@Chena wrote:
I had read that some potential solutions to this were:
* spend down the entire HSA account to zero
Not something I'm ready to do, although not in a high deductible medical plan since 2019 (the date of the excess contribution) , I'm still letting it accumulate until needed in later years
* rejoin a high deductible plan
Not possible as our current retiree plans do not offer a high deductible plan
* make a unqualified distribution
This is the option I would like to execute but it seems problematic. Fidelity won't process it as an excess contribution withdrawal, so the resulting 1099-SA will have an incorrect distribution code reported. I'm not sure what happens if I do this, letting the 1099-SA indicate distribution code of 1 (normal withdrawal) but try to correct that when filing taxes. Unclear if 1099-SA is reported to IRS and if they cross-check against the return.
I did find that for calculating the earnings attributable to the excess contribution one is to follow CFR 1.408-11. The calculation used for returned or re-characterized IRA contributions.
Thus, I can determine the correct values that would belong in box 1 (gross distribution) and box 2(earnings on excess cont) and box 3 (distribution code - 2 for excess contribution) --- but this would not match what Fidelity wants to create as they only seem firm they can't process an excess contribution withdrawal for me.
First, you need to file an amended 2019 return that reports the excess and you will pay income tax plus a 6% penalty on the excess, if you did not already report it.
Then, you need to file an amended 2020 return that pays a continuing 6% penalty on the excess, if you never withdrew it.
You also need to report the continuing excess on your 2021 return and pay a 6% penalty.
Then for 2022, simply take a regular withdrawal. There is no special distribution code on the 1099-R, it's a regular withdrawal. When you file your 2022 tax return, you will report the total of your withdrawals, and when the program asks "was all the money used for qualified expenses", answer no. The program will ask for your qualified expenses. The excess will be assessed income tax plus a 20% penalty, but will remove it from future treatment as an excess contribution.
For example, if your medical expenses in 2022 are $1500, and the excess contribution in 2019 was $100, you will withdraw $1600 for 2022 (before December 31). When the program asks about your qualified expenses and you report $1500, the excess will take care of itself. But this will only work if Turbotax knows you have a $100 excess contribution from a prior year, and it will only know this if you tell the program specifically, or if the program imports your 2021 tax return that also reports the excess.
