HSA excess contribution correction for prior year

[shinray]

I have an excess contribution from a prior year (2020) which I have finally corrected in 2023, resulting in a 1099-SA with distribution code 2. I'm concerned that this is not being handled correctly.

Because this is an 'excess contribution' that was withdrawn 'before the due date', on form 8889 the distribution is subtracted from the contribution, meaning line 16 is 0, meaning on form 5329, I cannot subtract my withdrawal from my contributions.

Also, it seems as though distribution code 2 causes TurboTax to handle some aspects of the HSA advisor automatically - I cannot list this as a normal distribution and pay the penalty.

I think this may mean I will be stuck in a perpetual loop every year with this excess amount. How can I fix this?

[shinray]

edit: this is in the wrong category, it does not belong under 'retirement'

[BillM223]

In order to avoid the excise tax (often called a "penalty") for the carryover of excess HSA contributions, you must withdraw the excess before the due date of the return. That is, if the original excess HSA contribution was for tax year 2020 as you seem to say, then the withdrawal had to occur prior to April 15 or so 2021 (there are other dates possible, but they are all in 2021).

After that point, a new set of rules take over. To eliminate the carryover of the excess, you need to do one of two things:

1. While you are still under HDHP coverage, you should reduce your HSA contributions so that the carryover can be added to your contributions and yet the total is still less than the annual HSA contribution limit. In this was, the carryover is treated as a personal contribution and is used up. The carryover is then used up and ceases.

2. You make a distribution from your HSA but not for qualified medical purposes. When the 1099-SA from this distribution is entered, the amount of the distribution will be added to your income and as a incur a 20% penalty, but, again, the carryover will cease.

#1 costs you less, but #2 allows you to continue to contribute the maximum to your HSA.

[shinray]

Thanks for the reply!

Let's say I already withdrew the excess contribution this year. However, it seems as though having the distribution as a code 2 distribution was a problem - I still have excess contribution on form 8889 and I don't appear to be paying the 20% penalty I expect.

[BillM223 · Accepted solution]

"t seems as though having the distribution as a code 2 distribution was a problem "

Are you saying that you told the HSA custodian that you wanted to withdraw an excess contribution?

As I noted above, you can't withdraw an excess contribution after the due date of the return (i.e., back in 2021). Instead, you need to take a regular distribution (so distribution code of 1) and tell Turbotax that it was not for qualified medical expenses. This will added it to your income and inflict the 20% penalty.

To get ready for this, tell the HSA custodian (nicely!) that the withdrawal of excess contributions was a Mistaken Distribution that you need to undo, and then you want to do a regular distribution for the amount of the carryover.

[shinray]

Thank you for the reply! That seems like the best path forward thanks

Would you also know how do I get around the issue where I am forced to select self or family for HDHP coverage? Neither is applicable since I no longer am under an HDHP

[BillM223]

The Review gets confused on why you are in the HSA interview if you don't have HDHP coverage.

No matter, when you indicated no HDHP coverage in the HSA interview, the calculations were made correctly. 

So you can safely enter Self, because that won't affect the calculations but will get you past the Review.