Deductions & credits

Ignore anything related to withdrawing earnings.  That only applies to withdrawing excess before the filing deadline of the same year.

 

For 2021, you have an excess contribution of $3500.  You need to file or amend your 2021 return to include a form 5329 that reports an excess contribution of $3500 in part VII, and pays 6% tax.  You also remove the tax deduction you claimed and pay income tax on the $3500, of course.   (Note that if you spent some money for qualified medical expenses, and your year-end balance was less than $3500, the 6% penalty is calculated on the year-end balance instead.)

 

For 2022, you have an excess contribution of $7500 (previous carry-forward of $3500 plus new of $4000).  You need to file or amend your 2022 return to include a form 5329 that reports the excess and pays 6% penalty on the entire accumulated excess contribution. You also remove the tax deduction you claimed and pay income tax on the $4000.  (Note that if you spent some money for qualified medical expenses, and your year-end balance was less than $7500, the 6% penalty is calculated on the year-end balance instead.)

 

For 2023, you will report that at the start of the year, you had an excess contribution accumulation of $7500 (or less if you spent it on medical expenses.  You need your 2022 form 5329 when preparing your 2023 return.)  Report the 1099-SA for your withdrawal.  The penalty for having an excess contribution is 6% of the excess, or 6% of the account balance at the end of the year, whichever is less, so if you withdrew the account down to zero on 12/23/23, your penalty for excess contribution on your 2023 is zero.    However, you will pay income tax plus a 20% penalty for non-qualified withdrawal.  So make sure that when entering your 1099-SA, you indicate if part of the withdrawal was used for medical expenses and how much, so you only pay tax and penalty on the amount that was not used for qualified medical expenses.  

 

Ignore the procedure for calculating or paying tax on the "earnings" due to the withdrawal of excess.  You did not complete a withdrawal of excess.  (A withdrawal of excess would mean withdrawing the $4000 excess for 2022 before October 15, 2023.  You missed that deadline.)   You simply have an ordinary withdrawal in 2023, that you either used partly, wholly, or not at all for qualified medical expenses.  The part of the ordinary withdrawal used for medical expenses is tax-free and the part not used for medical expenses is subject to income tax plus a 20% penalty.  Whatever interest or dividend earnings there might have been are included in the withdrawal amount on the 1099-SA and will be taxed accordingly.

 

Here, when you are asked "how much of the withdrawal did you spend on qualified medical expenses?" you can include all medical expenses not reimbursed by insurance or previously reimbursed from the HSA going back to when the account was opened in November 2021.  It's important to understand that once you have money in an HSA, you can spend it tax-free for any qualified medical expenses, even if if the deposit was technically not allowed and subject to penalty.  (Contributions and withdrawals are handled completely separately in the tax code.)  So any co-pays, tests, vision care, dental care, and other qualifying expenses that you might not have already reimbursed from the HSA, can be counted as qualified medical expenses and will reduce the tax and penalty you owe. 

 

Also note for future readers.  Withdrawing the entire amount may not have been the best action to take, depending on your age and expected future medical bills.  If you could have used up that $7500 in 5 years or less for qualified medical expenses (co-pays, glasses, etc.) then the 6% penalty declining over time as you used up the account would probably be less than the income tax plus 20% penalty on the lump sum withdrawal.