Handling excess contribution from HSA, moved to non-HDHP plan mid-year with job change

[vin_tx]

I'm struggling to ensure that I handled excess contribution to my HSA in 2021, and could use some advice. I'll share specifics here:

With Employer A till April-end in 2021 on HDHP family plan, enrolled in HSA. Employer A contributed $2600 to HSA in January 2021 as an annual benefit for being on HDHP family plan. Was contributing monthly payments towards maximizing the HSA annual contribution limit of $7200. By the time I left employer A, 2021 contributions to HSA were at $2600 + $1400 (my contributions) = $4000 (rounding up for simplicity). In Feb 2021, not knowing I was going to switch jobs, I started using up the HSA account balance to pay medical bills and used up most of the funds, leaving only about $500 in the HSA account, which means, I used up some of the excess contributions. Due to only 4 months employment with Employer A on HDHP plan in 2021, my HSA was only eligible for a prorated limit total of $2400, creating an excess of $1600 in the tax year of 2021.

Switched to Employer B April-end in 2021 but chose not to use HDHP plan with this employer, still employed here and no plans to use a HDHP plan.

In December 2021, I filed an excess contribution removal form with my HSA administrator for $1600, thinking they would refund the available balance to me (only about $500) and mark the total excess contributions in the appropriate forms. The form was declined with the reason of insufficient funds. In Feb 2022, I filed a new excess contribution removal form for the available balance of $500 and that has been processed, bringing the HSA balance to $0 now. Note - I do not have any earnings on my HSA balances, the money was never invested.

Please advise if I handled the excess contribution removal correctly, and will the excess of $1600 in the tax year of 2021 be reflected in the 1099-SA or 5498-SA correctly, and will I have to pay any penalty while filing taxes for 2021? Shouldn't the HSA administrator record $1600 as the excess, instead of $500? Anything specific I should pay attention to while doing my tax forms? THANK YOU

[RaifH · Accepted solution]

You had a $1,600 excess contribution in 2021, but only $500 left in your HSA. When you correctly withdrew the excess that you could and brought your balance to $0, you still have an excess contribution of $1,100 but you will not be taxed on it. The 6% tax is on the lesser of your over-contribution or the total value of your HSAs. 

This excess contribution will carry forward and continue to lurk on your tax return in future years. If you were to get another HDHP at a later date and contribute to your HSA, you will need to under contribute that first year or these excess contributions will come back to haunt you. 

To ensure you are not taxed on this in TurboTax, make sure you enter $0 when it asks What's the total value of all your HSAs after putting in your $500 withdrawal of excess contributions. Once everything is entered correctly, you will pay no tax on your over-contribution. You can verify this by looking for Schedule 2 Line 8 of your tax return. If you do not have a Schedule 2, that means you are not paying the additional tax:

1. Open or continue your return.
2. Select Tax Tools in the left menu (if you don't see this, select the menu icon in the upper-left corner).
3. With the Tax Tools menu open, you can then view your 1040 form: Select Tools. Next, select View Tax Summary in the pop-up, then Preview my 1040 in the left menu
4. Scroll down until you see Schedule 2 Line 8 Additional Tax on IRAs or other tax-favored accounts. If this line is blank or you have no Schedule 2, then you are not paying the 6% tax on your HSA. 

[vin_tx]

Thank you so much for your inputs @RaifH , very very helpful! Regarding the excess $1100 contribution, I'm wondering if it would make sense to submit a Distribution Reversal Form for that amount to my HSA administrator, such that I send them a check of $1100 back, and then file another Excess Contribution Removal form after that to withdraw that money back to myself. Will this process correct everything and avoid the need for any future under-contribution adjustment or other taxation paperwork? Thanks in advance!

[BillM223]

"a Distribution Reversal Form for that amount to my HSA administrator, such that I send them a check of $1100 back, and then file another Excess Contribution Removal form after that to withdraw that money back to myself. Will this process correct everything and avoid the need for any future under-contribution adjustment or other taxation paperwork?"

This is overkill. Yes, as Raif said, you will carry forward an excess contribution of $1,100 into the indefinite future; however, since, as noted, your HSA balance will be zero, the penalty will also be zero every year.

Suppose some day you get HDHP coverage. The simple way to deal with this is to under contribute by $1,100 the first year of your HDHP coverage. The excess will be used up, and that will be the end of it.

Since you don't know if you will ever have HDHP coverage again, this seems like a better way to go than to incur transaction fees at your HSA for declaring a mistaken distribution (which the HSA custodian does not have to honor), then declaring a excess contribution - all of which you have to do by April 18, 2022, by the way (or by October 15, 2022 if you file for an extension.

[vin_tx]

Thank you @BillM223 ! You make a fair point, I'll follow the advice.