Do you have no qualifying medical expenses? You can withdraw any amount to cover those qualifying medical expenses you have incurred since you opened the account. You can reimburse yourself for medical expenses you paid since the HSA was opened; you don’t just have to use an HSA debit card to pay the expenses. Medical co-pays, pharmacy expenses, prescription eyeglasses, contact lenses, dental cleanings and x-rays, anything like that?
Let’s go back to the beginning. For 2019, you made excess contributions and did not withdraw them by the deadline. You should report that fact on an amended tax return. The contributions are still taxable, but you will owe an additional 6% penalty.
Then for 2020, if you had absolutely no qualifying medical expenses, you have two choices.
1. keep the distribution. Because you do not have qualifying medical expenses, the distribution is fully taxable again plus a 20% penalty. But at least, you have closed out the account and won’t have to deal with it again.
2. return the mistaken distribution. You will have to pay another 6% penalty because the money in the account still represents ineligible contributions. But 6% is a lot less than 32%. In 2021, try to arrange to have some medical expenses. Maybe you’ve been putting off getting your teeth cleaned because your insurance doesn’t cover it, or maybe you need new glasses. Anything you spend for medical expenses can be withdrawn from the account and it will be tax-free on your 2021 tax return. You will still have to pay a 6% penalty on any of the original contributions that are still left in the account. Then for 2022, maybe you have more medical expenses and you can finally drain the account. When the account is empty, you won’t pay any further penalties.
It would really only make financial sense to keep the withdrawal and pay the full taxes and the full penalty if you thought it would take more than six years to use up the money in the account for medical expenses, and God love you if you are that healthy.
Now, if we assume that you have had at least some medical expenses since you opened the HSA, you can take the part of the distribution as a reimbursement. Suppose you had $400 in medical expenses between when you opened the HSA and 12/31/2020. You would only have to return $1600 as a mistaken distribution and pay the 6% penalty on the $1600 instead of the full $2000.
In TurboTax, when you enter the 1099-SA for 2020, the program will ask you if you spent all the money on qualified medical expenses. If you did not, answer no. The program should then ask you how you spent the money and you should be able to indicate that you spent some dollar amount on medical expenses (if you did) and that you returned some dollar amount as a mistaken distribution.
