Use HSA funds to pay HSA capital gains Tax in California?

[copyhhh]

My specific question is: can you use HSA Gains to pay HSA capital gains tax in California?

Example: I’m in the 9.3% state income tax bracket and sold shares in my health savings account for $100,000 in profit/gains. In California I should owe $9,300 for this gain since HSA gains are taxable. Can I use a portion of the $100,000 to pay this tax or do I have to pay from another source? i.e. paying a tax is not an HSA qualified expense?

[DaveF1006]

Yes since this is already a capital gains distribution, you can designate a portion of this to be paid to the State of California for capital gains tax. 

[Mike9241]

no. for federal purposes any distribution from an HSA other than for qualified medical expenses are taxable

You can receive tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA. If you receive distributions for other reasons, the amount you withdraw
will be subject to income tax and may be subject to an additional 20% tax.

[copyhhh]

Ok, so differing opinions, can’t find anything on this online I feel like if you were to get massive gains in your HSA and have to pay the state tax “out of pocket” it could be really devastating. California Love 

[DaveF1006]

It depends. I was under the impression from your question that you sold your shares and received your $100,000 distribution as cash in hand. However if the gains/profits from your sale was deposited into your HSA account, then you cannot request a $9300 distribution from your HSA without additional taxes and penalties. This is because the distribution is not for medical purposes as Mike9241 mentions above. 

As a result, this income would taxed as ordinary income plus a 20% penalty. This could be quite costly in addition to the $9300 capital gains tax.  

My suggestion is to wait until you prepare your federal and state income tax return. The reason being is that some or all of the capital gains tax may be negated by taxes already paid to California or there may be credits that may apply to reduce the tax liability in California.  

If you wish to pay the capital gains tax to California as an estimated tax penalty, use a voucher in this link.  Assuming you sold your shares in 2021, use the voucher dated 01/18/2022. You may wish to do this to avoid estimated tax penalties that may be levied if you underpay your California state tax for the year. You will need an alternate funding source to make this estimated tax payment other than a distribution from your HSA account. 

@copyhhh

[copyhhh]

Thanks, thats what I figured. Anyway to take the cash distribution as cash in hand and not have it deposited into the HSA account? I’m asking as a hypothetical, I haven’t actually sold anything yet, but trying to strategize. 

[DaveF1006]

Be careful. The HSA investment account and HSA account are closely linked. If you withdraw the $100,000 from the sale of your shares, you still may be subject to the ordinary income tax based on the distribution plus the 20% penalty for it being a non-medical distribution. 

[Mike9241]

you are correct but most taxpayers don't have such huge gains in their HSA's because they use them to pay medical expenses. anyway, California treats an HSA just like any other non-tax-deferred investment account. so any losses you have in a taxable account will offset the HSA gains. 

[fanfare]

@copyhhh 

hypothetical profits of $100,000 may be something that comes in your dreams.

But, if it becomes real, take the money, and the tax hit.

(If you don't have your Long Term Care financed, maybe not.)