Excess contribution to HSA years ago, what are my options?

[gooseontheloose]

I have been behind a couple years in taxes and am doing them now. I had contributed the full tax year's allowable amount ($3,450) at the end of 2018 out-of-pocket (after-tax), in December. I just found out recently that while my HSA was active, my accompanying HDHP wasn't technically active until January 1, 2019. It was in that window before the HDHP came online that I made my full out-of-pocket contribution. It seems very nitpicky, but in my interest in doing this very cleanly, it's opened up a huge can of worms that no one can seem to tell me the correct path for (not my HSA provider or any tax people I've contacted).

On my 2018 taxes, I have the full $3,450 listed as an "excess contribution". I've carried that forward for each year (since I haven't withdrawn the money), so each year I pay the excise fee. However this year (for 2021 taxes) I want to clean this up so I don't have to pay the excise or do anything special going forward.

I just want to fix this immediately, whatever the cost, so that I don't have to halt contributions or track unaddressed amounts across years. My HSA custodian said they cant help me because its past the window for the tax year where the "excess contribution" occurred, so they can't withdraw it as an excess contribution for me, and they're not even willing to calculate the gains on that contribution.

So I've calculated the rough gains from my initial investment. Do I just pull the full initial excess contribution + gains out, and then tell next year's Turbotax that I had an excess contribution, but that I'll pull it out by the tax deadline for 2021? The problem here is it seems to assume that the "excess contribution" is pre-tax, and so will tax me for promising to withdraw it. Is this right? Have I lost the right to my money being post-tax? Also, then do I report the gains as "other income"?

If I do the withdraw myself, I know the HSA custodian will report that I withdrew money, and the IRS may just see this as an early withdrawal and tax me (bad, since a lot of the withdrawn money would already have been taxed) as well as penalize me 20%. I'm happy to do this as a one time correction for my mistake if I have to, but obviously don't want to throw away money.

I don't think my 2018 taxes showed a deducted amount, I just have them reporting an excess contribution only (there were no employer contributions that year, only my "early" contribution).

What are my options here? Thanks in advance!

[gooseontheloose]

Still hoping to get some help here.

[Opus 17]

To clarify, which tax returns have you not yet filed?  After you enrolled in an HSA eligible HDHP on January 1, 2019, have you continued to be enrolled in an eligible HDHP?  Are you enrolled in an eligible HDHP now?

What is the balance in your HSA? Do you spend down every year or are you trying to accumulate funds for the future?

[gooseontheloose]

17-20 being filed now. So I can still alter them if I have to. I went through the signup in November ‘18 but technically the HDHP didn’t start until 1/1, 1.5 months later. That time in between is the window my out of pocket contribution was made in.

Have stayed enrolled to this day, still enrolled yes.

It’s been maxed every year since then so it’s multiple years of the max contribution. Zero spending from it, just accumulating in it.

[Opus 17]

OK thanks. This situation is quite simple, unfortunately you will pay end up paying a substantial amount of penalties.  If you have the money well invested, you might have earned more than the amount of penalty even so over the recent few years.

For 2018, you have as you say, $3450 of excess contributions. Because you cannot remove those contributions before April 15, 2019, the tax consequence is that the $3450 is not tax deductible, it is added back to your taxable income, and there is an additional 6% penalty.  This will be calculated on a form 5329, which TurboTax or your tax preparer will prepare as part of your 2018 tax return.

At this point, the only way to fix the excess contribution issue is to use up the excess amount by contributing less in the current year and treating the excess as a current year contribution. You can stop thinking about removing the excess and it’s earnings, that procedure is no longer relevant.  I will explain how that might work.

On your 2019 tax return, you must report that you had a $3450 excess from 2018. This will require that you have a copy of your 2018 form 5329 on hand when you prepare your 2019 tax return.  The 2019 contribution limit for a self only plan was $3500. Let’s assume that you only contributed $2500. You can consider that $1000 of the excess counts as a 2019 contribution, making your total 2019 contribution $3500 and the remaining excess is now $2450. You will pay a 6% penalty on the remaining excess on your 2019 tax return. However, if you already maxed out 2019 by contributing the full amount, then you still have the full amount of excess in your account and you will pay the 6% penalty on $3450. This will be part of your 2019 tax return on form 5329.

You will do the same calculation when preparing your 2020 tax return and you will need to have your 2019 form 5329 on hand.  Any amount of excess contribution that you can’t use up in 2020 will be subject to the same 6% penalty.

Finally, we reach 2021.  The maximum self only contribution for 2021 is $3600. Let’s assume in the worst case scenario, that you maxed out your 2019 and 2020 contributions, which means that you will pay the 6% penalty on the full $3450 in each year 2018, 2019, and 2020.  Now 2021 is when you can eliminate that penalty for good. You must contribute $150 (or less) of new funds into the HSA for 2021. That will allow you to treat the excess that you have been carrying forward as your 2021 contribution.  That will use up the excess and it will no longer be an issue going forward.  If you have already contributed more than $150 for 2021, you need to contact the HSA bank and request a “return of excess contributions“.  Make sure you tell them that you are requesting a return of the 2021 contributions that you have already made. Don’t tell them it is a return of 2018 contributions, because it’s not. It’s a return of 2021 contributions, so that you can get your 2021 contributions low enough that you can use up the excess carryover.  The bank will also be required to return to you any earnings from the 2021 excess that they are sending you, and that will be reported as taxable income on your 2021 tax return. 

because the penalty is based on the amount of excess, or the amount of money in the account, which ever is smaller, it would also be possible to eliminate the excess as a future concern if you spent the account down to zero. However, if you don’t have a large medical expense, then the withdrawal would be subject to a 20% penalty, on top of the penalties you have already paid, so I don’t think this is the way to go at this point.

Because it is after May 17, 2021, you can’t make retroactive adjustments for 2020.  But as 2021 is ongoing, it should be relatively simple to make sure that your $3600 of contributions for 2021 only include $150 of new money plus $3450 from the excess.

Of course, if you made smaller than maximum contributions in 2019 or 2020, then you will have used up some of the excess already, and that will allow you to put more new money into the account for 2021, as long as the new money for 2021 plus the excess that you are trying to eliminate, totals no more than $3600.  

And of course, this plan that I have outlined assumes that you are still covered by a self only HDHP, and that you have maintained eligible coverage throughout the years we are talking about.

[gooseontheloose]

WOW! Incredibly thorough and detailed answer... thank you so so much. What you describe about carrying the excess forward is precisely what I've already done on the years I've just completed my returns for so that's good. I do have a couple of questions.

I have maxed out all years, so I am in that "worst case" you mention.

1. Is there no faster path to fix this *today* (i.e. not waiting for 2021 taxes) by just manually withdrawing the contribution (and maybe the gains too) at this point? I know you said it's too late to withdraw by the 2019 date cutoff, but does that just mean "too late to withdraw without penalty"? Or is it literally too late to resolve this via *any* form of withdrawing (short of emptying the account), even if I'm prepared to pay taxes + penalties? If I manually withdrew the "correct amount" of 2018 excess+gains, obviously the HSA custodian will report it as an early withdrawal, and I'd pay the taxes and penalties as if it was. But would that cause the IRS to recognize that excess as "resolved"?

2. If I do a return of excess contribution for 2021 (since some contributions have already gone in for 6 months this year), and apply my carried over excess from prior years to this year, do I also have to account for the gains that have come from my original excess amount? In other words, if my original 2018 excess was $3450, is it enough to halt contribution, return this year's contributions as "excess", and "absorb" just that 2018 excess $3450 (that I've carried across years in my returns) in 2021, and be done with it? Or if my $3450 of investment has grown to say $5000, do I have to "absorb" $5000 (across two years because its obviously too much for a single year)?

[Opus 17]

@gooseontheloose 

1. No, there is no faster way to resolve this than waiting for your 2021 tax return.  A resolution might have been possible on your 2020 tax return but it would have to have been applied to your account prior to May 17.

There is a second possible resolution to the problem that could be made on your 2021 tax return other than using the excess contributions as part of your 2021 limit. I have not mentioned it because I am not sure if it would work, and even if it did, it would mean paying a further 20% penalty.  There’s absolutely no reason to do this since you remain eligible to make contributions and can use the method I already outlined, end it wouldn’t be any faster, because it would still only apply to your 2021 return.

2. At this point, you do not account for the gains that are attributable to the 2018 excess that has remained in the account. That’s what the recurring 6% penalty was meant to do.  You will have to account for the gains that are attributable to the 2021 excess that you will have returned to you in order to apply the previous excess carryover to your 2021 limit. The HSA bank should have no problem with calculating this, and the dollar amount will probably be small since it will likely amount to just a few percent interest on a couple thousand dollars over 6 months.  Since the excess will be returned to you in the calendar year 2021, it will be reported on your 2021 tax return as taxable interest or dividend income.

[gooseontheloose]

Thanks so much! It all makes sense now.

[Opus 17]

@gooseontheloose 

actually, there is a way to fix this on your 2020 tax return, but only if you applied for an extension of the deadline to file your tax return.  The 2020 deadline was May 17, 2021. If you requested an extension, using an online procedure, or mailing in form 4868 before May 17, then your filing deadline has been extended through October 15.  Also, if you made an estimated payment on the IRS website before May 17, that also grants you an automatic extension to October 15 even if you did not file form 4868.

When you said that you were just now catching up from 2017, I assumed that you had not filed an extension request for 2020, but that assumption may have been incorrect.

If you did file an extension request for 2020, then you can take the excess withdrawal for 2020 instead of taking it for 2021.  You would contact the HSA bank and ask them to return $3450 of your 2020 contribution as an excess contribution. If the bank says they can’t do this because it is after the May 17 deadline, you would point out that the deadline to return excess contributions is the deadline for your tax return including any approved extensions. By getting an approved extension, you move the deadline to take a return of excess contributions for 2020 all the way back to October 15, 2021. (The bank might want to see proof that you have an extension, or they might want you to sign an affidavit that you have a valid extension, so that if they are audited, the trouble falls on you instead of them.)

The procedure would then be the same as I previously outlined for 2021. The bank would return $3450 of your 2020 new contributions as a return of access, and the bank would also include the earnings from that 2020 contribution.   Then, you would apply the old carryover excess to your 2020 contribution limit. You would not have to pay the 6% penalty on your 2020 taxes. Since the earnings on the excess were physically paid to you in calendar year 2021, they would be reported on your 2021 tax return.

If you didn’t get an extension on your 2020 return, you can forget I mentioned this, and proceed with the original outline.

[gooseontheloose]

Excellent information again. Yeah I didn't file for the extension, but it's good to know that if I had it would've afforded me this opportunity. Either way I'm sure this extra information will help someone else! Thank again.

[Schagane]

Have similar situations. Could you confirm that because I already paid taxes on excess contributions to HSA in prior years (excess contribution was included in income), I would be able to deduct my HSA excess contribution on sch 1 in 2021 as adjustment to income (HSA deduction)? Basically my excess contribution from prior years would not only be eliminated by not contributing to HSA  in 2021 but also would be tax deductible in 2021 because I already paid taxes on it?

[Opus 17]

@Schagane 

That’s correct, you can treat a prior year excess (which will be shown on your prior year form 5329) as a current deductible contribution, as long as your total contributions (new money plus the excess) are not more than your current year limit.  

[danbez]

Apologies for replying to an old post, but I have a similar issue and I would like to confirm that my strategy will work.

@Opus 17 , I have a small HSA excess contribution from 2021 - aprox USD 700.00 total. I paid the penalty on 2021 and 2022 tax returns but I would like to avoid paying it again in 2023.

Since September 2021 I don't have an HSA plan (I'm using a basic "Obamacare" plan/HealthExchange plan). However, for 2023 I can enroll into an HSA supported plan again.

Even with this gap in HSA-supported plan from late 2021 and 2022, can I still use the excess contribution from 2021 against the new 2023 HSA-supported plan and get rid of it? (I don't plan to make any new HSA contributions, just use the HSA plan to fix the old penalty.)

thanks

Daniel.

[dmertz]

An excess contribution that is present in your HSAs can be applied as part or all of your contribution for any future year provided that you are eligible to make an HSA contribution for that year.  So yes, as long as you are eligible to contribute at least $700 to an HSA for 2023, you can apply the $700 excess from 2021 as part of your 2023 contribution.   The $700 will appear on line 43 of your 2023 Form 5329.  You can also contribute additional amounts bringing your total contributions (including the applied excess)  up to your contribution limit for 2023. 

If you are an eligible individual on December 31, 2023 you can make a total contribution up to the full-year limit under the last-month rule.  However, if you don't plan to remain an eligible individual throughout 2024, you might want to limit your HSA contribution for 2023 to only the annual limit prorated for the number of moths that you are an eligible individual.  Otherwise, I'm not sure why you would not want to contribute the maximum permissible unless you lack the funds to do so.

[danbez]

Fantastic, thanks !