return? Must anything be tracked from year to year?

If so, that sounds difficult, maybe more trouble than the account would be worth. Is it?

Please tell us your experiences with this.

2 Answers 2


I have a little experience with this. My home state of Wisconsin was on this list until 2011.

The thing to remember is that these states simply do not recognize the HSA. What this means is that there are no state income tax advantages to the account, and no state tax penalties, either.

Here are the implications:

  • Contributions. Contributions that you deduct from your federal income need to be added back in to your income on your state return.
  • Earnings. On your federal tax return, earnings such as interest and dividends inside your HSA do not need to be reported at all. However, these earnings need to be added in to your income on your state return so that you can pay state tax on them.
  • Distributions. Distributions that are not spent on qualified medical expenses are subject to tax and penalties on your federal return. However, since the state does not recognize the HSA, there are no state tax and penalties due on any distribution from the HSA, no matter what you've spent the money on. Distributions that were added into your income on your federal return can be taken back out on the state return.
  • Capital Gains. As far as the federal government is concerned, capital gains inside your HSA are free, and there is no need to track cost basis for investments inside your HSA. However, since your state does not recognize the HSA, any investing you do inside your HSA will be treated like an investment outside of the HSA on your state return. If you invest in securities inside your HSA, you will need to keep track of cost basis and pay state capital gains tax when you sell just like you would in a taxable account.

When you invest in a taxable account, your broker in many cases keeps track of cost basis for you. However, when you invest inside an HSA, your HSA custodian will generally not keep track of any of this, because it is not normally needed. Therefore, you need to keep track of any cost basis yourself, and when you sell, calculate the capital gain or loss on your state return.

In my opinion, the HSA is a good deal even if your state does not recognize it. The tax-free savings/investing is a great deal, even if only on your Federal taxes. The state return will be a little more complicated, but the savings you get on your federal return are worth it.

In my situation, our family spends the money in the HSA on medical expenses fast enough that we don't invest it in anything other than an interest-bearing savings account. Therefore, we didn't have to worry about capital gains inside our HSA, and only had to add contributions and earnings to our state income. I am very glad that our state now recognizes the HSA.


In addition to having separate income for federal and state tax purposes, things can get really complicated if you ever have capital gains and losses.

Suppose you sell taxable stocks for a loss of $5000, and meanwhile, have capital gains of $1000 in your HSA. From the federal perspective, the gains in the HSA don't exist, so you deduct $3000 of the loss, and then carry over the remaining $2000.

However, from the state perspective, $1000 of the capital loss went to canceling out the gains in the HSA. Therefore, you only carry over $1000.

Assuming you continue to have losses and gains, this will carry on forever. You'll have to track completely independent sets of gains and losses and carryover losses for federal and state purposes forever, even if you no longer use the HSA.

Therefore, I'd recommend not investing HSA proceeds at all if you live in a state that doesn't recognize HSAs. It's just too complicated to be worth it, especially since your provider won't track any of this for you.

  • Good point @Antimony (sorry for my delayed reply -- busy busy). I assume this problem can be avoided, by investing only in money market funds; that way, the basis does not change? The only problem would be reporting the money market interest on state and not federal income tax returns; hopefully TurboTax is smart about that. Commented Dec 18, 2016 at 20:50

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