2370888
I front-loaded my HSA contributions this year ($3,600 + $1,000 catch-up). I have not made any distributions from my HSA account. I lost my HDHP plan in April. I understand from the proration calculation that my contribution limit is $1,150 ($4,600 * 3/12), which leaves me with a $3,450 excess contribution. In reading IRS Pub 969, it looks like I can request an HSA Excess Contribution correction from my HSA custodian of my excess contributions and earnings, and thus avoid the 6% excise tax.
However, I am confused by the following points in Pub 969:
1. Testing period in the last-month rule:
"If you fail to remain an eligible individual during the testing period, for reasons other than death or becoming disabled, you will have to include in income the total contributions made to your HSA that wouldn’t have been made except for the last-month rule. You include this amount in your income in the year in which you fail to be an eligible individual. This amount is also subject to a 10% additional tax. The income and additional tax are calculated on Form 8889, Part III. "
2. This caution note under the Excess Contributions section:
"If you fail to remain an eligible individual during any of the testing periods, discussed earlier, the amount you have to include in income isn’t an excess contribution. If you withdraw any of those amounts, the amount is treated the same as any other distribution from an HSA"
Based on the above points, what should I do? Are the above points still applicable if I corrected my excess contributions and earnings?
Thanks.
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First of all, your eligibility is determined on the first day of each month. So if you changed insurance in the middle of April but qualified on April 1, your limit for 2021 would be 4/12ths, not 3/12ths.
The testing period for the last month rule addresses your 2020 contributions, not 2021. The last month rule says that if you are eligible on December 1 (the last month), you could contribute the full year amount instead of a partial amount, as long as you remain eligible for all of the next year. If you lose eligibility during this testing period, your prior year contributions made under the last month rule become retroactively disallowed, and become taxable.
For your current situation, the last month rule will apply to contributions made during 2020. If you relied on the last month rule to contribute the full amount for 2020, then you have a taxable event in 2021 because of the change in coverage. If you were fully eligible for 2020, then you did not rely on the last month rule and you don't have any problems.
The application of the last month rule for 2020 is separate from the excess contribution rule for 2021. You need to remove your excess 2021 contributions, plus their earnings, to avoid a penalty. (You already understand this.) Separately, if you relied on the last month rule in 2020, some of your 2020 contributions are retroactively disallowed. They can't be removed to avoid tax and penalty, you have to pay that. But if you did not use the last month rule, you can ignore this part.
First of all, your eligibility is determined on the first day of each month. So if you changed insurance in the middle of April but qualified on April 1, your limit for 2021 would be 4/12ths, not 3/12ths.
The testing period for the last month rule addresses your 2020 contributions, not 2021. The last month rule says that if you are eligible on December 1 (the last month), you could contribute the full year amount instead of a partial amount, as long as you remain eligible for all of the next year. If you lose eligibility during this testing period, your prior year contributions made under the last month rule become retroactively disallowed, and become taxable.
For your current situation, the last month rule will apply to contributions made during 2020. If you relied on the last month rule to contribute the full amount for 2020, then you have a taxable event in 2021 because of the change in coverage. If you were fully eligible for 2020, then you did not rely on the last month rule and you don't have any problems.
The application of the last month rule for 2020 is separate from the excess contribution rule for 2021. You need to remove your excess 2021 contributions, plus their earnings, to avoid a penalty. (You already understand this.) Separately, if you relied on the last month rule in 2020, some of your 2020 contributions are retroactively disallowed. They can't be removed to avoid tax and penalty, you have to pay that. But if you did not use the last month rule, you can ignore this part.
THE LMR says that if you are an eligible employee on the 1st day of the last month of your tax year (usually 12/1) you are eligible to contribute for the entire year. However, if you use the LMR, then you must remain eligible through 12/31 of the following year. this is the testing period referred to.
see this article which provides more details
https://livelyme.com/blog/last-month-rule/
@Opus 17 Thanks very much for your clarification of the last month rule and application of the testing period. Since I was fully HSA eligible in 2020, I understand that I don't need to worry about the last month rule and its consequences. This is a huge relief. I just need to deal with the excess contributions (and earnings thereof) for 2021. Thanks again!
@Mike9241 Thanks for your response. I now understand that since I was fully HSA eligible in 2020, I did not rely on the LMR in 2020. I now need to deal with the excess contributions in 2021. Thanks again!
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