2021 HSA Excess Contribution - Filed 5329, Then Custodian Withdrew Excess

[Jackscrj]

In 2021, I had an HSA Excess Contribution in total of $625: $600 due to a job change  that ended up resulting in my ineligibility for full contribution and the $25 ended up being due to additional employer contributions I wasn't expecting that posted in Jan 2022.

I was able to withdraw the $25 dollars with the HSA custodian, but didn't realize until later that I also had the $600 overage. I submitted paperwork to the custodian to withdrawn the additional $600 in excess contributions but did not hear anything back for probably a month. 

With tax day approaching fast, I elected to file my 2021 return with Form 5329 attached to pay the additional tax on the excess contribution and planned to leave room within my HSA contributions this year to reconcile the excess fully. 

Then to my surprise I get a check in the mail, dated April 14th, 2022, with the $600 in excess contributions removed. I considered I would need to file an amended return, but expected Optum to publish an updated 1099-SA but they didn't in a timely manner and I kicked the bucket road.

Come to 2022 taxes and Optum has posted two 1099-SAs for me, one with code 1 normal distributions, and the other with the code 2 $625 in excess contributions (with no earnings on the excess). 

Do I need to amend my 2021 return to avoid scrutiny? I am unconcerned with refunding my 36$ in excess tax vs the trouble to amending. But will it raise red flags to have the code 2 distribution essentially unaccounted for? If I don't amend I will carry over the 2021 excess and still be under the limit for this years contributions.

Thanks, J

[BillM223]

I would not worry about trying to "fix" the problem - as you note, it's not a lot of money, and will be more hassle than it is worth. Besides, it's not like you owe the IRS money; instead, they owe you. Furthermore, it is too late to fix the 2021 return, which needed to be done by the due date (as extended) of the 2021 return.

I would keep all your documentation in your tax file in case anyone ever asks. Just do what you had planned: report the two 1099-SAs (both the code '1' and '2') on your 2022 return and keep your 2022 contributions under the 2022 limit minus the "excess" contribution carryover from 2021. In this way, your return will e-file nicely, and it will appear that you have handled the excess contribution that you didn't have anyway.

There is a huge amount of paperwork that doesn't match, most of which does not trigger an audit anyway (although some audits are truly random), and the IRS does not get upset if they audit you and discover that they owe you money - but they will pay it to you...with interest...

[Jackscrj]

Thank you

[dmertz · Accepted solution]

Keep in mind that you'll not only be losing the $36 you paid for the penalty, you'll also be paying ordinary income tax on the $600 that you do not contribute to an HSA for 2022.  If you are in the 22% federal tax bracket, that's another $132 that you'll be out (assuming that your HSA funds eventually get spent on qualified medical expenses) and perhaps some state income tax too.  Finally, you'll have a $600 lower invested balance growing tax free.

It's certainly not too late to amend.  The due-date deadline was the deadline to obtain the corrective distribution, which you met, not the deadline to amend.  In fact, because the distribution occurred before the regular due tax of your 2021 tax return, you should not even need to claim that it was done pursuant to section 301.9001-2.  You would simply be correcting in incorrect original Form 5329.

Amending your 2021 tax return to remove the $600 excess from Form 5329 is pretty simple.  You would need to prepare the corrected Form 5329 separately because TurboTax will not produce a Form 5329 with the required zero on line 47, replacing the $600 previously reported on that line.  I would also file it with Form 1040 to show that there is no change anywhere else on your 2021 tax return because the $600 was already added as other income income.

[Jackscrj]

Thank you for your response, dmertz.

Yes I have decided to amend the return after carefully scrutinizing what the Turbo Tax Desktop software had produced for my 2022 forms. Dangerously it had led me into preparing an inaccurate return, where I would be under calculating my 2022 tax liability, by wait for it $140.

Now the reason for this is apparent as I answered that I did have an excess contribution from 2021 (but really didn't) so it was considering the withdrawn funds as a deduction for 2022. This could be adjusted to show the correct liability by entering 0 for excess contributions. But in doing so this years return (lacking a Form 5329 if entering 0) wouldn't really match the prior years inaccurate Form 5329.

As such for the sake of correctness, I will be mailing my 1040x, Schedule 2 (line 8 now 0), and Form 5329.

And who knows I still have time to decide if I want to make a prior year contribution for 2022 to my HSA to max the benefits of correction.