Reversal of IRA-to-HSA direct transfer due to ineligibility for HSA?

[msbrand]

I did a one-time $7000 direct transfer from IRA to previously existing HSA (like rollover) in May 2019.  I haven't used any of it.  I just learned that I am/was no longer eligible for HSA contributions since we no longer had an HDHP in any of 2019.  No problem with income tax, but is there a way to avoid the 10% penalty?  Somehow reverse the transfer at this point?  Withdraw the balance and close the HSA?

[BillM223 · Accepted solution]

May I assume that when you did the HSA interview, that you indicated to TurboTax that you did not have HDHP coverage in 2019? And that TurboTax then told you that the $7,000 contribution was all in excess?

If so, please contact your HSA administrator before April 15th(see footnote***) and tell them that you would like to request a "withdrawal of excess contributions" (use this exact phrase). If they accept this, then the HSA administrator will send you a check for the $7,000, which would be just as if you had taken an IRA distribution on which you pay income tax.

This should let the HSA administrator update their reports to the IRS, that you made a contribution but withdrew it before the deadline (the due date of your return), and you should also avoid any penalty.

The only problem is if you no longer have $7,000 in the HSA for the HSA custodian to send back to you. If this is the case, withdraw as much as you can to avoid the penalty.

Note that you do NOT want to close your HSA just because you no longer have HDHP coverage. You want to keep using your HSA to pay for qualified medical expenses, until the funds run out. Any distributions for reasons other than payments for qualified medical expenses are hit with a 20% penalty, so why do that?

***As of this edit, the IRS has announced that the filing date has been moved to July 15th, but has not updated the myriad of rules to clarify that this includes any regulations that depend on the due date of the return. So while the IRS will probably not mind you contributing to your HSA until July 15th, there is no guarantee that your HSA custodian - lacking written instructions from the IRS - will accept such a contribution after April 15th. In these uncertain times, it would seem prudent to make such a contribution by April 15th in any case. 

[Edited 3/24/2020 1:59 pm CDT - added July 15th note]

[dmertz]

In this case you need to obtain a return of excess contribution from the HSA by the due date of your tax return to avoid an excess contribution penalty for the HSA contribution.  You would also not report the distribution as having been deposited into an HSA so that you are not subject to any of the potential penalties associated with an HSA Funding Distribution.

As far avoiding the early-distribution penalty, if the distribution from the IRA occurred less than 60 days ago you are still within the rollover window and the distribution can be rolled over provided it does not violate the rule prohibiting rollover of no more than one rollover in 365 days.  Otherwise, the only way that I can see that happening is if you can roll the money back into the IRA by using self-certification under Revenue Procedure 2016-47 that the distribution would qualify for a waiver of the 60-day rollover deadline.  However, I don't see any listed reason in Rev. Proc. 2016-14 that would apply to this situation.  Reason 3.02(2)(c) refers to the money having been deposited into an account that was mistakenly thought to be an eligible retirement plan, but an HSA is not a retirement plan.  This would still be subject to the one-per-365-days rollover limitation.

https://www.irs.gov/pub/irs-drop/rp-16-47.pdf

[msbrand]

Following my original question above an HSA contribution even though I was ineligible, a response included:

"In this case you need to obtain a return of excess contribution from the HSA by the due date of your tax return to avoid an excess contribution penalty for the HSA contribution.  You would also not report the distribution as having been deposited into an HSA so that you are not subject to any of the potential penalties associated with an HSA Funding Distribution."

The excess contribution was properly returned to me.  In reading about Form 8889, etc., and trying to manipulate Turbo Tax to do the right thing, I'm back to seeing that statement above. I had wondered if I just ignore the $7000 into my HSA and its return, or if there were some proper way to show both steps. I see again the above that tells me NOT to report the distribution into an HSA.  And since I must now treat it as income, with no penalty, where does it show up as income?  Income from the IRA and not from the HSA?  I don't need Form 8889?  I did receive Form 5498-SA for the $7000 into the HSA.  No action needed since it was properly returned to me?  Thank you.

[BillM223]

"I see again the above that tells me NOT to report the distribution into an HSA.  And since I must now treat it as income, with no penalty, where does it show up as income?  Income from the IRA and not from the HSA? "

I believe that @dmertz intended for you to report the 1099-R (since the IRS has a copy of it), but to not answer the question on a subsequent screen that you transferred it to an HSA.

Additionally, if you were in the 60 day window, as dmertz points out, you could conceivably just transfer the IRA distribution back to the IRA (or later if you met one of the exceptions dmertz referred to) so there would be no addition to taxable income.

You say that the "The excess contribution was properly returned to me." To your IRA or to you for spending money? In the latter case, you will report the $7,000 as income.

The only thing outstanding is the 5498-SA. The HSA custodian really ought to issue a correct 5498-SA, and I wonder if the custodian will issue you one.

@dmertz?

[dmertz]

I agree with everything that BillM223 said except that, with the return of excess contribution properly paid to you, the HSA custodian should not be issuing any corrected Form 5498-SA.  The Form 5498-SA is still required to include the excess contribution in box 1 even though the contribution was returned.  The code 2 2020 Form 1099-SA will indicate the return of the contribution.  The distribution remains a distribution from the IRA that is includible on your tax return without treating it as an HSA Funding Distribution.

(I can't imagine that the HSA custodian and the IRA custodian could have conspired to make it as if the distribution from the IRA never happened, particularly since the Form 1099-R reporting the distribution from the IRA would become erroneous.)

[msbrand]

Thanks!  I was beyond the 60-day window and didn't meet any of the exceptions (ignorance wasn't one of them).  The returned money came to me as a check this February.  

Ahh...  I now see that the TD Ameritrade IRA 1099-R gross distribution includes the $7000 that went to the HSA.  Nothing in that 1099-R shows anything about money going to HSA, so I see I just report it all as income coming from the IRA.  I imported the TD Ameritrade 1099-R and the TT version shows the $7000 as an HSA funding distribution...but once I deleted it and confirmed all questions were answered correctly, all seems to make sense and errors are gone.  

Regarding the 5498-SA, the HSA custodian had stated:  "Neither an amended Form 5498-SA (HSA, etc…information) nor an amended Form 1099-SA will be issued to you for the taxable year for which the excess contributions were made...  consult your personal tax advisor if any questions regarding how to report the return of excess contributions."  So I guess it's no problem if my 5498-SA shows a $7000 contribution as long as the tax return all makes sense.

And I see that, even though the $7000 is reported as 2019 income, the whopping $2.75 earnings on that will be reported for 2020. 

Any further comments?  Thanks...and stay healthy!