How do I correct 2021 total HSA contributions to reflect excess contribution distributions on line 43 of form 5329?

[wag1]

Hello,

I have an excess contribution in the amount of $1500 from 2019 that I am trying to take care of so that I do not continue getting penalized with the 6% excise tax. One such way to do this is to contribute less to the current tax year (2021) such that the excess of $1500   2021 HSA contributions = $3600, the HSA contribution limit for individuals in 2021. The issue is, I contributed the full $3600 at the start of 2021. However, I then took a distribution of excess contribution in the amount of $1500 from 2021. So, my total 2021 HSA contributions should be $3600-$1500=$2100. However, because the initial $3600 in contributions appears in box 12 of my employer W2, TurboTax is entering $0 for line 43 of form 5329, when it should be showing $1500 to take into account the distribution of $1500. Per tax form 5329 instructions (https://www.irs.gov/pub/irs-pdf/i5329.pdf), line 43:

If contributions to your HSAs for 2021
(line 2 of Form 8889, Health Savings
Accounts (HSAs)) were less than your
contribution limit for HSAs, enter the
difference on line 43. Your contribution
limit for HSAs is the amount on line 12 of
Form 8889.

Any help on how to get the correct amount of $1500 to show up on line 43 is much appreciated!

[BillM223]

So, let me get this straight. You had an excess HSA contribution of $1,500 on your 2019 tax return, and are trying to fix this on your 2021 return? The problem is that you can't do it by withdrawing the 2019 excess in 2021.

It is not at all obvious, but the last date you could withdraw an excess for TY 2019 was the due date of the 2019 return (usually April 15th, but for 2019, the due date was moved to July 15, 2020). And, in fact, if you filed an extension that year, you would have had until October 15, 2020 to withdraw the excess.

But after those dates, you can no longer withdraw the 2019 excess and escape any penalty.

And distributions are not tied to contributions. That is, just because you withdrew "excess contributions", that doesn't change the amount you in fact contributed. So the 0 on line 43 on the 5329 is correct.

So going forward, there are two ways to get rid of the 2019 excess. 

1, Reduce your contributions in a future year (since you already maxed out 2021) so that your contributions plus the $1,500 fall under that year's annual HSA contribution limit.

2. Make a distribution equal to the excess that will not be used for medical expenses. This, however, is added to your income and incurs a 20% penalty.

The thing that catches many taxpayers is that the HSA is not a savings account into which you can willy-nilly make contributions and take withdrawals. There are definite rules, which, unfortunately, are not laid out very well in Pub 969 at the IRS website.

There is another issue: that you can't withdraw an "excess" when there isn't an excess for that year. In your case, you don't have an excess for tax year 2021. You contributed $3,600 which is the annual HSA contribution limit for a Self-only plan. So, no excess. In fact, if you don't do something and get audited, you will find that $1,500 you took out to be considered a distribution that was taken out for other than medical expenses, so it would be added to your Other Income and penalized 20%.

You have two choices:

1. Call your HSA custodian and ask if you can treat the $1,500 distribution as a "Mistaken Distribution". Note that the HSA custodian doesn't have to accept this (so be nice), but if they accept it, you will repay the $1,500 that they sent you, and they will amend their paperwork (to show that the $1,500 that you just sent them was not a normal contribution).

2. If you have $1,500 of unreimbursed medical expenses that were created AFTER the start date of the HSA, make a list of these expenses and apply the $1,500 to them. That is, at any point after you create the HSA, you can withdraw funds o pay for unreimbursed medical expenses incurred after the start date of the HSA. They don't have to be in the same year or even the same decade.

[Edit 3/7/2022 02:09 PST - corrected typo on date on original due date for due date]

[wag1]

I see...looks like I made things worse for myself.

If I am able to get the HSA distribution treated as a mistaken distribution, would I still answer yes when TurboTax asks if I've taken any distributions, or could I answer no and skip that part?

If I'm not able to get it treated as a mistaken distribution and I do have enough medical expenses to make up for it, am I able to change the distribution code from 2: Excess Contribution to 1: Normal Distribution? Do I need to do this through my HSA provider, or can I simply change the distribution code when I go to file my taxes? You mentioned making a list of these expenses...do I submit this list of expenses anywhere?

Additionally, could I just re-code it as 5: Prohibited Transaction and pay the 20% penalty and be done with it? Similar to my question above, what is needed to get it re-coded? This would be a last resort.

*** UPDATE ***

I called my HSA provider and it seems they will honor a request to treat it as a mistaken distribution. However, they said that the corrected forms will not be available until May of this year. I don't understand how to go about reporting both the initial distribution and the return of funds as part of a mistaken distribution. Would I just fill out the information using the 1099-SA I was given, or would I proactively indicate a gross distribution and earnings on excess contributions of 0 and check the box indicating it has been corrected? When next year (tax year 2022) rolls around, will I need to do anything to report the mistaken distribution that was returned? Can you please help me understand this process?

At this point, if there is an easy way to convert the distribution code from 2 to 5 and just pay the penalty and be done with, I'd consider it. Please let me know if this is possible.

[BillM223]

"If I am able to get the HSA distribution treated as a mistaken distribution, would I still answer yes when TurboTax asks if I've taken any distributions, or could I answer no and skip that part?"

If the only distribution (1099-SA) that you received was for this mistaken distribution, leave it off your return, because it will confuse things when the HSA custodian issues a corrected 1099-SA.

"am I able to change the distribution code from 2: Excess Contribution to 1: Normal Distribution?"

As a general rule, do not change data on a form sent to you, because the IRS is sent a copy, and they may wonder why you changed the form.

"I called my HSA provider and it seems they will honor a request to treat it as a mistaken distribution. However, they said that the corrected forms will not be available until May of this year. "

This is good news. 

"I don't understand how to go about reporting both the initial distribution and the return of funds as part of a mistaken distribution."

I assume that you told the HSA custodian that the initial withdrawal was for excess contributions. We now know that it wasn't (because it wasn't any excess for 2021), but I assume that the 1099-SA (have you received it yet?) will show a distribution code of "2". Go ahead and enter that as is. This will not make much difference to your tax return.

Personally, I would file an extension (form 4868) as soon as you can, because life for you will be easier if we do all the following in the original return and not have to file an amendment. Just because an amended return has a due date of October 15th, doesn't mean you have to wait that long.

However, if the distribution code is "1", then you will have to enter it as is and count on the corrected 1099-SA showing up in a timely manner.

In May, when the corrected 1099-SA arrives, enter it instead of the original 1099-SA. Be sure to check the little box on the second screen of entering the 1099-SA that says "The corrected box is checked on this 1099-SA".

"When next year (tax year 2022) rolls around, will I need to do anything to report the mistaken distribution that was returned?"

Don't do anything about this mistaken distribution. 

"if there is an easy way to convert the distribution code from 2 to 5 and just pay the penalty and be done with, I'd consider it. Please let me know if this is possible."

As noted above, don't change data on forms when you enter the forms. This just invites letters from the IRS. 

In any case, let me summarize. 

1. File an extension. TurboTax supports this form, but you can't e-file it. Just print and mail the 4868 as quickly as possible.

2. Now you have some time to get other matters settled. Wait for the correct 1099-SA to come. When it arrives, enter it instead of the original 1099-SA (because it will confuse everyone). When the IRS sees a second 1099-SA with the correct box checked, they should know that the first one should be ignored (since we are not going to enter it anyway, that's OK).

3. For tax year 2020, two things:

A. TurboTax should know that you are carrying over an excess (yes, from 2019). So I don't think it will ask you if you overfunded in the previous year (because it already knows). If it does ask, be extra sure to review the 8889 so that you don't end up telling TurboTax that you have twice the carry over that you should.

B. BE SURE to reduce your normal HSA contributions by $1,500, so that this 2019 excess will be used up in tax year 2022. Too many taxpayers forget and max out the contributions and end you propagating the excess. 

[wag1]

The next few questions/comments assume an extension is NOT filed.

"If the only distribution (1099-SA) that you received was for this mistaken distribution, leave it off your return, because it will confuse things when the HSA custodian issues a corrected 1099-SA."

This is indeed the only distribution I have for 2021.

"I assume that you told the HSA custodian that the initial withdrawal was for excess contributions. We now know that it wasn't (because it wasn't any excess for 2021), but I assume that the 1099-SA (have you received it yet?) will show a distribution code of "2". Go ahead and enter that as is. This will not make much difference to your tax return."

I have received a 1099-SA for this distribution with a code of 2. Your guidance to go ahead and enter that as is conflicts with your above guidance to leave it off of my return..which should I do?

Additionally, when TurboTax asks "What's the total value of all your HSAs," I would add the $1500 back in, correct? If I input the 1099-SA, I can see this confusing the IRS since I'm entering that it has the $1500 in it, but the IRS thinks I withdrew it based on the 1099-SA.

To clarify, the above approach requires me to submit my taxes by the April 18 deadline, wait for my corrected 1099-SA to come in May, and then amend my tax return. There is no way to file once before April 18 and not have to later amend my tax return, is that correct?

The other option is requesting an extension. The next few questions/comments assume an extension IS filed.

"Personally, I would file an extension (form 4868) as soon as you can, because life for you will be easier if we do all the following in the original return and not have to file an amendment. Just because an amended return has a due date of October 15th, doesn't mean you have to wait that long."

Some questions related to this:

1. My estimated federal taxes are quite high: 11k+. My understanding is that it will be penalized if I don't pay by April 18, regardless of an extension. Should I just pay my best estimate? Should I pay slightly over?

2. Assuming the answer to #2 is yes, the IRS website says "You can also get an extension by paying all or part of your estimated income tax due and indicate that the payment is for an extension using Direct Pay, the Electronic Federal Tax Payment System (EFTPS), or a credit or debit card. This way you won’t have to file a separate extension form and you will receive a confirmation number for your records." Would you recommend utilizing this, or filing form 4868 manually?

3. When I receive my updates 1099-SA and am ready to file my taxes, can I e-file through TurboTax still?

Thank you! I tried figuring this out last year as well, and this is the most helpful someone has been.

[BillM223]

I see above that I wrote: "3. For tax year 2020, two things:" This was a mistake, it should read for tax year 2022. I will change it in a few minutes.

"I have received a 1099-SA for this distribution with a code of 2. Your guidance to go ahead and enter that as is conflicts with your above guidance to leave it off of my return..which should I do?"

Sorry, too many options. You can enter it if the dist code is 2 because that will have little impact on your tax return, but at the point I wrote that, I wasn't sure of you have a 1 or a 2 on your 1099-SA (in fact I wasn't even sure you had the first 1099-SA yet). But I really would prefer that you pay your tax by April 18th, check that you want to make an extension, and then file your original return when the corrected 1099-SA comes in (in which case you don't need to add the original uncorrected 1099-SA into the return).

"1. My estimated federal taxes are quite high: 11k+. My understanding is that it will be penalized if I don't pay by April 18, regardless of an extension. Should I just pay my best estimate? Should I pay slightly over?"

You mean that you expect to owe +11k? Then, yes, the IRS really expects you to pay that by April 18th in any case. But on or about April 18th, you should pay the amount of tax that you will owe when you file your final return. If you file your return in late May or early June, you won't be declaring that $1,500 as Other Income, nor the 20% penalty), so don't pay that on April 18th - instead pay what you are supposed to owe. If you think about it, the IRS won't know what you are supposed to owe until you file your return, so don't give them too much money just to ask for some of it back.

"2. Assuming the answer to #2 is yes, the IRS website says "You can also get an extension by paying all or part of your estimated income tax due and indicate that the payment is for an extension using Direct Pay, the Electronic Federal Tax Payment System (EFTPS), or a credit or debit card. This way you won’t have to file a separate extension form and you will receive a confirmation number for your records." Would you recommend utilizing this, or filing form 4868 manually?"

Yes, since you are going to pay, go ahead and check the extension box when you pay - just don't forget!

"3. When I receive my updates 1099-SA and am ready to file my taxes, can I e-file through TurboTax still?"

This is why I want you to delay filing - you can e-file your original return through TurboTax up through October 15th, but even now I am not sure that you can e-file your amended return through TurboTax (I've gotten conflicting messages about that).

But what I did NOT want you to do is e-file your initial return, paying the 1,500 as Other Income and the 20% penalty, and then try to get that money back on an amended return that will likely have to be mailed, not with the IRS some 20,000,000 paper returns behind. You would be giving the federal government a nice loan, even if they pay you interest on it next year (they are actually good about that - but I think you'd rather have the money).