HSA earnings taxable in California

[ter2b2]

I've had an HSA in California for several years. This is the first year that Turbo Tax is prompting me to report HSA earnings so that they can be taxed on my CA state return.  It's also the first year that I used HSA cash to purchase shares of mutual fund (within my HSA).  Thus far, I have only bought shares. I have not sold any.  Checking over my Year-end  HSA summary from Fidelity, I was surprised to see that I have over $2000 of "Income" from my HSA.  This consists of about $100 interest on my HSA cash and $1600 of Long Term Capital Gains distribution, and $100 of Short Term Capital Gains distribution, and $200 of "Dividend".  All of the Capital Gains and Dividends were awarded by the mutual fund on Dec. 30 and immediately/automatically reinvested to buy more shares of the same fund.  Must I report the whole $2000 so that the state of CA can take about 10% of it?

[MaryK4 · Accepted solution]

Yes, unfortunately, California taxes HSA contributions and the Long Term Capital Gain is considered a contribution so you would have to include the entire $2000.

[ter2b2]

One Follow up question:  

Do my unrealized gains/losses (& fees) factor into the state taxes I should pay?

As I mentioned, I've not yet sold any of the mutual fund shares purchased in my HSA.  At the end of 2019, my account shows an $850 loss (unrealized) considering Total Market Value versus Total Cost Basis.  Am I taxed on the full $2000 of earnings even though I have $850 of losses on the shares purchased?  Also, can I deduct the $37 of fees charged to my account in 2019?

[BillM223]

California treats an HSA as a regular financial investment vehicle.

That is, you report the HSA just as if it were an after-tax investment account for your federal return.

You would not report unrealized gains or losses, because you haven't incurred them yet. That is, the unrealized loss may disappear (and I hope it does) before you actually sell the stocks or fund shares.

Yes, you can report the $37 in HSA fees as investment fees on your CA return.

[MartinH]

I also have an HSA investment account, however I received no 2019 earnings statement.  I did not contribute, or withdraw in 2019.  Estimating about $1000 earnings in 2019.

It is reasonable to assume that I do not need to report HSA earnings since the provider didn't generate a 1099? 

[MaryK4]

Yes, if you did not make any contributions or distributions, you do not need to report anything on your tax return this year.  

@MartinH

[Chaulk]

Do we have to list the HSA earnings in  California Other Income worksheet? Feels like I am entering it twice.

[BillM223]

In California, on the screen with the heading "Here's the income that California handles differently", scroll down to the subheading "Investments", and click on Start for Health Savings Accounts (HSA) earnings. In the screen that follows, enter your interest, dividends, and capital gains in your HSA.

Remember that California considers your HSA to be a regular investment account.

[Chaulk]

We should only have to fill it out in one place right?

[BillM223]

For the dividends, interest, and capital gains in your HSA, you have the one place I gave you above. Look at the subheading Investments and click on Start for Health Savings Accounts (HSA) Earnings to enter them.

I guess I should have mentioned a second place, right there in the same subheading "Investments". Under Investment income expenses, click on Start and enter any fees and expenses that you had to pay for the HSA account.

[ter2b2]

Hi, 

I am the original poster for the main thread.  I am posting again to try to get better clarity.  I'm not sure that I buy this argument from MaryK1101 that making no HSA contributions/distributions means one doesn't need to report anything.  Like the poster Martin (above), I did not receive a tax form such as 1099 for my HSA.  I also did not receive an "earnings statement".  Rather, I proactively searched for my standard end-of-year statement that every HSA account owner should have access to.  Through my diligence in combing over my statement, I noticed that one section says I had "Tax-free" "Income" of ~$2000 (But I assume it is only tax-free from a Federal perspective).   Sorry for being long-winded, but my point is: I don't think one has to make any contributions in the given tax year in order to receive capital gains and dividends distributions from a mutual fund.  I believe this would happen on a periodic basis (similar to how I continue to hold my company stock and it pays me dividends every quarter based on how much I continue to own/hold).  So it seems like a contradiction to tell user Martin that his roughly $1000 in earnings are somehow exempt from CA state taxes because he didn't contribute in 2019.??? (This seems to go directly against what I was told in the earlier post)

[Chaulk]

In the state I filled out the California HSA dividends ,interest,&cap gain in the HSA part. When it got to Non taxable income expenses:I went through the brokerage account and figured out what part of their expenses that I was deducting were for non taxable income, plus dividends on over 50% Us Obligations Bond Funds ,HSA Fees,etc,added all those up and then put a negative number in front of the total. to come up witha figure for non taxable income expenses. I hope that is right. The only problem is that I did not go to that detail the year before and one CPA said not to bother, and another CPA said not to ammend the previous years return over that because I am already ammending for something else and it would be confusing

but from now  on I will use my formula.

[TaxPayer888]

Jumping in for 2020 tax year.  Mary stated "...the Long Term Capital Gain is considered a contribution ".   I'm confused...

Does this mean HSA interest, div, cap gains count towards the annual contribution Federal limit for this year?  ie possible to exceed the contrib limit and get penalized?

I've not been investing my HSA, so interest $ is trivial at this point.  I had no idea CA treated it different until TurboTax asked me this year (March 21).

Thank yoU!

[bill_sg]

Based on https://www.ftb.ca.gov releasing on Feb 18, 2020. 

As a tax levy, this bill would be effective immediately upon enactment and specifically operative for taxable years beginning on or after January 1, 2020, and before
January 1, 2025.

Federal/State Law

Federal Law

Under federal law, eligible individuals may establish an HSA, which provides tax- favored treatment for current medical expenses, as well as the ability to save on a tax- favored basis for future medical expenses. An HSA is a tax-exempt trust or custodial account created exclusively to pay for the qualified medical expenses of the account holder and his or her spouse and dependents. Generally, individuals are eligible to establish an HSA when they are covered by a high-deductible health plan (High Deductible Plan) and have no other health coverage (with the exception of plans providing certain permitted benefits/coverage).

Within limits, contributions to an HSA made by, or on behalf of, an eligible individual are deductible by the individual in determining adjusted gross income (AGI). Contributions to an HSA are excludable from income and employment taxes if made by the employer. Earnings on amounts in HSAs are not taxable. Distributions from an HSA for qualified medical expenses are not includible in gross income; however, distributions made from an HSA that are used for non-qualified medical expenses are includible in gross income and are subject to an additional tax of 20 percent. The

20 percent additional tax is inapplicable if the distribution is made after death, disability, or the individual attains the age of Medicare eligibility (i.e., age 65).

All details can be check from https://www.ftb.ca.gov/tax-pros/law/legislation/2019-2020/AB2384-021820.pdf. Can you confirm that Earnings on amounts in HSAs are not taxable for California?

[marychris]

I have the same question because my CPA is telling me I don't need to report anything about my HSA investments on my CA return even though I sold an investment at a loss.