How to correct an excess HSA contribution that was made years ago ?

[Log_Lady]

I ran into HSA over contribution issue this year when doing tax for 2022, realizing that I did not follow the last-month rule for 2021. For the option of emptying out HSA account, do I have to make qualified distribution for all the remaining HSA balance, or the balance after taking out 2021's over contribution chunk? 

[RalphH1]

[Note added by RalphH1 later: As Opus 17 (who thankfully caught this) clarifies, my advice here applies to a regular HSA excess contribution, as I failed to consider Log_Lady's "Last Month Rule" circumstances. So anyone with an excess resulting from failure to meet the Last Month Rule test (in the following year) should skip my post and read Opus 17's very helpful one below instead!]

The lingering amount of 2021’s excess contribution (to stop the ongoing 6% penalties) will need to be a non-qualified distribution. After you tell TurboTax the excess amount (from line 48 of last year’s Form 5329), the program should advise you to withdraw it, and allow you to check a box indicating exactly how much of it you plan to take out.

If you do it this way, you can then choose to empty out the remaining funds in your HSA account whenever you wish. There’s no rush, as the lack of a high-deductible health plan only means you cannot make any contributions. But you can still have the account, and take qualified or non-qualified distributions going forward, as you normally would with an HSA.

Of course, as Fangxial pointed out, there’s a 20% penalty on this year’s withdrawal, so spending the whole account down to $0 during 2023 instead — assuming you have enough medical expenses — might be a better way to wrap things up. Bgkr, Opus 17 and others also provided some very helpful and thorough info on this earlier in the thread, but don’t hesitate to re-post here if any additional clarification is needed!
 

(@Log_Lady)

[Edited 2/18/23 | 6:30 am PST]

[Opus 17]

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@Log_Lady wrote:

I ran into HSA over contribution issue this year when doing tax for 2022, realizing that I did not follow the last-month rule for 2021. For the option of emptying out HSA account, do I have to make qualified distribution for all the remaining HSA balance, or the balance after taking out 2021's over contribution chunk? 

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The last month rule is special and does not follow the usual rules for making excess contributions.  You may be getting the wrong information because you are posting to an old discussion that was started by someone who had old excess contributions that were for other reasons, not the last month rule.

The consequences of failing to meet the testing period for the last month rule are much simpler.  No withdrawals are required.  Any amounts you contributed in 2021 that are not eligible (because you failed the testing period) are added to your taxable income for 2022, and assessed a 10% penalty.  You can't waive the penalty by making withdrawals, but you are not forced to make withdrawals, and the money is not subject to the ongoing 6% penalty that attaches to excess contributions made for other reasons.

Separately, if you made excess contributions for 2022, you need to remove them before the tax filing deadline or pay income tax plus a 6% penalty.

https://www.irs.gov/pub/irs-pdf/p969.pdf

If you fail to remain an eligible individual during the test- ing period, for reasons other than death or becoming disa- bled, you will have to include in income the total contribu- tions 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.

[Log_Lady]

Thank you so much for your detailed response. I was trying to search for an answer when I saw this discussion and thought it's the same as my situation. It made me think the over-contribution due to failing last-month rule is subject to this year's penalty (10%+income tax) plus future years' (ongoing 6%+income tax). It's a relief to know at least I don't need to make non-qualified withdraw or empty out my HSA account to avoid future penalties. So many tax details when trying to save a little bit of money on medical expenses with HSA. 

[Opus 17]

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@Log_Lady wrote:

Thank you so much for your detailed response. I was trying to search for an answer when I saw this discussion and thought it's the same as my situation. It made me think the over-contribution due to failing last-month rule is subject to this year's penalty (10%+income tax) plus future years' (ongoing 6%+income tax). It's a relief to know at least I don't need to make non-qualified withdraw or empty out my HSA account to avoid future penalties. So many tax details when trying to save a little bit of money on medical expenses with HSA. 

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The income tax and 10% penalty for failing the testing period for the last month rule are only reported on form 8889, there is no carryover to form 5329.  So although there is a 10% penalty now, there is no ongoing 6% penalty.  

(Likewise, if you were in a situation where you spent all the money in the account, you still pay the 10% penalty for failing the testing period, even though your balance is zero, because the penalty for failing the testing period is calculated differently than the penalty for making excess contributions.) 

[bnelson7]

Hello,

Can the source for bullet two be sited please. After reading P969 I am not seeing this stated anywhere under excess contributions. Also, if true, this doesn't seem to be a universal rule if the individual is no longer eligible at the time the excess contribution occurred. 

• You can take qualified withdrawals (for medical expenses) that take your HSA balance to $0. The penalty is assessed on the lower of your excess contribution or your HSA balance at the end of the tax year. By drawing the account down to $0, you will have no more penalty assessed.

[BillM223]

This is not in Pub 969, this is on form 5329.

[Line] "49 Additional tax. Enter 6% (0.06) of the smaller of line 48 or the value of your HSAs on December 31, 2022 (including 2022 contributions made in 2023). Include this amount on Schedule 2 (Form 1040), line 8".

So when your HSA balance goes to zero, then this particular penalty also goes to zero. There are other penalties calculated differently.

"Also, if true, this doesn't seem to be a universal rule if the individual is no longer eligible at the time the excess contribution occurred. "

Sorry, this is a very long thread, and I don't know what this refers to. Could you identify the person who posted it and what exactly was said? That is, "what isn't a universal rule?"

[Craig55]

In 2020, I made an excess HSA contribution of $4050. Turbotax generated a 5329 form which charged me the 6% penalty. The $4050 was carried over to 2021 and I was again charged the 6% penalty. Then for my 2022 taxes I expected to see the $4050 carried over again, but it was not. There was no 5329 form generated, no 6% or 20% penalty. It seems the penalty does not go on forever, just two years, according to Turbotax. Am I missing something?

[Opus 17]

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@Craig55 wrote:

In 2020, I made an excess HSA contribution of $4050. Turbotax generated a 5329 form which charged me the 6% penalty. The $4050 was carried over to 2021 and I was again charged the 6% penalty. Then for my 2022 taxes I expected to see the $4050 carried over again, but it was not. There was no 5329 form generated, no 6% or 20% penalty. It seems the penalty does not go on forever, just two years, according to Turbotax. Am I missing something?

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That depends.  Have you spent the account down to zero?  Do you have HSA eligibility that allowed you to use up the excess?  For example, if you were eligible in 2022 but did not make contributions, that would absorb the excess.  However, it would still show that on form 5329.  It's also possible you started a new Turbotax account by mistake and didn't transfer last year's information.  There are questions about prior year excess during the HSA interview, how did you answer them?  Did you have your 2021 form 5329 available to answer the questions?

Ultimately we can't see your return.  If you had form 5329 in 2021, you would have to also have form 5329 in 2022, unless line 48 from 2021 was zero, indicating you used up or zeroed out the excess in 2021. 

[Craig55]

Thank you, Opus 17, for your detailed reply. Here are the answers to your questions.

Have you spent the account down to zero?

NO

Do you have HSA eligibility that allowed you to use up the excess?

NO I started Medicare in July 2020.

It's also possible you started a new Turbotax account by mistake and didn't transfer last year's information.

NO, I used the same account login ID and password, and it did transfer last year’s information.

There are questions about prior year excess during the HSA interview, how did you answer them?

Did you have your 2021 form 5329 available to answer the questions?

YES

If you had form 5329 in 2021, you would have to also have form 5329 in 2022, unless line 48 from 2021 was zero, indicating you used up or zeroed out the excess in 2021.

2020 Form 5329, Line 48: $4,050  ($8,100 contribution, $4,050 excess)

2021 Form 5329, Line 48: $4,050

2022 Form 5329, Line 48: Form not generated.

Other Info:

I took a 2022 HSA distribution of $5,574 for qualified medical expenses, so the taxable distributions were $0. I thought this might be affecting the excess distribution carry-over so I did a Turbotax experiment changing the $5,574 to 0$. There was no change in the result. Form 5329 was not generated. No 6% or 20% penalty was charged.

I appreciate your help.

[Opus 17]

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@Craig55 wrote:

Thank you, Opus 17, for your detailed reply. Here are the answers to your questions.

Based on your answers, I don't see any reason that you would not have a form 5329.  You may want to contact customer support and have them do a screen share, they can also look at the program internal worksheets.

I will note that once you turn 65, you can withdraw funds for non-medical reasons and only pay income tax and not the 20% penalty, so one way to resolve the excess and avoid the continual 6% penalty will be be withdraw the $4050 excess and not say that it was used for medical expenses.  But even if you did that, you should have a form 5329 that starts with a carryover balance.

@rjs 

@dmertz 

Do you see anything that I missed that would explain the absence of form 5329 for this taxpayer?

[dmertz]

I agree with everything Opus 17 said.

With $4,050 shown on line 48 of your 2021 Form 5329, the only ways for it to no show up on line 42 of your 2022 Form 5329 is if you did not transfer in your 2021 tax file to begin your 2022 tax return, you told 2022 TurboTax that you had no excess shown on line 48 of your 2021 Form 5329 either by changing the value to zero or deleting the entry, or you somehow deleted the entire Carryover Worksheet.  Given that nobody else has reported such a problem, it's unlikely that a TurboTax bug is responsible.

To make the correction, simply tell 2022 TurboTax in the HSA section that you have a $4,050 excess contribution carried in from 2021.

As Opus 17 indicated, the excess contribution and penalty will persist year after year until you either spend the HSA down to zero or you make a taxable (not applied to medical expenses) distribution of $4,050.  The only reason that you might want to delay obtaining that distribution is if you are not yet age 65 but will be age 65 in the next year or two.  A taxable distribution made before you reach age 65 is subject to a 20% extra tax and paying the 6% excess contribution penalty for up to another 3 years would be less than that.

[nanlii]

I’m in the similar boat where I had an excess contribution of $6000 accumulated from 2020 and 2021. Would it work if stopped HSA (family) contributions this year and consider the $6000 (which is within the family limit) as this year’s contribution? So this way I don’t need to pay the 20% penalty for non-qualified distribution.

[dmertz]

Yes, that works if you are eligible to contribute that $6,000 to an HSA for 2022.

[nanlii]

Eligible as in I’m eligible for a HSA account this year? Yes, I’m and have updated my company health plan to stopped contributing it.