Deductions & credits

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@2985 wrote:

Hello-

I am having a similar issue but hopefully getting it cleared up all within the same year simplifying things a bit. I have a couple follow-up questions though. 

My situation is: I was told by my insurance provider that I was eligible this year to open a HSA. I've never had one before so I did as they suggested and was able to open one with Health Equity.  I contributed and used several thousand dollars this year on qualifying medical expenses (but never earned any interest), only to see when I went to renew my health insurance this year through the marketplace that only a rare few high deductible plans actually qualify and the one I had this year wasn't one of them!

I called my HSA provider as this post suggested and they said I need to fill out two forms to get it squared away. The two forms are: HSA Mistaken Distribution and HSA Excess Contribution.  I wanted to check here first if those seemed like the right forms to fill out and avoid any penalties which, according to this answer, I shouldn't have to pay any of since I was never eligible. I really don't want to get pegged with some 20% penalty for a mistake I did not know I was making!  I also don't know if I should close the account or not. My new health plan for 2022 Does qualify for a HSA but it kind of seems like I should start fresh with a new account. Thanks for any insights!

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The penalty for making unqualified withdrawals (not used for medical expenses) is 20%, but that does not seem to apply here.  The penalty for making ineligible contributions is that you don't get the tax deduction, plus 6%.  The 6% penalty is on the amount of ineligible contributions or the amount remaining in the account, whichever is smaller.

So one option would be use the "return of excess contribution" form to request the remaining balance from your account.  You don't need to request all the contributions, only the remaining account balance.  You only need to do this by the filing deadline (April 15, 2022), so you could leave the account open, start making contributions for 2022, and then withdraw the excess from 2021.  (Or you could request the return of excess now, close the account, and open a new account.  It depends on whether there are account closing or opening fees or other maintenance fees and whether you are happy with the bank or want to change banks.). In Turbotax, you will first report the contributions.  Then when you indicate you did not have qualifying insurance, the contributions will be added back to your taxable income (not deducted) and the penalty will be calculated on the remaining balance (zero), so zero penalty.  With a return of excess, the bank must also return the earnings on the ineligible contributions, which is probably only a few cents interest, unless you invested in securities that performed better.  That interest would be taxable on your 2021 income (if the return is processed before 12/31) or 2022 income (if you do the return after 1/3/22.)

Note that it may take a few days to process, and there are only a few business days left in 2021, so you might not get the return processed in 2021 even if you request it right away.

Your second option would be to leave the ineligible balance in the account, pay the penalty and then contribute less next year.  For example, suppose your remaining balance is $500.  If you leave it alone, you would pay a 6% penalty ($30), and then for 2022, if you have a single plan and are eligible to contribute $3650, you would contribute no more than $3150, and the $500 excess from 2021 would be counted as a legal 2022 contribution so there would be no more penalties.  

If you have additional medical expenses that have not been reimbursed yet, a third option would be to request reimbursement before the end of the year and zero out your balance that way.  

You would only use "Mistaken distribution" if you wanted to put money back in the account because you withdrew if for a non-qualified expense.   As long as your reimbursements were for qualified medical expenses, you don't need this form, even if the original source of the money was ineligible contributions.