How to calculate income earned on excess HSA contribution?

[nospam]

My wife and I both have HDHP health insurance plans. The kids are on my wife's insurance.

This year, my wife opened an HSA and contributed $6900, the maximum allowable for a family. As I have done in previous years, I contributed $3450 through bi-weekly payroll deductions. I've come to understand that this is not allowable... the family limit applies to the entire family, regardless of who has what coverage.

As I understand it, I need to take the following actions before filing my taxes (per IRS pub 8889):

• Withdraw the $3450 as "excess contributions" to avoid paying the 6% excise tax 

• Work with my payroll office to ensure that this appears on my W2 as "other income"

• Work with my payroll office to ensure that any applicable payroll taxes are withheld against this year's taxes to cover this correction (I assume... haven't seen this explicitly stated)

• Withdraw any income earned on the withdrawn contributions (again as "excess contributions") and include the earnings in "Other income" on my tax return

It's this last bullet that gets complicated. I've not found any guidance on how to do this. My periodic cash contributions are automatically swept into an investment account, and automatically invested in mutual funds. To be super-precise, I'd have to figure out the date of each contribution, and figure the compounded gain from the day it was invested until today. Not a minor task. My understanding is that the IRS allows some flexibility here, and would allow me to aggregate the contributions and calculate an "average" return, but I can't find any examples or formulas for this.

Any suggestions?

[Opus 17]

How did your spouse contribute to her HSA? You have an overall family limit of $6900. Your need to withdraw $3450 could be satisfied by either one of you withdrawing any combination of money equaling that amount. If your wife contributed after-tax money directly, it would be much easier to have her take out $3450, so you don’t have to mess around with payroll.

 Removing excess contributions is not a regular withdrawal. It requires that you notify the bank in advance, and may require a special form. The HSA bank will determine the amount of earnings attributable to the excess contribution and refund it for you.

[Opus 17]

Also, for 2019 it will be better for you to contribute up to your single limit and then have your wife contribute up to the single limit rather than the family limit.  If your wife makes after-tax contributions, they are exempt from federal income tax, and state income tax in most cases.  If you make contributions through payroll, they are exempt from federal tax, state tax, AND Social Security and Medicaid tax.   So making contributions via payroll deduction saves an extra 7.65% tax compared to making after-tax contributions.

[nospam]

My wife's contributions were also pre-tax through payroll, so it doesn't really matter who makes the contributions.  I'm aware that it's not a regular withdrawal, which is why I said it would be withdrawn as "excess contributions".  Thanks for the heads up!

My HSA bank (Optum) said it had no idea how to calculate the earnings attributable...  I was on my own to hire an accountant.  Very irritating.  My best guess is that it's just the Net Income Attributable (NIA) equation, like with excess IRA contributions.  

The only other question would be if I can do it at the "aggregate" level... Consider the opening balance on Jan 1, the closing balance on the day I make the correction, and the "excess contribution" as the sum of all contributions over that period, rather than calculate each one's NIA individually which seems painful

[dmertz · Accepted solution]

This would only involve your employer if your employer requested the return of contribution be paid to them, in which case, if the amount contributed through the employer was by payroll deduction, the employer would pay you the money refunded to them and include it in box 1 of your W-2, withholding accordingly.  If you obtain the distribution yourself, you would not involve your employer and, when you enter the code 2 Form 1099-SA for a return of excess contribution, TurboTax will automatically include the amount in income, including whatever amount the HSA custodian calculates and distributed as the earnings on the excess contribution, reported in box 2 of the Form 1099-SA.

The calculation is the same as for a return of contribution from an IRA before the due date of your tax return.  The HSA custodian should do the calculation for you when you tell them that you want a return of excess contribution.  CFR 1.408-11 describes the required calculation:  https://www.law.cornell.edu/cfr/text/26/1.408-11

[nospam]

Unfortunately my HSA custodian isn't willing to calculate this.  They said it's up to me to figure out and request the correct amount.  I've asked my employer to initiate the distribution so the payroll taxes get withheld properly and it shows in my W2, as you stated.  The NIA calculation was the piece I was missing.  

It my payroll department and/or HSA custodian were more helpful, this is exactly how I thought it should get resolved!

[Opus 17]

You don’t need to involve payroll.  It’s very nice that you want to pay payroll tax but it’s not required, why be out an additional $230 for no reason.  

If your HSA won’t calculate the right amount, they may not report it correctly on your 5498 or 1098 either which concerns me.  Can you withdraw the $3450 from your spouses HSA? Maybe they know how to do the calculation correctly.  You don’t need to involve the spouse’s employer, just report it in TurboTax.  

[dmertz]

I don't understand how an HSA custodian can prepare a code 2 Form 1099-SA without themselves validating the amount that they report in box 2.

A return of contribution paid to you has no effect on the Form 5498.  The Form 5498 would only be affected if the excess was paid back to your employer, in which case the HSA custodian should not include the returned amount on the Form 5498, treating it as if it the money had never been deposited into the account.

Yes, as Opus 17 indicated, the excess can be resolved by obtaining a return of excess contribution from your wife's HSA instead.  It's up to you and your spouse to decide which account contains the excess.

[linattruong]

@nospam Hey, were you able to figure out what to do? I'm in the same situation with contributing an excess of $275 and have no idea how to compute earnings on excess since HSA Bank "cannot help." My EOY savings/investment balance was negative to what I put into the account so I wasn't sure if I should put 0 there. I'd like to avoid paying the 6%, but would save money by just paying that then going to a tax advisor.

[dmertz]

The calculation is the same as for excess IRA contributions and is described in 26 CFR § 1.408-11:
<a rel="nofollow" target="_blank" href="https://www.law.cornell.edu/cfr/text/26/1.408-11">https://www.law.cornell.edu/cfr/text/26/1.408-11</...>

[hiteshsabnani3]

In the formula to get earnings on excess contribution, it shows that any distributions or transfers need to be added to the closing balance to calculate the adjusted closing balance. Does anyone know if account fees such as monthly fees or account transfer fees will count as distribution in such a scenario (this wasn't reported as a distribution on 1099-SA but wanted to check if we should treat it as distribution for calculating investment profit).

[dmertz]

Since the fees were not reported as distributions, the fees are equivalent to investment losses.