HSA Excess Contribution Withdrawn, Still Showing an Excess

[astreby]

In 2020 my husband became eligible for a HDHP and an HSA account. He started in July, so we invested the maximum we could that year for a family. When we did that we didn't realize that his company would also contribute a lump sum ($1,846), so the lump sum became an excess contribution. I paid the taxes on the excess several years in a row, and in December 2023 I had it and the interest earnings removed through his HSA custodian. For filing taxes, I input the 1099-SA with the distribution and earnings and marked the distribution code 2, and also included the other qualified medical distributions in a separate 1099-SA. Turbo Tax then asks for excess contributions from 2022. I enter in the $1846 from the prior year. Turbo Tax is telling me I still having me pay the 6% taxes on the excess. Is this correct? Is it still considered an excess, or am I paying the taxes on the distribution? I filled out the form by hand, but I can't review the form in Turbo Tax until I pay, and I want to make sure it's correct first.

[BillM223]

On multi-year situations, we need a simple layout of what happened:

So do me a favor, and tell me what you really did.

2021 - what was your HDHP coverage? Type and months? What were your HSA contributions?

2022 - what was your HDHP coverage? Type and months? What were your HSA contributions?

2023 - what was your HDHP coverage? Type and months? What were your HSA contributions?

[astreby]

Sure! My husband has an HSA eligible HDHP from Blue Cross from his employer. He started in July 2020, and each year we have been putting the maximum family limit into the HSA. He's under 55 and has been at the same job since, with no lapse in coverage. It is the sole health care plan for our family, so there's no overlap or confusion there. 

2020: $5,396 (which includes the $1,846 excess)

2021: $7,200 (+ excess)

2022: $7,300 (+ excess)

2023: $7,750, deducted excess & interest

I filed form 5329 each year, paid the 6% tax and essentially rolled the excess over until 2023 when I had it removed from the account through the distribution from the bank to try to fix the problem.

Hope that helps clarify.

[BillM223]

I am stuck at the beginning: 2020

2020 - Self plan - last month rule - annual HSA contribution limit - $7,200 - HSA contributions - $5396 (TPs 3550, Emp 1846) 

It appears that you two (or maybe just your husband) had only Self only coverage in 2020. If you would have had Family coverage in 2020, then TurboTax would have invoked the last-month rule for December 1, 2020, and the annual HSA contribution limit would have be $7,200 - meaning no possible excess. You would have had an excess only if you (he) used the last-month rule for December 1, 2020 on a Self-only plan, for an annual HSA contribution limit of $3,550...which added to the company's $1,846, would make an excess of (drum roll) $1,846.

So is that correct that your husband/you had Self-only HDHP coverage for 2020?

I ask because you said that "each year we have been putting the maximum family limit into the HSA " and this does not seem likely.

[astreby]

I really appreciate your response on this. I went back and looked at all my HSA bank statements and also my tax documents from 2020, and I was wrong in my previous posts. We were definitely covered for a family beginning in July. My husband contributed to $3,500, and his employer contributed $1,896, giving the total of $5,396 for the year 2020. In the tax return on form 8889, the family box is checked, then lines 3-8 have the self-only amount of $3,550. Is that the error? Should lines 3-8 have been the family amount of $7,100?

[BillM223]

It sounds like you did not enter in TurboTax that you had Family coverage for 2020, July onwards.

The reason is that if you had indicated Family coverage as of December 1, 2020, the last-month rule would have given you the full annual Family HSA contribution limit for 2020, which was $7,200. This means that you actually had in fact no excess HSA contributions in 2020 nor any carryovers in the years that followed.

So, you need to count on your fingers and toes to see how much money you have spent on extra income tax and 6% penalties since 2020, to see if you want to go through the bother and expense of amending your 2020, 2021, and 2022, returns. 

The thing is that you are approaching the deadline for amending your 2020 return. It is normally 3 years from the original due date which is next week. But there is a Covid-era IRS Notice (Notice 2023-21) that apparently pushes the amendment deadline out to May 17, 2024.

This would mean waiting on your 2023 return, and then filing an extension, then amending 2020, 2021, and 2022, and buying the software for these years if you already didn't own the desktop software for these years...and doing all this before May 17th...

So think about it and come back if you have any more questions...

[astreby]

In 2020 I used a different company to file my taxes, and maybe there was an error in their system. Anyway, it feels good to be getting some understanding and moving forward to solve this. I have a couple more questions before I make a decision on how to proceed. I definitely shot myself in the foot by waiting to file this year. I wasn’t expecting it to be so complicated. 

1) If I don’t file the extension and correct the previous returns, will I be taxed the 6% penalty forever?

2) Why didn’t removing the excess through the custodian correct the issue?

3) If we contribute about $2,000 less than the family limit for 2023, would that resolve the issue?

I greatly appreciate your responses, and you taking the time to help me work this out. 

[BillM223]

Responses absolutely out of order...

"2) Why didn’t removing the excess through the custodian correct the issue?"

There are two types of excess contributions: "short-term excess" and "long-term excess". Unfortunately, the IRS calls them all the same thing. But the solutions to each is quire different.

Short-term excess is excess in the current year. You must withdraw this by the due date of the current return. If so, then the excess is "cured". 

But once the due date has passed without the excess being withdrawn, then the short-term excess is converted to a long-term excess.

To cure the long-term excess, you have to either:

1. In a future year when you have HDHP coverage, you reduce your other HSA contributions so that the long-term excess that is carried over plus any current year HSA contributions is less than or equal to the current annual HSA contribution limit. Since the long-term excess carryover is treated as a personal HSA contribution (line 2 on your 8889), if there is room for it under the current year limit, the long-term carryover will be used up, and done with. OR

2. Make an HSA distribution and enter the 1099-SA, showing that an amount equal to the long-term excess was not made for qualified medial expenses. This amount will be added to Other Income and penalized 20%, but your long-term excess will disappear.

"1) If I don’t file the extension and correct the previous returns, will I be taxed the 6% penalty forever?"

If you go under HDHP coverage in a future year AND reduce your annual HSA contributions to match #1 immediately above, that would work. But it means that you would reduce your cash contributions to the HSA for one year...just don't be surprised.

"3) If we contribute about $2,000 less than the family limit for 2023, would that resolve the issue?"

Yes, but haven't you already made your contributions for 2023? 

[astreby]

Okay, so now I'm back to my original problem. In your response to my second question,

2) Why didn’t removing the excess through the custodian correct the issue?

You said I could

"2. Make an HSA distribution and enter the 1099-SA, showing that an amount equal to the long-term excess was not made for qualified medial expenses."

So this is exactly what I did in 2023. At the end of December I had the "$1,846 plus interest earned removed. The bank sent me a 1099-SA with a distribution code of 2 for excess. I also received a second 1099-SA showing the distributions made for medical expenses. When all is entered into TT I'm still getting the 6% tax fee of $111 in the Other Taxes section.

(For my third question, I miss typed 2023 instead of 2024.)

[BillM223]

"When all is entered into TT I'm still getting the 6% tax fee of $111 in the Other Taxes section."

Somewhere along the way, you had an extra $111 in excess contributions, sorry it's not immediately obvious in reading the text above where it came from.

If you are still working on your 2023 return, go back to the HSA interview, and see if you can get TurboTax to tell you that you have an excess of $111. Then try to tell TurboTax that you will remove that amount. 

If TurboTax lets, you, then this is still a "short-term excess". Call the HSA custodian today (April 15th) and ask for the "withdrawal of excess contributions" - the $111 and its earnings (the custodian should calculate that).

If TurboTax won't let you withdraw this amount because it was from a previous year, then the $111 is a "long-term excess", and removing it by April 15th won't do any good. Instead you need to treat it like a "long-term excess" (above), and just withdraw that amount not as excess contributions, (this can be done any time before you do your 2023 return in early 2024).

You will get a 1099-SA with a distribution code of '1' (because you did not ask for the withdrawal of excess contributions) and you will mark it as NOT for qualified medical expenses. This will adjust your income, and maybe add a 20% penalty, but you will be done withy it.

I am sorry, but I needed to ask you what TurboTax's reaction was to the $111 excess, to see if we could treat it as a "short-term excess" or a "long-term excess".